Dana Gas Restructuring: The “Art” of the Deal

Unconstrained Mirth at the Announcement of an Imagined Successful Negotiation  

Asian analysts are divided on whether the picture is from 13 May or 12 July of this year.  As you’ll recall, Dana Gas announced its “successful” restructuring on the former date, “accretive to all stakeholders”.  On 12 July the conclusion of another allegedly fantastic deal was announced.  By at least one account (Twitter?) this one “irrevocably sealed” with a handshake. 

Early on in its negotiations with creditors, DG adopted a rather pugnacious strategy, reminding AA of the “hit them back harder” strategy advocated in a business book published first in 1987 by a self-proclaimed dealmeister under the same title as this Blogpost. A remarkable coincidence!  Hence, this remark.  

Let’s review how DG was able to apply this “winning” strategy and negotiate a “fantastic” deal with its creditors. 

On 3 May 2017 DG issued a press release stating that it would commence restructuring negotiations with its sukuk holders because its cash flow problems made full repayment of principal on 31 October 2017 impossible as it needed to conserve cash.  

On 17 May 2017 the creditors announced that they hired advisors for the restructuring.  DG announced that it hired its own set of advisors on 5 June. 

Subsequently, on 6 June 2017, in a conference call with sukukholders DG announced a set of principles which it later codified in a 13 June press release:  

1. Illegality:  Due to changes in interpretation of Shari’ah, the existing sukuk was no longer compliant with Shari’ah or UAE law. Consequently, DG in good conscience could not make any payments, including the upcoming profit payments in May and October 2017. 
2. New instrument:  To be Shar’iah compliant.  
3. Tenor:  4 years with bullet repayment.  
4. Profit Distributions (Interest): Less than half of the 9% rate on the sukuk with provision for unspecified amount to be paid in kind (PIK), i.e., additional debt.  
5. Prepayment:  At company’s discretion with no prepayment penalty. Something not usually granted on a fixed rate debt instrument.  

DG also advised that it had asked the eminent courts of Sharjah to rule on the legality of the existing sukuk.  

This was the company’s first offer. Like anyone else negotiating in the suq, including the suq al mal, probably an opening offer intended to start negotiations with the expectation that that final terms would differ.  

In quick order thereafter the company advised that it had obtained restraining orders in Sharjah, the Cayman Islands, (effective 13 June), and the UK (apparently effective June 16) preventing the sukukholders’ agents from taking action against the company to enforce their rights.  Rather quick action given DG’s announcement that it hired advisors on 5 June.  

On 27 July DG advised the sukukholders that its “previously contemplated offer” (apparently the 13 June “proposal”) “is now off the table, and that the Company is pursuing litigation driven outcomes” as per its 31 July press release.        

What happened?   

According to an apologia for DG published by Al-Khaleej newspaper –available on DG’s website--under the title “Dana Gas has, from the outset, been transparent and sought fair solutions for Sukuk holders and has been justified in its actions to protect all of its stakeholders.”  Move over Gulf News you've got a strong competitor in local "journalism".

What rather sad and unprofessional behaviour by the sukukholders forced what was no doubt DG’s reluctant hand?  

In Al-Khaleej’s words:  

”However surprisingly (and unlike previous and normal practice) the committee refused to even meet and instead, in a very unusual and hostile ill-advised step according to Houlihan Lokey, one of the leading international financial advisers specialising in debt restructuring, the Company received threatening letters and a draft default notice that would have greatly harmed both the Company's ability to secure its outstanding cash receivables and realise the value of its enormously valuable assets; and negatively affecting all stakeholders including the Sukuk holders themselves.” 

First, a shout out to the phrase “its enormously valuable assets”.  Those would be the ones that over a rather prolonged period have been unable to generate an acceptable ROA or ROE, even ignoring risk, to say nothing of generating cash in a timely fashion.  

Second, earlier like Al-Khaleej I believed that HL was one of the leading international financial advisers specializing in debt restructurings.  Taking Al-Khaleej’s quote of HL at face value, my opinion has changed. I’m guessing that it’s more likely they were experts in restructuring church and charitable organization debts where more genteel creditor behavior is more likely to be commonplace.  In purely commercial deals creditors can be quite hostile when an obligor announces its inability to pay--an event which highlights the manifest failure of the lenders’ or investors’ underwriting of the deal at inception.   

In general debt restructurings are not pleasant affairs.  AA has been regaled by his elder brother and other equally reliable sources with stories of irate creditors verbally abusing the obligor and its advisors as lacking integrity and business sense, threatening to call a default and “destroy” the borrower.  And generally behaving “shirty”.  

In one case an unsecured creditor threw a rather heavy object at an obligor’s outside advisors when that advisor had the temerity to note that unsecured creditors were lower in legal priority of payment than secured ones.  In another case where an aggressive creditor rejected an initial restructuring proposal with a string of profanities directed at a former senior US government official who had returned to his lawyerly and advisory roots.  

Even more so if the obligor is a serial defaulter as is the case with Dubious Gas.  On top of that the company raised a rather preposterous defense against payment after having promised in the sukuk not to challenge the legality of the instrument.  See  Page 108 "Events of Default" (c) in the Prospectus.  

To add insult to injury DG prepaid other creditors in preference to the sukukholders sometime prior to 11 May.  Some cash is more worthy of preservation that other cash, I suppose.  A reasonable creditor would seem justified in ascribing manifest bad faith to the obligor. 

No wonder the creditors made the threat they did.  More here.  A perhaps rougher elbowed group of creditors would have called default immediately.   

Finally, according to the Al-Khaleej account, the threatening letter was sent on 23 May 2017.  On 6 June the company conducted a conference call with sukuholders.  Not a meeting in person, but a meeting nonetheless.   No doubt the sukukholders were less than enthusiastic about DG’s proposal as would be “normal practice”, especially given DG's less than good faith behaviour outlined above..  

Whatever the case here, subsequently, DG was quick off the mark (especially if advisors were hired on 5 June) with a blitz of legal actions. To boot the eminent courts of Sharjah seemed squarely on its side.  DG had seized the initiative from DG’s creditors.    A providential prepayment of other bank obligations prior to 11 May 2017 reduced the risk of creditor contagion.   

From all the above, it sure looks to AA like DG was preparing to take a hard line well before the 23 May “threat”.  

But DG has more up its sleeve, according to Bloomberg, DG also noted that the assets in the Trust--primarily, the company’s fine Egyptian assets--had dismal returns. DG have well-established track record in this field and were clearly speaking from experience and expertise.  DG noted that if it were to unwind the sukuk ab initio (because of its illegality) and recast the “profit payments” in excess of the assets true return as principal repayments it would then owe the sukukholders only USD 55 million.  On the other hand were it to covert the sukuk to equity in the fine Trust Assets, the sukukholders would owe DG some USD 150 million.  You will perhaps note an apparent contradiction between asserting these fine assets generated minimal returns and a valuation of some USD 850 million.  Such are the mysteries of “Islamic” finance and GCC finance.   For more on DG’s strategy/threat see my post here.  

Given the propensity of the eminent courts of Sharjah to see things DG’s way, including allowing the company to pay a dividend in the midst of a debt restructuring and in contravention of the UK High Court’s ruling, and basically refusing to apply other foreign court decisions on DG, it doesn’t seem unreasonable that they would see things DG’s way on this topic as well.    

One side note, investors who bothered to read the sukuk prospectus would not have been surprised by the actions of the eminent courts of Sharjah.  

Let’s take a look at the fantastic deal that DG secured for itself from an apparent position of strength and a no-nonsense take-no-prisoners approach.   

1. Tenor:  Three years instead of DG’s originally proposed four years.  Commencing from October 31, 2017.  
2. Profit Rate: 4% instead of the company’s 3% rate.  A partial win, but note that the average life of the sukuk has been shortened dramatically by the down payment and promised prepayment, though as structured the latter does not appear to be mandatory. 
3. PIK – No PIK.  
4. Principal Repayment:  No bullet repayment. DG will use USD 385 million of its cash to make a principal payment on signing.  Assuming sukukholders are smart enough to sign up for Tranche A (immediate payout at a discount), the principal amount of the sukuk will be reduced from USD 700 million to USD 420 million, roughly a 36% reduction.  
5. Prepayment:  Another USD 105 million prepayment no later than 31 October 2019, 15 months from anticipated signing in August 2018.  If made, the prepayment will reduce the sukuk to USD 315 million or 55% of the original USD 700 million.  If DG fails to prepay, the profit rate will increase to 6%.  Failure to pay appears not to constitute a default.  
6. Additional Obligations:  Promise to use all net free cash from NIOC settlement or sale of the fine Egyptian assets to buyback sukuk under certain undisclosed terms.  Neither the NIOC settlement nor the proceeds from the sale of the Egyptian assets are collateral.  Both of these are potential but probably not highly probability future events (assets).  A sale of the fine Egyptian assets has probably been harmed by DG’s trash talk about their multi-year disappointing performance not to mention the whiskers on the associated receivables. Recent moves by the USA to apply financial pressure to Iran could reasonably be expected to frustrate an NIOC payment if settlement were reached.  What is notable here though is that DG has accepted an obligation to use the NIOC settlement as a source of prepayment even though it is not part of the Trust Assets.   
7. Dividends:  Ability to pay 5% of paid-in-capital as dividends subject to certain undisclosed minimum cash maintenance requirements.  Potentially a stake into the heart of the sukukholders’ repayment prospects if this is not structured properly.  

It doesn’t seem that DG’s hard-nosed “clever socks” strategy has resulted in any real benefit to the company in terms of the restructuring unless we assume that a less confrontational negotiating style would have resulted in repayment of the full amount upon signing as well as board and senior management members pledging their first born offspring to the sukukholders.  

Not only did DG not get its wishes, but also DG has committed its cash windfall from the KRG settlement to repayment of the sukuk.    

But there’s more. 

Real damage has been done to the company.  

The cash drain is happening at the time when DG asserts it needs cash for needed development of its operations.   DG's clever socks strategy has burned a lot of bridges.  

Existing creditors and potential creditors with half a brain (note that caveat) have probably been alienated; though DG may be able to “bank on” bankers’ and investors’ chronic ADD and the rather large bloc of creditors and investors with little credit skills or sense.  See the Abraaj saga for examples of the latter.  

There is another lesson here.                   

If you’ve found what appears to be a clever business strategy in a book, check out the bona fides of the author before you act.  What is the business track record of the author? Is the author a true "captain of industry"?  Or been involved in serial shipwrecks?  

If you also see the author, even if he or she claims to be a billionaire, hawking steaks, wine, or dubious educational institutions on the TV, it may be a testament to his or her (a) less than stellar track record in business and thus (b) lack of real business acumen.  

After all, how many successful businessmen or women engage in such peripheral activities when they could earn additional billions in their more lucrative mainframe pursuits?  Lloyd Blankfein hasn’t come around to Chez Arqala offering gardening or pool services.  Warren Buffet isn't doing reality TV.

When reality collides that violently with image, it’s probably wise to heavily discount the advice. 

It's also wise to ensure a sound understanding of the correlation of forces.  If conditions are not good, even a "wise" strategy can fail.