Dana Gas: Creditors Negotiating With Themselves?

The Chicago Way But Not Milton Friedman's Way

As reported by Bloomberg, DG’s tragically unfortunate creditors made DG an offer to restructure the approximate USD 700 million of outstanding sukuk with the following terms:

1. An upfront repayment of USD 300 million (par value) in principal.
2. A maturity extension of three years. 
3. Maintenance of the existing interest rates:  7% on the exchangeable sukuk and 9% on the ordinary sukuk. 
4. A request for a dual listing of DG shares on the London Stock Exchange. 
5. Maintenance of the existing conversion price at AED 0.75 for the exchangeable sukuk. 
6. Payment of interest amounts due last July and this October. 

DG rejected the offer and is said to be pursuing a litigation-based strategy. Bloomberg cited an unnamed party not authorized to speak on DG’s behalf.  The FT was more categorical that the company had rejected the offer.  FT article here. 

Some comments. 

AA wonders about the creditors’ negotiating strategy.  In Middle Eastern carpet stores, the seller’s initial price is a long way from the price at which he sells.  The prospective buyer needs to have a similar negotiating strategy.  Once the buyer begins negotiations and gives his first price, it's hard to go lower. 

But DG’s creditors face a more complicated situation that buying a rug from a reputable merchant.  DG has adopted an extreme position.  Its current “offer” to the creditors is (a) you owe us money or (b) in worst case we owe you no more than USD 60 million.   

That’s what Herb Cohen would describe as a “Soviet” negotiating strategy.   The appropriate response is not to make a typical counteroffer and then split the difference because the Soviet tactic moves the frame of reference way off market terms.  

Often the counterparty (the party not adopting the Soviet style tactic) proceeds as though it’s in a “normal” negotiation, replies with a counteroffer to the extreme offer, and winds up in effect negotiating with itself to its detriment. 

DG’s creditors need to be very careful not to embark on that path. 

They’ve made an offer (their first price in rug shop terms) from which they will most likely negotiate less favorable (to themselves) terms.  So what does that mean?  A five year tenor?  A USD 100 million principal payment?  An interest rate of 3%?  All of the above. 

A Jimmy Malone (pictured above) strategy seems to be more appropriate given DG’s negotiating strategy and its less than sterling behaviour.  When you’re negotiating with someone you don’t trust, the typical rules of negotiation go out the door.  There’s no “win-win” when the other party is trying to cheat you.  

One other bit of unsolicited advice for creditors: a single word “amortization”. 

No doubt some clever mind has stated that with a three year instead of a five year tenor the average life of the sukuk has been drastically reduced – 5 to 3 years.  But –a rather large but—a bullet is a bullet.  Payment is promised in one lump sum in the future. Creditors would be better off with recurring principal payments (amortization).  Money in the hand now is much more valuable than a promise of money in the future, particularly when the integrity/ethics of the party making the promise to pay are doubtful. 

AA was particularly intrigued by the creditors’ request for a dual listing on the LSE. 

Listing this mutt on the LSE is not going to turn it into a purebred. Or magically create investor demand.  The dumb money is already present.  

Is this an attempt to try and force better corporate governance on DG or somehow bind them closer to English law?   Corporate governance is fundamentally a people issue.  Listing on the LSE doesn’t by itself change that.   Unless DG reincorporates, it is a Sharjah company with all the drawbacks of UAE law. 

Is this an attempt to scare shareholders that the creditors intend to convert the sukuk and take some or all of this “gem” of an investment from their hands, thus, prompting shareholders to put pressure on DG’s board to be more accommodative?  Not bloody likely, the shareholders are a disparate group.  From ADX trading statistics, they appear to be primarily retail investors who no doubt are right now calculating how they will spend their share of the USD 1 billion they imagine will soon be in DG’s hands. The major shareholder is a related party no doubt on board with DG’s “clever socks” strategy. 

To AA’s surprise Goldmine and Blackrock are apparently holders of DG paper.  Unless they bought their stakes at a deep discount and have a reasonable prospect of turning a profit with a fractional return of nominal principal, they should not be DG investors. 

Side note: If they purchased their stakes at a discount, then “whole” dollar creditors should understand there is a fundamental conflict between their own full price interests and  creditors whose entry price is much less. 

In defense of Goldmine and Blackrock, you might be inclined to remind AA about the role of risky securities in a well-diversified portfolio. 

AA is well-schooled in how such a portfolio can tolerate some risky securities.  DG paper certainly falls into that category.  The promised return is tempting, particularly in the current low rate environment.  But there are some risks that one shouldn’t take.  Or if one mistakenly takes them, one should exit.  Despite widespread belief to the contrary, finance theory doesn’t magically protect one from unwise investment decisions. 

Some of the "red" flags on this paper.

1. This company defaulted five years ago. 
2. Since then, its performance (ROE and ROA) and cash generation are dismal -- clear signs of likely future inability to repay. 
3. The sukuk is structured as a bullet which is not appropriate for an issuer like DG nor one that operates in squirrely markets (that’s a technical finance term). 
4. If that weren’t enough, DG is based in a country whose fine legal system motivated the government of one of its constituent emirates to set up an offshore regime, including offshore laws and an offshore court system.  It doesn’t take a law degree to figure out that legal protections for creditors are uncertain (you knew I’d slip a euphemism in somewhere) in DG’s home “court”. 
5. Exacerbating that factor, the deal is highly structured with cross-jurisdictional legal issues abounding.  The fundamental (“Islamic”) structure is not well tested in courts.  Courts in more “certain” legal jurisdictions are unfamiliar with Shari’ah and likely to defer to local courts, undermining to some extent the benefits cross-jurisdictional legal structuring was designed to confer. 

Just one or two of these factors should disqualify this paper. But all of these? One can surely find other high yield securities with less risk baggage.   

One further point for those who read the FT article cited above.  To get more insight into the KRG settlement take a look at my earlier post. And don't miss the posts in reply.  Despite a comment in the FT article about the settlement removing DG’s “ability to pay” defense, cash is not about to rain down on DG.    

Dana Gas: Comments on KRG Settlement

Unless you’ve been asleep you’ve already read about the settlement between the Kurdistan Regional Government and Pearl Petroleum announced on 30 August by Dana Gas. 

Most of the headlines focused on the USD 1 billion payment by the KRG to Pearl Petroleum and did not discuss other aspects of the transaction.  The market reacted with characteristic irrational exuberance. Hence this post.

To start a side comment. In a rather bizarre but not uncharacteristic move, DG did not confirm PPL’s receipt of the payment until 5 September after receiving “numerous market enquiries”.  Apparently, neither DG’s crack investor relations staff nor its management thought that there were parties who would be interested in knowing for certain that the KRG actually made the payment.

Not a particularly “brilliant” move to sit on such critical and positive news but sadly par for the course at DG.  Or as AA’s brother no doubt would have it, “shelled another dolly.” 

Here’s an extract from the joint KRG/PPL press release published by Dana Gas.

The agreed settlement highlights are as follows:

1. The KRG will immediately pay Pearl (PPL) a sum of US$600 million.
2. The KRG will also immediately pay Pearl a further US$400 million to be dedicated for investment exclusively for the aforesaid further development to substantially increase production.
3. Pearl will increase gas production at Khor Mor by 500 MMscf/day, a 160% increase on the current level of production (the "Additional Gas"). The Additional Gas, together with significant additional amounts of condensate, is expected to begin production in approximately two years.
4. The balance of sums awarded by the Tribunal ($1,239 million) is no longer a debt owed by the KRG and will be reclassified as outstanding cost recoverable by Pearl from future revenues generated from the HoA areas.  The profit share allocated to Pearl from future revenues generated from the HoA areas are adjusted upwards to a level similar to the overall profit levels normally offered to IOCs under the KRG's Production Sharing Contracts. This adjustment reflects the larger investment risks and costs involved in the development of natural gas resources compared to oil developments. After the recovery of costs and a return on investment by the Consortium, 78% of revenues generated from the HoA areas will be for the account of the KRG, and 22% for the account of Pearl.  
5. The Parties have clarified the Khor Mor block boundary coordinates and the KRG has awarded the Consortium investment opportunities in the adjacent blocks 19 and 20, and added these to the HoA areas, with commitments by the Consortium to make appraisal investments on these blocks, and developments if commercial oil and gas resources are found.  The KRG will purchase 50% of the Additional Gas on agreed terms to boost the gas supply to power generation plants in the Kurdistan Region.  The other 50% of the Additional Gas (250 mmscf/d) will be marketed and sold by Pearl to customers within Iraq or by export, or can be sold to the KRG as well to further boost power generation within Iraq.
6. Pearl will also expand its local training and employment programs towards achieving maximum localization and content, as well as supporting local communities through its active Corporate Social Responsibility (CSR) programmes.
7. The Parties have exchanged mutual releases, waivers, and discharges in relation to all claims in relation to the Arbitration and related court proceedings. The Parties have also amended and clarified the HoA language and terms, including extension of the term of the contract until 2049. 

Now for a closer look. 

1. DG is a 35% shareholder in PPL so at a first cut, DG’s share of the USD 1 billion payment is USD 350 million.  Sounds good, but there are at least a few wrinkles.
2. That money is at Pearl not DG, though DG will show the USD 350 million in its September financials, just as it shows its 35% share of PPL’s aggregate trade receivables.  If and until PPL transfers funds to DG, DG will not have use of the funds.
3. Also note the money in two tranches.  One of USD 210 million and one of USD 140 million.
4. Let's start with the second amount the USD 140 million. That amount will not be available for DG to use as it wishes because the USD  400 million tranche is required to be spent in the KRG to expand production, assuming of course that PPL honors its commitment to the KRG. 
5. As regards the first amount DG's USD 210 million share of the USD 600 million, how much of this DG will ultimately obtain unrestricted use of depends on Pearl's cash needs, particularly if PPL will require more than USD 400 million to fund the promised increase in production.   If the amount exceeds USD 400 million, then any funds ultimately transferred to DG and its partners for their own use will be lower than the USD 600 million discussed above. 
6. PPL has agreed to release the KRG from its obligation to pay the remaining USD 1.239 billion of the arbitral award.  However, this amount is not completely forgiven or “lost”.  It’s been transformed into a “recoverable cost”.  Under concession agreements, the operator is entitled to recover its invested costs plus a certain return (not specified here and I could not locate it in DG’s financials or other information it publishes) before the profit sharing mechanism becomes operative. 
7. What this means is that PPL and thus DG and its partners will recover this amount over time, if the Kurdistan fields produce.   PPL is thus highly incentivized to ramp up and maintain production as soon as possible.  That’s the good news. 
8. The bad news is that this is an installment payment which is estimated to begin some two years hence.  On a present value basis then PPL will recover less than the USD 1.239 nominal sum.  Depending on the timing of production, the amount may be much less. 
9. The KRG has increased DG’s share under the profit sharing agreement to 22% and has extended the concession period to 2049.  That gives PPL the opportunity for additional earnings and will counteract to some extent the present value loss on the USD 1.239 billion.  Just how much is not clear as again it will depend on the timing of cashflows. 
10. Dana will also be able to sell 50% of the Additional Gas for export neatly side stepping further exposure to the KRG's creditworthiness.
11. PL and the KRG have issued mutual releases on arbitral claims.  You will recall that earlier this year PPL was reported to be pursuing some USD 26.5 billion in claims against the KRF for alleged damages. On a positive note, the settlement of all claims may lead to an increase in KRG payments of outstanding be-whiskered trade receivables which would help DG’s cash flow but not its profit.   The stale receivables have already reduced DG’s realized profit from that reported by the operation of present value.  Nonetheless, more cash in hand would provide DG additional flexibility in conducting its operations.  Were it so inclined—an assumption for which there is scant evidence so far—the cash could be used to repay the sukuk.  This claim has been dropped as language from the preface to the press release indicate. 

The Parties have mutually agreed to fully and finally settle all their differences amicably by terminating the Arbitration and related court proceedings, and releasing all remaining claims between them, including the substantial damages asserted by the Consortium against the KRG.

While there is both some good and some not so good news for DG in the PPL settlement, on balance it probably is a net positive.  AA suspects that those who have read the news of the settlement and are expecting a cash bonanza at DG will be like the bankers who are anticipating "rich investment banking fees" in Saudi Arabia.

But Is this good news positive enough for AA to change his recommendation against investing in DG equity or debt? 

A resounding no. 

The first rule of investing is not to invest with issuers who have demonstrated that they cannot be trusted to honor obligations.   

Tulips and Bitcoin

At Least They're Real

This Tuesday self-described “no nonsense take no prisoners” Jamie Dimon lambasted Bitcoin at a New York investor conference as per press reports. 

The cryptocurrency “won’t end well,” he told an investor conference in New York on Tuesday, predicting it will eventually blow up. “It’s a fraud” and “worse than tulip bulbs.”

Indeed, at least if you buy a tulip bulb, you have something tangible.  A Bitcoin is the monetization of a wish.

Many self-described “sober investors” who buy Bitcoin offer as their “sound” rationale that governments create national currencies out of thin air without “backing” the issuance with any tangible asset and that as a result these currencies are inherently dangerous.  To avoid this “clear” danger they instead “invest” in a currency issued by a private sector entity out of thin air without “backing” by any tangible asset.  

But there are key differences that make this investment a “wise” one so they say. 

• First, aggregate issuance is limited.  
• Second, unlike a government, the private sector entity issuing Bitcoin has no legal powers or ability to support its currency’s value, instead relying on the proven performance of the “free market” for magical solutions.  A dogma that almost certainly Jamie sadly won't have time to address.

To those wise investors AA wants to offer an even more compelling opportunity: AA’s new “virtual” company that will manufacture digital electronic vehicles.  The upside is clearly unlimited as costs of manufacture and selling are low. No raw material except an odd electron here and there is used in the manufacturing process.  There are no associated shipping costs for the product.  Nor do our dealers need to hold physical inventory.

AA’s digital cars also are environmentally friendly.  There are no emissions associated with the manufacturing process or the finished product when in operation.       

Patriotic investors will be happy to note that AA is a proud participant in the current Administration’s Make America Great Again Manufacturing Program.  Our factory is based in the United States where we project that we will employ a virtual workforce of over 150,000 when full capacity is reached.  Strict sourcing standards ensure that only US electrons are used in our product.    

Disclosure: AA and a member of his direct household (Madame Arqala) hold investments in tulips between 15 and 30 bulbs planted in the elegant gardens of Chez Arqala. 

Further Pressure on Qatar. Really?

When A Story Falls Through the Cracks, Who Catches It?

If you read Gulf News regularly, you’ll have seen their article on Fitch’s downgrade of Qatar’s long term sovereign risk rating to AA- “Qatar Faces Further Pressure as Fitch Downgrades Sovereign Rating”.  

Sounds grim, perhaps even "subdued" if we apply Indian standards. 

But when context is missing, AA is there to catch what’s fallen between the cracks or perhaps in this case deliberately dropped between the cracks given GN’s demonstrated past ability to quote press releases verbatim.

Fitch did indeed downgrade Qatar’s sovereign rating.

A couple of points.  

First, AA- is still investment grade. 

Second, within the GCC context, Qatar’s sovereign rating is certainly well within range of its neighbors.  Fitch ratings page here.

COUNTRY	RATING
Bahrain	BB+
Kuwait	AA
Oman	BBB
Qatar	AA-
Saudi Arabia	A+
UAE	AA

Earlier this year, Fitch downgraded KSA several notches in one go. The pressure must be intense if one applies GN standards.  As to Bahrain, if you don’t know, BB+ is non-investment grade.  

Third, regarding my comment about taking flawless dictation from press releases, here are some quotes that GN somehow omitted.  Fitch press release here.  AA comments in red boldface.  Other boldface to highlight key points.

At an expected 146% of GDP in 2017, Qatar's SNFA [sovereign net foreign assets] are well above the 'AA' median and are sufficient to finance two decades of fiscal deficits or to repay all the estimated external liabilities of GREs, banks, and the private sector (around 90% of GDP).  Qatar's SNFA are underpinned by the foreign assets held by the QIA. Specific figures on the size, returns and asset allocation of the QIA are not publicly disclosed, but we estimate that its foreign assets amounted to USD283 billion at end-2016. We expect QIA foreign assets to fall in 2017 as a result of draw-downs to support the banking sector, which may not be completely offset by the return on QIA assets.

And here's another.

Qatar has been able to restructure its supply chain and avoid major economic and social instability. We expect only a slight up-tick in inflation (to 4% in 2017 from 2.8% in 2016). Inflation was 0.2% yoy in July 2017 (4% for food). Imports dropped 40% in June, but we expect that this will be temporary. Ports in India and Oman have replaced Dubai's Jebel Ali as transhipment points for goods destined for Qatar. Significant stockpiles of construction materials are giving the government time to examine longer-term supply options even as deliveries from quarries in Iran and Oman continue. Qatar Airways' cargo capacity has been used to maintain supplies of food and other perishable goods.

When you factor all this in, and AA hopes you do, you may have a different view of Qatar’s current situation. (Note that caveat.)

Unwarranted Hubris on the Potomac

Some Countries Have Scary Clowns Others Have Happy Ones    

This week Rachel Sylvester at The Times published a rather unflattering article on the UK’s Foreign Secretary Boris Johnson, “Our Foreign Secretary is an International Joke”.

“According to diplomatic sources, even officials at the Trump White House “don’t want to go anywhere near Boris because they think he’s a joke”. 

A rather low blow, indeed. 

AA wonders--and wonders if you do too— if officials at the TWH are self-aware enough to realize that Boris is appropriate company. 

Matthew 7:3-5  is no doubt appropriate here. 

Dana Gas: A Closer Look at Pearl Petroleum Limited

This post takes a closer look at DG’s لؤلؤ of an investment, Pearl Petroleum Ltd. BVI which accounts for the lion’s share of DG’s bewhiskered Trade Receivables.  

What can we learn about how Pearl is doing from DG? In performing this exercise we’ll ignore for the moment that cash payment by the KRG has severely lagged billing.   If DG’s information is lacking (a question that might not really need to be asked), do we have alternative sources of information? How do we exploit that information?  

Why take a closer look? 

According to press reports, DG’s management has admitted that its Egyptian operation has generated only USD 60 million in net profit during the ten-year life of the sukuk and just this month advised that Zora field production was down some 49% from the “corresponding quarter” in its 1H2017 interim financial report.  With a track record like that, taking a look at DG’s “jewel” is well worth the effort.

Dana Gas Information on PPL

As I posted earlier, DG’s disclosure regarding Pearl Petroleum Limited is rather limited.  For some reason no doubt well-reasoned and Shari’ah compliant, DG does not disclose its share of net income in PPL but only gross operating income. 

As regards Shari’ah, AA supposes that there has been evolving interpretation of what “selling” or “wet corn” means (Muslim/Abu Hurairah) or “selling without disclosing defects” (Ibn Majah/ Wasila bin el-Asqa). 

AA has trawled through DG’s audited financials note on joint operations and prepared the following summaries. 

Let’s start with the statement of condition aka “balance sheet”. 

DG Info: PPL Balance Sheet USD Millions
Year	CA	NCA	TA	LIABS	EQUITY
2016	2,117	726	2,843	194	2,649
2015	2,123	777	2,900	89	2,811
2014	1,950	790	2,740	100	2,640
2013	1,358	823	2,180	45	2,135
2012	1,088	848	1,935	25	1,910
2011	670	878	1,548	28	1,520
2010	343	908	1,250	58	1,193

Technical notes:  

• The joint operations note presents only DG's share of PPL's assets and income.   
• To get PPL level information, one must divide DG's share by 0.35 in 2016 and 2015 and by 0.40 for the earlier years shown.  Why the change in 2015?  DG sold an additional 5% to RWE in 2015.  
  

Comments:

• DG “consolidates” its share of PPL’s assets and liabilities in preparing its (DG’s) financial statements. When it does so, it eliminates intra-group (DG and PPL) transactions. Therefore, it’s possible that PPL’s balance sheet is larger than shown above. 
• What could such intergroup transactions be?  Intra-group company loans, accounts receivable payable by PPL, etc.

Now to the income statement.  

DG Info:  PPL Income Statement USD Millions
Year	NET REV	OPCOST	GPROF	CHGEQ	DOI/OCI
2016	223	100	123	-163	-286
2015	406	97	309	171	-137
2014	618	88	530	505	-25
2013	575	105	470	225	-245
2012	645	85	560	390	-170
2011	565	73	493	328	-165
2010	205	15	190	348	158

Technical notes:  

• Same methodology as with the balance sheet to convert the information DG presents on its share of income to the aggregate income for PPL. 
• As noted DG only presents PPL’s Operating Profit not Net Income. 
• Using the change in equity (CHGEQ) as a proxy for net comprehensive income, I have computed the amount required to plug the gap in CHGEQ.  This is labeled DOI/OCI.  Derived Other Income (including other expenses not in gross operating profit) and Other Comprehensive Income.  (AA's calculations are in red typeface.)
• Examples of OCI would be change in carrying value of PPL’s contractual rights, value of reserves, etc. 
• DOI would include the interest that PPL accrued on the unpaid KRG receivables.  Recall that when PPL reversed the interest at 9% DG’s share of the reversal was USD 121 million or roughly USD 346 million for PPL in aggregate.  However, the arbitral decision allowed PPL to charge interest at L+2%.  Looking at note 28 in both 2016 and 2015, the change in interest due is some USD 68 million, implying (note that word) that the net of the reversal of the 9% interest and the accrual of interest at 2% was USD 68 million or roughly USD 194 million for PPL.   

So with DG’s “wet corn” tucked under the “dry” corn, we’re left with questions about PPL’s balance sheet and its income performance before allocation of DG expenses to PPL. 

Other Sources of Information on PPL 

It would seem like we’re at a dead end. 

But there are other sources of information on PPL.  DG has four partners in PPL.  Crescent, OMV Austria, MOL Hungary and RWEST Germany.

Crescent is a private company and does not appear to disclose its financials.  You’ll find Crescent on the web at http://www.crescent.ae/home.html.  Note that the Chairman of Crescent is also the Chairman of DG. Other apparent members of the Chairman’s family are on DG’s board.  Crescent is DG’s largest shareholder and thus would have rights to seats on DG’s board.   

Having a bit to do at work, AA looked only at the financials of OMV and MOL.  Preparing info on PPL from RWEST is left as an exercise for the student. Expect an announcement soon on the opening of Arqala University!  It’s going to be a huge success more so than Arqala Steaks –also under formation. 

OMV Information on PPL 

Here’s the data compiled from OMV.

First, the balance sheet. 

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Technical notes: 

• Despite its 10% ownership share, OMV accounts for PPL as an equity investment because it has substantial control over PPL because as I noted earlier some PPL decisions require shareholder unanimity. 
• OMV reports data for PPL’s balance sheet and income statement so there is no need to adjust numbers. 
• OMV only began reporting separate data on PPL in 2014.  Before that PPL was aggregated with another equity accountee. 
• I’ve used year end spot exchange rates for the balance sheet (ECB) and averages for the year (IBRD) to convert OMV’s reporting currency (euros) to USD.   You’ll also find this info at the Deutsche Bundesbank with slight variations to the IBRD average rate, a cautionary note about the potential for “different” versions of the same data from well-regarded sources.  I used the IBRD average rate for HUF to convert MOL data so for consistency I used IBRD for OMV as well.  Where there was a lapse, e.g., 2016 average for the euro in the IBRD data, I used the Bundesbank data. 
• CA and NCA are current assets and non-current assets respectively.  The same C and NC prefixes are used for liabilities.

Comments:

• Three things of note from the OMV data.
• Noncurrent liabilities are disclosed.  Based on other information in both OMV and MOL’s financials, these amounts primarily consist of loans extended by shareholders to PPL.   The difference between NCLs and the derived loan balances may consist of accrued unpaid interest.
• Side Note:  The loans were extended at Libor plus 2% which both OMV and MOL describe as a “market” rate.  AA would like to borrow some money from a “market” that rates Kurdistan risk this low because AA could probably get a loan at Libor minus 2%.   
• In 2015 OMV restated PPL’s equity as of 2014 or more precisely marked it down roughly USD 1.5 billion.  There is no restatement of PPL’s equity in DG’s financials. 
• OMV’s calculation of equity is higher than DG’s for 2014-2016.

Now to the income statement.

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Comments:

• As you’ll note OMV did not restate income in 2015 for 2014 which AA believes indicates 2014 restated equity reflects a change in reserves or contractual value of PPL’s rights in the KRG. 
• Also OMV’s operating profit differs from that of DG.  It’s not clear what’s causing this, but AA believes it is the difference between gross operating profit (net revenues less depreciation and operating costs) as reported by DG and net operating profit (which includes other expenses) as reported by OMV.
• Not a particularly “pretty” profit picture.

MOL Information on PPL

MOL Info:  PPL Balance Sheet  USD Millions
Year	CA	NCA	TA	CL	NCL	Equity
2016	2,345	658	3,003	138	1	2,864
2015	2,123	686	2,809	88	229	2,492
2014	2,038	690	2,728	98	248	2,382
2013	1,415	716	2,130	49	253	1,829
R2012	1,122	734	1,856	24	490	1,342
2012	1,122	3,556	4,678	24	490	4,163
2011	684	3,582	4,266	28	644	3,595
2010	345	3,607	3,952	61	782	3,108

Technical Notes:

• Like OMV, MOL uses the equity method to account for PPL. MOL’s reporting currency is Hungarian Forint (HUF).
• It reports PPL’s aggregate balance sheet and income statement except for 2010-2012 when it reported only its share of the balance sheet and income.  Figures for those years have been divided by 0.1 to calculate PPL’s aggregate balance sheet. 
• I used the same IBRD source mentioned above for average annual rates for the HUF and laboriously copied fiscal year end spot rates from NMB (Hungarian Central Bank) website. 

Comments: 

• Both MOL and OMV report very similar balance sheets for 2014-2016 which AA takes as indicating that this exercise has produced a fairly accurate picture of PPL’s balance sheet for those years. 
• Note that their equity numbers are equal for the period 2014-2016 and different (higher) than DG’s. 
• But there is a significant difference between MOL and OMV regarding the restatement of PPL’s equity.  At MOL the restatement occurs in 2013 for fiscal 2012 and is a much larger amount USD 2.8 billion versus USD 1.5 billion at OMV for fiscal 2014.   It is unclear what caused this timing difference. 
• NCLs as reported by MOL track those reported by OMV.  With the longer data period at MOL we can see the shareholder loans have declined to next to nothing from roughly USD 782 million in 2010.  
• Looking at the change from 2015 to 2016 in NCLs, at a 35% share, DG received roughly USD 80 million in repayments from PPL in 2016.  Because these are intergroup transactions, they would not be reflected in DG’s consolidated statement of cashflows. 
• The USD 80 million was likely reflected in consolidated cash as DG’s 35% share of PPL’s total cash. Once payment to DG was made DG’s consolidated cash balance would not change.  If DG prepared and disclosed parent only financials, we should see the USD 80 million as a separate transaction there.   

Now let’s turn to MOL’s version of PPL’s income statement. 

MOL Info PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	MOL
2016	223	235	154	388	0
2015	357	-188	293	106	11
2014	618	524	28	553	55
2013	575	470	17	487	84
2012	645	564	5	570	57
2011	565	494	-8	486	49
2010	205	192	5	197	20

Comments: 

• Similar to OMV, MOL’s restatement of PPL’s equity did not result in a restatement of net income which seems to bolster AA’s theory that this is a valuation change of contractual rights or reserve values. 
• But OMV and MOL part company on income. 
• MOL’s calculation of net income tracks closely the change in equity and is much large and more consistently positive than OMV’s.  OMV does not appear to consider OCI. Yet the difference between the two is apparently not solely the result of OCI. 
• Based on MOL’s calculation, PPL appears to be a highly profitable investment. 
• But there is a wrinkle here.  Despite recognizing larger net income, in 2016 MOL stopped accruing income on PPL shifting to a “cash basis”.    That is not a vote of faith in PPL’s prospects or the ability of the KRG to settle the trade receivables. 

Summary 

• We’ve been able to recreate PPL’s balance sheet in more detail than DG has provided.  This can serve as a basis for further analysis by other interested parties, e.g., sukuk holders’ advisors, equity analysts, and equity holders. 
• However, this exercise has not resulted in a completely identical set of financials.  As regards the balance sheet, there is an approximate 10% of so difference between DG’s value of equity and that reported by OMV and MOL.  
• More importantly for a meaningful analysis, there are striking differences in PPL’s income as reported by DG, OMV, and MOL. 
• DG only provides gross operating profit not net income or net comprehensive income.  The above mentioned “interested parties” may wish to push DG to provide additional information.  For starters, to disclose its calculation of PPL net comprehensive income before and after allocation of DG expenses. 
• OMV and MOL have very different net income figures for PPL. While PPL is a small fish in OMV’s and MOL’s operations, parties interested in those companies may also wish to understand more about PPL’s performance. 
• As noted, this does not seem to be solely the result of MOL considering OCI while OMV does not as OCI does not equal the difference between OMV and MOL’s figures.
• Interestingly, DG, OMV, and MOL are all audited by Ernst and Young, though it's important to note that each of the firms are legally separate partnerships within the global E&Y “family”.
• Differences among these companies' accounting for PPL is the result of differences in accounting practices. DG “consolidates” its share of PPL.   OMV and MOL use the equity method to account for their respective holdings in PPL. But, as noted above, OMV and MOL have remarkably different results for net income. 
• Finally, this approach to reconstructing/estimating undisclosed information by using other sources might be useful to bankers, investors, and other interested parties for a range of other transactions and obligors.  Where there is more than one partner in a venture and that partner is listed in a reasonably well regulated market, there may be disclosures available.  One can also look to counterparties to a transaction who may disclose details in their public disclosures that their counterparty does not. 
• Side Note: On that topic, early in AA’s career, a dearly respected white-haired mentor told AA how a colleague of his had recreated a rudimentary set of Aramco financials from SEC-mandated disclosures by the listed US oil companies who were Aramco shareholders at the time.  This chap later off-handedly discussed key elements of Aramco’s financials with the company, much to the consternation of Aramco officials who were concerned about the reaction of the “new” Saudi shareholder.