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.

El-Erian on Emerging Markets

Sheep Get Sheared Repeatedly

Mohamed El-Erian had an interesting take on the state of markets on 10 July. 

One bon mot that caught AA’s eye is the following (italics are AA’s):   

“When liquidity recedes and global risk aversion increases, the underlying differences in the technical robustness of markets come to the fore. This is particularly the case for emerging markets where the base of dedicated (and more stable) investors is small relative to the more flighty dabbling in the asset class.”

AA would argue that this shortcoming in technical is important at all times, particularly in those markets where free float is more theory than reality.

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. 

 

More Nonsense from Gulf News About the Qatar Crisis

Here’s another gem from the Gulf News re the Qatar crisis under the headline:  “Qatar’s defence of Iran drives further wedge with neighbours”  with the subheading “Comments by defence minister prove Qatar’s arrogant position when it comes to solving year-long crisis”.  

Just what did Qatar’s Defense Minister ("QDM") say to prompt such criticism?  

Let’s read GN's charges.  Words in quotes are verbatim from the GN article cited above. 

First, the Qatari Defense Minister “defended the Iranian nuclear deal despite criticisms from Arab states that the deal has empowered Tehran to wreak havoc in the region.”   

As AA reads the GN’s charge, it’s clear that the QDM did not defend Iran but defended the JCPOA, a position shared with the former President of the United States, Australia, Canada, China, the EU, France, Germany, Ireland, Japan, the Netherlands, Norway, Russia, Sweden, and the UK – all no doubt as arrogant and intransigent as Qatar at least in the eyes of the GN.  Citations here and here.  

Interestingly, neither Kuwait nor Oman have adopted the “Quartet”'s position. 

Also Tehran’s influence/actions in the region pre-date the 2015 JCPOA, e.g., the Huthis seized Sana in 2014, Tehran has been supporting the Syrian Government since before  the JCPOA, and its influence in Iraq also predates the JCPOA.  While JPCOA's negotiations concluded in 2015,  the agreement came into effect in January 2016 (“Implementation Day”). I suppose one, perhaps the GN, would argue that actions before 2015 or 2016 did not consist in wreaking havoc.

Second, the QDM said that “Qatar would not ‘go and fuel a war’ in the region and called for engaging in talks with Iran” and that a war with Iran would be “very dangerous”.  

That seems an eminently sensible position on general terms.   

But for a region that has seen the sad consequences of wars in Iraq, Libya, and Syria a bit more caution on war would seem to be in order.  

Finally there is the lesson of 1967.  If you’re bogged down in a war in Yemen, best to keep your head down with regard to further military adventures, particularly if the potential new adversary’s power is a multiple of the current adversary in Yemen.  

GN had another article earlier "Lack of Wisdom Prolonging Qatar Crisis".  The article referred to above is perhaps an exemplar of the headline.  

Expect more to come as I clear out from under a rather busy past three months.

Dana Gas "Swings" to Profit in 2017

DG Ready for Takeoff The Sky is the Limit

DG announced its FY 2017 results on 15 March.  Net profit was USD 83 million equivalent up from a USD 88 million equivalent loss in 2016. 

Does this mean that DG has turned the proverbial corner and that future results are likely to show similar and perhaps even improved results? 

You might think so reading DG’s earnings press release.   

“The turnaround was led by higher realised liquid prices, higher production in Egypt and tight management of operational expenses. Higher profit was also supported by the successful settlement agreement ('Settlement') with the Kurdistan Regional Government ('KRG'). However, Q4 net profit was impacted by an impairment charge of $34 million (AED 125m) against the UAE Zora asset following the year-end reserve report.”

While admittedly it's too early to state conclusively, as the picture above indicates, AA is not convinced that DG has a smooth flight path to a rosier future. There are some fundamental problems at DG.  It's hard to see these being corrected.  Another cautionary message to the unfortunate existing creditors of DG and to any potential ones.

1. DG’s 2017 Gross Profit was USD 118 million equivalent compared to 2016’s USD 103.  That’s a USD 15 million turnabout or just under 9% of the USD 171 net change between the two years.  So this led the “turnaround” only in the sense of occurring first in the income statement.  Note: Gross Profit = Gross Revenues –Royalties – Operating Costs and Depletion.   The Gross Operating Margin (GOM) in 2017 was some 26.22% versus a slightly higher percentage in 2016.  GOM = Gross Revenues/Gross Profit. 
2. The real “turnaround” occurred in other expenses and income which were a net credit of USD 3 million versus a net debit of USD 58 million in 2016. 

Has DG discovered a magic solution to controlling expenses?  Has its business fundamentally changed, leading to new ongoing "other revenue" stream?  Or has it benefited from one-off events?

If you guessed the latter, you’ve guessed right.  References to notes below are to those in the 2017 FY Audited Financials available here. 

1. DG had USD 26 million in other income (note 7).  Under the agreement with RWE regarding its investment in Pearl Petroleum Ltd, RWE owes DG additional payments when PPL pays a dividend.   PPL paid a dividend as a result of the settlement with the KRG.  Future PPL dividends are likely to be contingent on settlements with Iran’s NIOC.  Probably a low probability event. 
2. DG benefited from a USD 114 million reversal of Surplus over Entitlement (note 29) again resulting from the settlement with the KRG. 
3. These two items aggregate some USD 140 million in credits that are unlikely to recur.  Adjusting for these, 2017 results would be a net loss of some USD 57 million.  Income tax expense (note 9) appears related solely to DG’s Egyptian operations and so would not change based on these adjustments. 
4. One interesting side note – DG appears to have accrued interest on the sukuk at contractual rates for the full year – some USD 67 million.  Though as the Statement of Cash Flows shows the Company only paid total interest of USD 32 million out of the USD 71 million accrued. 

On that basis, DG has not turned the corner. 

1. With the recorded USD 83 million in 2017 net income, DG earned a whopping 2.9% on equity. More cellar than stellar. 
2. Assuming 10% is the minimum appropriate rate for the risk of this company (Disclosure: AA thinks it should be higher but doesn’t want to pile on DG) and that other expenses are roughly USD 100 million a year, DG has to earn net operating revenues of USD 382 million. If ongoing other revenue streams of this magnitude are not likely, then DG has to increase its net operating profit.
3. Assuming the 26% GOM would hold (and it probably wouldn’t given higher production), DG would have earn gross revenues of roughly USD 1.469 billion or 3.3x 2017 gross revenues. 
4. Alternatively, without a change in gross revenue, DG’s GOM would have to be roughly 85% which is almost certain not to happen.  If gross revenues were doubled, the GOM would have to reach 42% - another level that seems less than attainable.

Other Information in DG’s Financials

What else did we learn from DG’s FY 2017 annual report? 

1. Of the USD 1 billion KRG settlement, DG received USD 350 million of which USD 140 million is restricted for investments to increase production in the KRI. DG is able to utilize that amount for other purposes if it can raise financing.  Imprudent or uninformed is the financial institution that would lend to this discredited (that’s a partial pun) borrower for a venture in what might charitably be described as a squirrelly market.
2. Some (a) USD 695 million in be-whiskered KRG trade receivables and (b) interest due on them which had been deducted from Surplus over Entitlement have been “discharged”.  The KRG no longer is legally obliged to unconditionally pay these amounts.  Rather they have been transformed into additions to “petroleum cost” carried under “property, plant, and equipment”.  Under its concession agreement with the KRG, PPL has the right to recover certain costs of investment in the KRG from future production. If there is insufficient future production or none at all, the amount is lost.  If recovery of these costs requires an extended period, then the present value of the amounts recovered will be less than the amounts booked.  And it appears that unlike the trade receivables, PPL and thus DG have no right to interest on the unpaid amount.  In short, as part of the settlement PPL has transformed a sum certain debt payment into a contingent payment the amount and timing of which is uncertain with no protection by way of interest accrual.  On the other hand, as a practical matter this may have been the only way to “collect” this debt. 
3. The woes at Zora continue.  2017 production is 39% down from 2016.  The Company also assesses that “At present it is unlikely that further well interventions can be economically justified …” Financials page 5. 

Quibbles

As usual with AA, he just can’t resist a technical quibble.  Or two. 

1. In its FYE 2017 Financials, DG observes that its 2017 net income of USD 83 million represents a 194% turnaround from the 2016 loss of USD 88 million.  That’s an interesting calculation.  If, for example, DG earned USD 1 million in 2016 and USD 83 million in 2017, then the net change would have been an impressive 82 times or 8200%.  But going from a loss of USD 88 million in 2016 to USD 83 million in 2017 is only 194%!  Trust this is an outlier error in DG's financial calculations.
2. In commenting on DG’s 2017 results AA’s favorite GCC financial newspaper apparently misread the quote above from DG’s press release causing GN to say that “Revenues of the company went up to $450 million in 2017, from $392 million a year earlier due to higher oil prices, increase in production in Egypt and tight management of operational expenses, the company said on Thursday.”   DG’s quote referred to net income not gross revenues which are before any expenses.

Thoughts on "Thoughts and Prayers"

There has been significant adverse reaction from some quarters to politicians stating that their "thoughts and prayers" are with the people of Parkland, Florida.  They have been accused of dodging responsibility to do something to prevent events of this sort from happening by hiding behind pious words.

But what if instead of denigrating this approach, we were to react positively and apply it to other situations?

As an alternative to passing a tax cut and reducing spending on the average citizen, we could tell the affluent and big corporations that our "thoughts and prayers are with them" and do nothing more.  

Saudi Arabia: Value of AlSanea Group Debt Surges 67% to 200%

Beatrice and Benedict Discuss the Value Surge

1 February Thompson Reuters reported that following recent reported efforts by the KSA Government to “step up its efforts” to resolve the Ahmad Hamad Al Gosaibi/Maan al Sanea USD 22 billion or so debt dispute: 

“In a sign that some creditors are now more optimistic there will be a positive outcome to the debt dispute, Saad Group’s debt has been trading up at 3 to 5 cents on the dollar in recent weeks, compared to 1 to 3 cents previously, bankers say.”

In percentage terms that's quite a movement.  Not so much in absolute amounts.

AA would guess that these now more optimistic creditors are the same ones who made the original loans to AlAwal and TIBC.  Or would have if they had had the chance. 

For some of those earlier “great moments” in banking you can refer to the posts right here on SAM, e.g., AlAhli Bank Kuwait letters of credit, Mashreq Bank’s split value FX deals, and many more.  Here. Or here.  Name lending combined with what some might rightly consider unsound banking practices.  Talk about compounding errors!

Those less charitable than AA might also make a comment about the extent of the “step up” by the KSA Government of its efforts.  After all, it’s only been a scant 8 years 10 months. 

No surprise that when there’s good news, there’s always some naysayer like AA who refuses to acknowledge it or see the upside potential.  Saudi investment banking fee riches is yet another example. 

“But some investors remain skeptical. A hedge fund trader who had been considering buying Saudi debt described the attempts by Saad’s advisers to resolve the issue with creditors as a “dog and pony show” and said “very little” work had been done to reach a settlement since November." 

Note that the anonymous hedge fund trader quoted above would be purchasing the paper at a deep discount.  Unlike the original lenders who have been well and truly skinned, he could still make a profit even if final settlement were at a 8% recovery level.  Yet, he still doesn’t find it attractive. 

Why is that?

As AHAB/AlSanea and REDEC have well demonstrated, generally KSA prefers (in the technical legal sense of a preference) domestic over foreign lenders. SAMA take good care of their banks. Foreign banks not so much. 

If that weren’t enough, the Saudi courts and legal system generate “uncertain” outcomes (euphemism of this post).  Hapless foreign creditors are more likely to get “shaken down” than to get a “fair shake”.  Or is that shaykh?  To be fair KSA is not alone in the region.  One need  look no further than Dana Gas in the UAE.