Goldilocks and the 3 Bears - A Financial Fairy Tale - Part 1 GFH

Only One Bear Had the Right Meal for Goldilocks

In an earlier post I noted that the disappointing FY 2019 performance of the Goldilocks Fund—a loss of 7% for the year—didn’t explain the rather large drop in cumulative performance since inception (July 2015) from 219% for the first ten months of 2018 to 134% for 2019.

And promised to take a closer look at what happened with a series of three posts on Goldilocks and the Three Bears.

The three bears in this tale are: GFH Financial Group, Noble Group, and Dana Gas.

We’ll start with the first.

Before we do, a few words on methodology. I’ll begin by reviewing the history of Goldilocks investment in each “bear”.

Then I’ll compute the return to actual exit or if the fund still holds the asset until a current date.

Afterwards I’ll look to allocate the loss or gain over fiscal years.

On 8 January 2018, Goldilocks announced it had taken an approximate 4.99% stake in GFH a Bahrain-based Islamic financial institution that has been struggling for some years. An appropriate target for Goldilocks to work its constructionist magic as abundant posts on this blog indicate.

As of 31 December 2017, GFH had 3,681,650,441 shares issued and outstanding. Goldilocks actually appears to have acquired a 4.987% stake or 183,612,310 shares.

At a rough estimate of trading prices around that time of USD 0.42 per share that’s USD 77,117,170.

But how did it acquire these shares?

With GFH’s trading volumes a purchase of this sort even over a prolonged period would likely increase the entry price.

Situations like this are what friends are for!

From an analysis of disclosures in the equity notes in GFH’s annual financial reports, it appears that Goldilocks bought its shares from ADFG/IC.

According to GFH’s 2016 audited annual report, at year end, Integrated Capital held some 13.38% of GFH’s shares. One year in GFH’s 2017 audited annual report, it held 8.01%. 

Supporting a purchase from ADFG/IC is a record of an insider trade on Mubasher by Integrated Capital on 7 January selling 243,377,750 shares at USD 0.40 per share. 

Using that price, Goldilocks’ entry cost would be USD 73,444,924.

We’ll use this as the assumed entry price.

There’s no explanation who bought the 59,765,440 in additional shares sold. Sold to ADFG or “sold” to a lender to secure financing?

So how did GFH make out on its investment? GFH basically exited GFH in 2020.

On 22 January 2020, as part of a clarification regarding AlHilal Bank’s 5.3% shareholding, GFH revealed that Goldilocks held only 0.39% of its shares. It also noted that the ADFG/IC group and related parties held 9.69% of GFH’s shares. 

For those who follow AFDG/IC note that Reem Finance is listed as a related party in the announcement.

So Goldilocks must have sold its shares to a party or parties considered to be outside the ADFG/IC “group”. 

Assuming that GFH is not tardy in reporting significant changes in major shareholders’ and related parties’ holding of its shares, we can assume that purchase took place in December 2019 and early January 2020.

Let’s assume 1 December 2019 through 22 January 2020.

Looking over daily trading records at the DFM for GFH, this sale does not appear to have taken place on the DFM.

That’s also supported by the fact that the total value of GFH stock traded during the period was some USD 78.4 million equivalent over 3,622 trades.

Why look at the DFM?

Because roughly 74% of GFH’s shares are held and traded there.

What that probably means is that the shares were sold to another investor or investors “off the market” in a single or several “large ticket” transactions. 

AA will be looking at disclosures in GFH’s FY 2019 audited financials to see what information we can glean on who the new shareholder(s) are. Distribution of share ownership in the equity note and any disclosures about major shareholders.

Not by any means an easy task. In conformity with local regulations GFH only reports details on shareholders with 5% or more.

Because Goldilocks sold roughly 4.6% of GFH’s shares unless that shareholder already had holdings of 0.4% we’re not likely to learn its identity.

Let’s turn to the more important question, How did Goldilocks fare on its investment in GFH?

First, let’s estimate Goldilocks exit price.

The average price of GFH stock on the DFM between 1 December 2019 and 22 January was USD 0.2332 (based on DFM closing price data during the period). 

2017 and 2018 cash dividends (paid in 2018 and 2019) add another USD 0.0311 per share so total realized is USD 0.2633.

Based on AA’s assumptions (note that word), Goldilocks bought at USD 0.40 a share and sold at USD 0.263 a share. On its original investment of 183,612,310 shares, it lost USD 0.137 per share or USD 25.2 million. That includes the unrealized loss on shares it didn’t sell (the 0.39%).

Also during 2019 Goldilocks received roughly 10,373,577 in bonus shares which at current values are worth some USD 2.4 million.

That means its loss on the GFH investment is about USD 23 million. Or roughly 31%

This assumes that the above price assumptions are reasonably correct. It also assumes that Goldilocks did not have a price guarantee or favorable put option from IC.

Let’s now allocate that performance over FY 2018 and 2019. Essentially that consists of two allocations: one for dividends (cash and stock) and another for mark-to-market.

As you’ll see from the chart below, the loss was essentially booked in FY 2018 with dividends offsetting further mark-to-market losses.

Goldilocks Investment Returns in GFH
Millions of US Dollars (except share price)
			Dividends
Date	Price	MTM	Cash	Stock	TOTAL
08Jan18	$0.40
31Dec18	$0.25	-$27.5	$4.2	$0.0	-$23.3
31Dec19	$0.23	-$3.7	$1.5	$2.4	$0.2
20Jan20	$0.23	$0.0	$0.0	$0.0	$0.0
TOTAL		-$31.2	$5.7	$2.4	-$23.1

Dramatic Fall in Goldilocks Investment Fund Performance in 2019

Once Shorn Is She Still Goldilocks?

After more than a year of total radio silence on its website, Goldilocks published a press release on its 2019 performance.

No surprises here that the news wasn't good. When a fund stops publishing glowing reports about acquisitions and realisations you don’t need to be Warren Buffet to figure out that things are not going well.

For FY 2019 the fund had a negative 7% return.

On the bright side, Goldilocks noted that its cumulative return since inception in July 2015 was 134%.

That sounds very good until one looks at earlier cumulative returns.

If I’m not mistaken, Goldilocks used to publish its return history on its website. Today for some reason I couldn’t find that information there.

But there are other sources.

On 12 February 2017 ADFG won the “Best UAE Equity Fund” award for its Goldilocks fund at the MENA Fund Manager Performance Awards 2017. According to the news article on WAM, Goldilocks had an “absolute” return of 226% in FY 2016 and its cumulative return since inception was 384%.

ADFG’s website shows a cumulative return through October 2018 for the fund of 219%.

Now if you're like AA, you might wonder why performance for the full year wasn't given.  Another sign that all is not well.

From the change from FY 2017 to FY 2019 in cumulative returns and the relatively small negative performance in FY 2019, you don't need a PhD in math or finance to figure out that FY 2018 must have been a dreadful year.

I suppose the thought was to let 2018 quietly slip into the memory hole and hope no one would notice.

Some of this stuff is just so laughably transparent as well as sad.

So to recap cumulative returns since inception:

1. 2016 - 384%
2. 2018 - 219%. But only 10 months.
3. 2019 - 134%.

In that context not so good.  A rather disappointing trend. 

And if an investor bought say in 2017 or 2018 (when the price was high), the cumulative returns would be much lower.

In the coming days, I’ll publish a series of three posts under the title: “Goldilocks and the Three Bears – A Financial Fairy Tale”.

Dana Gas: FYE 2018 and 1Q2019 Financial Performance - A Brighter Picture But Not by Much

A 5 Watt Bulb is Brighter than 2 Watts

Last December I made a bold prediction based on DG’s 3Q18 financials that the company would have a break-even year or at best case perhaps earn a 4.5% ROAE.  

DG’s 2018 financials  (but not its glossy annual report) have been released. 

Let’s take a look and see how prescient AA’s prediction was.  

Net income for 2018 is what might charitably be described as “disappointing”, a net loss of USD 186 million driven by impairment provisions of USD 250 million.  USD 187 million for the write-off of the Zora field and USD 59 million for certain Egyptian assets (or perhaps uncertain Egyptian assets).  

Pretty far off from AA’s less than less than "prescient" prediction a scant five months ago.  

In the MD&A section of the report DG’s Directors emphasize that the 2018 impairment provisions were “non-cash items” and that “On a like for like basis, excluding one off impairments, profit from core operations increased to USD 64 million (AED 234 million) as compared with USD 5 million (AED 18 million) in 2017".  

On that basis, DG earned an ROAE of some 2.35% using total shareholders’ equity as reported on the balance sheet.  If we adjust 2018 equity for the non-cash impairment that year (add it back) then ROAE is 2.27%. 

In the Directors’ “best” case, a dismal return.  

Certainly well below the risk-adjusted return DG should be earning given its business concentration in risky markets.  Equally well below the return it should be earning ignoring risk.  

However, the picture in 1Q19 is brighter, but only marginally in an absolute sense.  

Net income of USD 35 million, largely driven by a USD 10 million reduction in interest expense.   If this pattern continues, projected ROAE for 2019 is some 5.3% much better than 2018.  

But still subpar for the risk.  No longer pitch dark.  But a 5 watt bulb is cold comfort.  

There was other good news.  

Continued reasonably good collection of receivables from Kurdistan.  

A less favorable 70% collection rate in Egypt, including some receipts in Egyptian pounds.  A less than happy approximate USD 9 million increase in Egyptian receivables.  Both factors –accepting funny money (Egyptian) and increasing receivables --something to keep an eye on.  

DG also reported that it and Pearl had prevailed in their arbitration (LCIA) with MOL over the KRIG settlement. 

So is DG out of the woods?  

Not quite yet.  

While better than 2018, the projected ROAE is still not at a level that a company with this risk pattern should be earning.  

One quarter does not a turnaround make.   

More importantly the factor driving the turnaround is financial not operational.  The current interest charge is based on a non-market rate.  Once the company has to borrow at market rates again, this financing advantage will disappear.  And financing will be important if DG is to materially grow its business.  

With an approximate 5% ROAE, there will also be little opportunity to use financial leverage to increase shareholders returns materially.  And, if lenders demand more than the ROAE, leverage will actually diminish ROAE.

There's a real negative on the operational side: the write-off of Zora.  It was DG's one revenue stream from a creditworthy country. Admittedly small, but perhaps with a potential to grow.

There's also another cloud on the horizon.  

DG is looking at a roughly USD 400 million principal payment on the sukuk in October 2020 some 17 months from now.  

With USD 442 million in cash as of 1Q19, an almost certain USD 95.5 million dividend this year and one next year which is likely to be approved and paid prior to repayment date, there’s little margin for error. 

The sukuk lenders/investors did not or could not impose any real control on DG's payment of dividends.  They agreed that DG could pay dividends equal to 5.5% of paid-in- equity on the condition that after such payment, DG would have cash of at least USD 100 million.  And they did this knowing the repayment due in October next year was going to be a multiple of USD 100 million.  Roughly 4 times.

If DG is able to honor the repayment obligation in full, and that’s not certain, it could be left with little cash for its business.  

In such a case it’s hard to imagine investors and lenders rushing to support DG, but then they (lenders and investors) routinely demonstrate little common sense in their underwriting. 

So the future while brighter (5 watts instead of 2 watts) isn't bright enough to lift DG from the dog investment category.

Dana Gas 1Q18 Earnings - No Sign of Change in DG's Prospects

"Looks Like the Runway's Too Short Even with Jet Engines"

DG reported net income of USD 14 million equivalent for the First Quarter of 2018. 

On an annual basis, that’s an ROE of roughly 1.9% based on the very simple assumption that each following quarter will have the same NI of USD 14 million and that equity will increase by the same amount.  

However, as the Company’s directors noted in their report, 1Q18 income benefited from a USD 13 million reversal its share of accrued operating costs at Pearl Petroleum no longer needed because of the settlement with the KRG.  Thus, 1Q18 operations generated a pathetic USD 1 million in net income.  Annualizing that amount results in net income of USD 4 million for 2018 and a projected ROE of 0.15%.  

DG is likely to do better than either of these scenarios.  

But it’s hard to see it reaching an ROE commensurate with its risk profile or performance robust enough for thinking creditors.  

The settlement with creditors will result in interest expense for 2018 between USD 23.3 million and USD 25.7 million, depending on the take-up of Tranche A.  Calculated as (a) USD 700 million for the first 7 months of the year at 4% and (b) either USD 420 million (full take up of Tranche A) or USD 560 million (no take up of Tranche A) for the last 5 months of the year at 4%.  When compared to 2017’s USD 66 million, this is a “savings” of roughly USD 40 million to USD 43 million.     

The Company will also benefit from the reversal of two months of interest accrued in 2017 on USD 700 million or roughly USD 5.8 million.  This represents the difference between 9% and the negotiated 4% which is retroactively effective as of 1 November 2017 based on the draft restructuring terms.  

In my post on 2017 net income I made the case that if one deducted non-operating items DG’s reported net income of USD 83 million was actually a loss of USD 57 million.   

Let’s make projections for 2018 based on both 2017 net income as reported and net income as adjusted (by AA) for non-operating one time events.  

If we add an interest “benefit” of USD 50 million (a generous round-up) to 2017 reported net income, 2018’s projected net income is some USD 133 million.  Projected ROE is roughly 4.5% compared to 2.94% for 2017.  An improvement but still well below what I’d consider --and hope you would too--the required return for a company with DG’s risk profile.   

If we look at my calculation of an operating loss of USD 57 million for 2017, and are a bit more generous on the interest benefit (USD 57 million), then on an operating basis DG breaks even in 2018.    

Neither scenario should be comforting to equity holders.  

Creditors thinking of Tranche B may want to “think again” particularly as the restructuring and proposed dividends are likely to significantly reduce DG’s cash this year. 

Dana Gas Sukuk First Look at Restructuring Terms

Dr. Arqala Will See You Now

On 5 June Dana Gas reported progress in reaching an agreement with 93.69% of its sukukholders for a “consensual” restructuring.  Later this month DG will be seeking shareholder agreement to the deal which was outlined in a 13 May press release.  

AA has just resurfaced after an intensive several months of work (not every investment turns out well) so initially missed the 13 May press release. 

While fully detailed terms haven’t been released yet, let’s take a first look at what we know. 

The USD 700 million sukuk which matured in October 2017 will be restructured in two tranches.  

Tranche A – Early Exit Option 

Up to a maximum of 25% of the face amount of the existing USD 700 million sukuk (USD 175 million) will be offered for immediate payment at 90.5% of the face amount of the sukuk.  Those responding within 7 days of the formal offer (“early election”) will receive an additional 2.5% flat of the face amount or a total of 93%.   No interest will be paid.  

Assuming a 31 July conclusion of the deal (roughly DG’s target date) and full take-up of the USD 175 million Tranche A, some USD 13.1 million in interest will be due-- 6 months at 9% and 9 months at 4% (the new “profit” rate) because DG’s last interest payment appears to have been made in April 2017.    

Including the “to-be-lost” interest in the calculation results in an effective discount of the total amount owed to holders of 15.8% or, if the early election is made, 13.5%. 

Tranche B – 3 Year Sukuk Maturing 31 October 2020  

The sukuk will have a three-year tenor starting from 31 October 2017 – the maturity of the existing sukuk.  It will be structured as a “wakala” with underlying “ijara” / “deferred sale” obligations.  

The new “profit rate” will be 4% per annum. 

Holders who make an early election to enter the deal will receive a similar 2.5% flat fee of the face amount of their tendered sukuks. 

DG will make an upfront payment of 20% of the face value of the existing instrument allocated to Tranche B (75% of USD 700 = USD 525).  This will result in a new sukuk with a face amount of USD 420 million. 

The terms call for a prepayment of 20% of the face amount of the existing sukuk (USD 105 million) within the first two years, i.e. no later than 31 October 2019.  That will reduce the sukuk to USD 315 million.  If DG does not make the prepayment within the specified time, the profit rate will increase to 6% per annum.  

DG will be allowed to pay dividends up to 5.5% of the paid in capital of DG (USD 1.9 billion equivalent) or roughly USD 105 million per year, subject to a minimum liquidity requirement of USD 100 million.  The dividend allowance is not tied to actual cashflow. 

All net free cash proceeds from the results of the NIOC arbitration and sale, if any, of Egyptian assets for repayment of the Sukuk.  There are also provisions relating to the buyback of the new sukuk under certain circumstances.  Not particularly clear, but then this is a summary.  

DG’s May 2018 Corporate Presentation appears to provide some additional information on this latter topic. Comments on page 5 state that, if Tranche A is not fully taken up, DG will use the remaining amounts allocated to Tranche A to buyback new sukuk at the market price within 9 months of closing of the restructuring.  If there is insufficient offer, then DG will prepay sukukholders pro-rata at par.   From the wording it seems that when the May report was issued, no deal had been struck with sukukholders. So these terms may not have been modified.   

Danagaz WLL has apparently been removed from the security package, perhaps compensated with the above. 

Comments 

Better Structure: Shorter tenor, more periodic amortization, additional “collateral”. 

You’ll recall, and if you don’t AA will remind you, that very early on AA wrote that the sukukholders needed to shorten the tenor (from five years), obtain interim principal repayments (no bullet structure) and secure more collateral.  To an extent that seems to have occurred.  To be very clear, AA is not claiming any credit for this outcome.  The sukukholders’ advisors don’t need AA to tell them the obvious.  

Reaching agreement is like some telephone calls with President Macron.  One doesn’t know all the details or what the course of negotiations was.  Like sausage one just has to eat it.  No doubt the case here.    

But as an outside commentator, AA will exercise his right to highlight things that might be better without the responsibility to make them so. 

Prepayment Failure: Doesn’t trigger acceleration of maturity.  

Failure to make the interim prepayment does not appear to constitute an event of default that allows acceleration of the sukuk.  Ideally it should be particularly given this issuer. Rather the penalty seems to be only an increase in the interest rate.  Realistically, if the Company can’t pay, a higher interest rate won’t be much deterrence.  

Dividend Payments:  Risks of cash leakage controlled?   

According to the transaction summary, approximately, USD 105 million in dividends can be paid each year—subject to maintenance of the USD 100 million minimum liquidity requirement—because  the dividend “allowance” is based on USD 1.9 billion in paid-in-capital at a 5.5% rate.  It is not tied to DG’s cash generation which would be preferable from a creditor standpoint, i.e., dividends tied to new cash generation.  

We don’t have sufficient details about the minimum liquidity requirement to know if it protects against leakage of cash needed to repay principal via dividends.    

The key issues are that DG's ability to generate cashflow from operations has been volatile, there are operating issues in Egypt and the UAE, much of its USD 636 million in cash as of 1Q18 will be expended on the restructuring, and the dividend allowance on its face appears overly generous.   

Over the past five years DG’s cashflow (defined as the net change in cash on the Statement of Cashflows adjusted to remove non-operating cash receipts–the sale of 5% of Pearl to RWE, the RWE dividend, the KRG/Pearl settlement, new borrowings, etc.) has been very volatile, averaging approximately USD 46 million per year.  While future cashflow (2018 forward) will benefit from an approximate USD 50 million a year reduction in interest expense, there seems to be little margin for error, absent asset sales or settlement with NIOC., the timing of which appear uncertain, if they will occur at all.  That’s particularly the case if sizeable dividends are paid.   

At closing of the restructuring, DG will have expended some USD 300 million of its USD 636 million in 1Q18 cash and banks (an amount which excludes USD 140 million earmarked for development of Pearl).  The prepayment on Tranche B will use another USD 105 million, reducing the remaining 1Q18 cash balance to USD 230 million and the sukuk principal to USD 305 million.  

Compounding risks, the final principal payment may be due shortly after the prepayment.  If it’s made on the last day (31 October 2019), only 12 months will remain until final maturity.  

Tranches A and B:  Sukukholders’ interests aligned?

The early exit option and ongoing market buybacks represent a potential preference to some creditors over others.  It will be interesting to learn, if possible, if those institutions that elect early exit were key in negotiating the restructuring.   There is a fundamental conflict of interest between those who are whole dollar creditors and those who acquired their stakes at a discount.  

Which option would you choose? 

So having raised that point, what would AA do if he had been unwise enough to purchase the sukuk?  

Take the early exit for three key reasons.  

First, if one doesn’t trust a potential business partner or issuer, one simply doesn’t do business with him.  No need for any further analysis.  

Second, if basic legal protections are lacking in a market, you can’t rely on the law to compel your counterparty to comply with the contract or the local courts to execute the judgments of foreign courts.  You are on the high wire without a safety net.  Usually, this is another deal breaker, unless your business puts the burden of risk preponderantly on the counterparty.  For example, you are a seller of investments rather than a buyer.  But is it worth the risk and bother?  

When the Ruler of Dubai created the DIFC, he sent a very clear message about the state of the law and courts in the UAE.  If you weren’t paying attention then, the recent decisions of the Sharjah Court hopefully caught your attention.  

Third, at the issuer level, DG exhibits high operating and credit risks.  Weak performance and a contration in squirrelly markets (that’s a technical term in case you don’t know).  DG has a “rich” history here (but not in the financial sense).  Future prospects do not appear bright.