The Evil Diaries: A Trip Down Memory Lane

Where do I start with Afren and its announcement of Friday? Let’s leave the horrors of the operational update aside and just concentrate on the finances of the restructuring.

The first thing to say is that my previous figures were based on a hypothetical debt for equity swap of $863m bonds. This would have been healthy for the Company going forwards, but disastrous for existing shareholders as they would be left with (at most) 5% of a company with vastly reduced debt. Incredible as it may seem, today’s deal is actually WORSE than that as shareholders will be diluted to 11% ownership (if they take up their rights), yet the Company will be stuck with total net debt of $1.7bn.

That’s right, folks, total net debt isn’t going to go down much at all, but shareholders still get diluted massively to 11% IF they are willing to inject more money on very poor commercial terms. In return, Afren’s immediate cash flow problems are banished as payment of debt & interest is kicked down the road, but the debt doesn’t go away. Who would have thought that I’d have been more generous than the ad hoc bondholder committee have been?

The shares are currently trading at 4.7p because existing shareholders don’t understand what has just happened in this smoke and mirrors act. It is essential for anyone trying to understand the situation to read the presentation on the Afren website at afren.com, particularly slides 5 and 6.

Shareholders (and bondholders) are being offered the chance to buy $75m worth of new shares in an open offer at a large discount to the current share price but there is no good commercial reason for doing so. You will note that the $75m open offer is not underwritten by anyone, which is a strong indication itself of value – the offer is just there in case there are any mugs who are willing to take it up. It improves the headline dilution figure for shareholders, but it’s a complete red herring. As a bondholder, I can assure you I won’t be taking up my rights in the open offer.

Let us assume, however, that shareholders do put in the $75m required to maintain an 11% shareholding in New Afren. What will New Afren be valued at, bearing in mind it will still have $1.7bn in net debt?

Let’s say that it’s valued by the market at £300m. I would be selling any shares I receive in the debt/equity swap as quickly as I could at that level but, for argument’s sake, let us assume that the market absorbs bondholder sales.

Afren is currently valued at £52m at 4.7p, but holders must take part in the open offer of $75m to maintain an 11% holding in New Afren. Assuming they do so (although they’d have to barking mad to take part) they then get to own 11% of New Afren that is generously valued at £300m (given $1.7bn net debt), giving a value for existing shareholder equity of £33m. Not looking good, is it? Why are the shares trading where they are?

Is £300m market cap. of New Afren realistic, however? It is effectively an option on the oil price recovering and what is a sensible way of pricing that option?

Using the New High Yield Notes As an Indicator Of Value

One thing that hasn’t been commented on is that the existing 1st Lien Ebok facililty (bank debt) has agreed to be pushed down the pecking order so that $321m worth of New High Yield Notes (to be supplied by bondholders) rank ahead of it. The price for these super senior bonds is a 15% coupon and 50% of New Afren equity after the restructure as a bonus.

So, the New High Yield Note holders get a 15% coupon for two years and, oh, 50% of the Company as well, thank you very much. Read that again, very slowly. New High Yield Note holders get 50% of New Afren simply for lending $321m at a 15% coupon for up to two years. They get their money back, a 30% return AND 50% of the Company.

It would seem that the option that New Afren offers on the oil price can be bought very cheaply indeed through buying bonds, which will ultimately be converted to High Yield Notes. Somebody cleverer than me will be able to put a hard price on it, but I believe it will be much, much lower than the Company’s shares currently indicate.

What value do you think that puts on New Afren equity in the new structure and how does its risk profile look?

Using The Existing Bonds As An Indicator Of Value

Bonds can be bought today at 48% of par value. Existing bondholders will get 33% of New Afren, even if they choose not to subscribe for the New High Yield Notes described above, in exchange for only 25% of the nominal debt that is owed to them. They keep 75% in new, restructured notes, albeit well down the capital hierarchy, but still get 33% of New Afren. The value of $863m nominal in existing bonds in the market is currently $414M. What is the read across value for the price of New Afren shares? If a bondholder is willing to invest fresh capital in the New High Yield Notes mentioned above as well, relative value compared to the equity price now becomes even more remarkable.

Personally, I can see no justification for the shares to be trading above 1p and, even then, there is no reason to buy. If anyone wants exposure to Afren shares, they would be wise to wait until the recapitalisation is complete in June – if they are unable to invest through the bonds. There will be no shortage of equity for sale and I fully expect the current mispricing in the market to be unwound when billions of new shares forced on reluctant bondholders are flooding the market. I don’t expect Afren to go to that level just yet, purely for liquidity reasons but the trajectory is set, and the next trigger will probably be the announcement of the open offer terms and then its subsequent failure to raise any meaningful sum.

I am sorry for all genuine shareholders who have lost money here. It isn’t a pleasant experience to lose so much money so quickly, but shorters haven’t brought this Company to its knees – that is a product of poor management, too much debt and a weak oil price. All we’ve done is point out what is likely to happen and I hope that sensible readers will appreciate being told the truth, however unpalatable it may be. The opinions of short sellers may have influenced people to sell, or avoid buying in recent weeks, but who can genuinely argue that that has been a bad thing in light of today’s announcement, over which they had no influence at all?