Sunday, December 20, 2020 / 01.57PM / By Proshare
Research / Header Image Credit: Ecographics
With the naira stuttering over the last twelve months, corporations with dual listings in domestic and foreign markets and have Eurobond Issues outstanding may find themselves in a bit of a jam. The declining foreign exchange rate(s) have increased the nominal values of Eurobond Issues leaving Issuers struggling to meet payment obligations. For Nigerian companies like oil and gas company SEPLAT Plc and financial service provider Zenith Bank Plc, the coronavirus has been more than a physical health challenge, it has been a financial squeeze.
Both companies showed unusual foresight and strategic thinking when they listed in foreign stock markets in the middle 2000's. They became even more daring by floating Eurobond Issues that were heavily oversubscribed but inevitably launched Nigerian companies into the rarefied arena of international corporate finance.
Right up until 2018, SEPLAT Plc had done an impressive job of growing top and bottom lines earnings while also covering its foreign financial market obligations.
The question this analysis sought to look into, in the light to the questions raised about Seplat's information credibility - which of its two statements are true; arising from the press release it issued; relates to two questions:
Find below our preliminary submissions, based on publicly available information sourced.
The upstream oil giant has seen its local Nigerian share price fall steadily over the last eleven months as COVID-19 troubles and a fall in the international oil prices seems to have created a perfect storm. SEPLAT's London Stock Exchange (LSE) price has fallen from GBP125 per share in January 2020 to a more recent December 16, 2020 price of GBP62.20 per share, representing a loss in the company's market value of -50.24% in twelve months. Things have not been much better on the local Nigerian Stock Exchange (NSE).
SEPLAT Plc's share price has dropped from N592 per share in January 2020 to N4o2.3 per share in December 2020 representing a tumble of -32.04% over the last twelve months (see chart 1 below). SEPLAT's share price drop must equally be connected to its recent profit weakness. The upstream major posted a 9 month 2020 fall in turnover of -10.73% year-on-year (Y-o-Y) from N151.9bn in 9 months 2019 to N135.6bn in 2020. The company's profit numbers have not fared any better as profit before tax for 9 months 2020 slipped to a loss of N45.5bn from a profit of N56.7bn in 9 months 2019 (see table 1 below).
Chart 1: SEPLAT Plc's Price Movement January to December 2020
Source: Nigeria Stock Exchange (NSE), Proshare research
Table 1 SEPLAT's 9 Month 2020 Financial Scorecard
Source: The Nigeria Stock Exchange (NSE), Proshare research
The underlying weakness of the company's operating performance in 2020 puts it under pressure concerning its global credit rating which Fitch put at B- at the time of the Bond Offer in 2018, Standards and Poor (S&P) rated the Offer at B while Moody's rated it at B2. The below investment grade status of the Offer explains the bond's relatively high coupon rate of 9.25% (see table 2 below).
Table 2 SEPLAT's Eurobond Offer: A Dash of Anxiety
With SEPLAT Plcâ€™s operating numbers looking far more modest than in 2018 the O&G company may have to take a second look at its Bond Issue which is expected to mature in April 2023 (i.e. 28 months to maturity). The pressure on the Eurobond Issue is reinforced by the devaluation of the local currency, the naira.
In its report for the 9 months 2020 the company noted the following:
"Total revenue for the period was US$387.8 million, down 21.6% from the US$494.8 million achieved in 2019. Crude oil revenue was US$305.6 million (9M 2019: US$322.8 million) a 5.3% reduction compared to 2019, reflecting lower realised oil prices of US$38.6/bbl for the period (9M 2019: US$64.2/bbl) offset by added production from the Eland assets. A US$39.1 million oil underlift was recorded under other income in the period, compared to US$30.5 million in 9M 2019.
Total working-interest production volume for the period was 13.9 MMboe (9M 2019: 12.9 MMboe) with the total volume of crude lifted in the period being 7.9 MMbbl, compared to 5.0 MMbbl in 2019. The higher volume was due to a maiden contribution from OML40 and Ubima, and higher production from OML 53. The Company experienced TFP reconciliation losses of 8.6% for the nine-month period, but we expect these to fall when the delayed Amukpe-Escravos underground pipeline comes onstream.
Gas sales revenue decreased by 21.8% to US$82.2 million (9M 2019: US$105.1 million), due to lower gas sales volumes of 27.5 Bscf compared to 37.2 Bscf in 9M 2019. The lower volumes reflect higher downtime at third-party infrastructure and a planned 15-day shutdown of the Oben Gas Plant for turnaround maintenance in March. There were no gas processing revenues in the period, compared with the one-off gas processing revenue of US$66.9 million in 2019, which was the Oben gas plant tolling payment by NPDC. Gas sales contributed 21.2% of total Group revenue in the period (9M 2019: 24.6%, excl. tolling) and the average realized gas price was US$2.88/Mscf (9M 2019: US$2.82/Mscf)"
Like other O&G companies, SEPLAT has had a hard time keeping revenue and profits on an upward path but the harsh headwinds could be temporary if oil and gas prices rise and a quick-fix vaccine-aided recovery from the coronavirus pandemic occurs in 2021 as global economies grow faster than earlier analysts' forecasts.
Indeed, although the equity market in Nigeria has been modestly bearish tending towards a mild overall decline, SEPLAT's share price tumble has been more severe than both the Nigeria Stock Exchange (NSE) All Share Index (ASI) and the decline in the Exchange's Oil and Gas Index (see charts 2,3 and 4).
Chart 2 SEPLAT Sliding Down A Recovery
Source: NSE, Proshare Research
Chart 3 NSE ASI 2020; A Mild Rise and A Reversal
Source: NSE, Proshare research
Note: NSEASI Movement as of 18 Dec. 2020
Chart 4: O&G Sector Yields 2020; Closing The Year on A High
Note: Oil and Gas Sector Index Yields as of 18 Dec. 2020
Source: NSE, Proshare research
Trouble at The Rigs
SEPLAT Plc's operating performance has opened up concerns amongst investors and analysts alike about the underlying strength of the business in the face of declining oil and gas prices caused by coronavirus-induced lockdowns and manufacturing stoppages. But besides anxiety over the company's core oil and gas (O&G) business, there are key concerns around the gas major's loan repayments and third-party obligations which have added fresh layers of care. Halted Jack pumps have led to lower revenues and shrinking cash flows, but of equal concern is the fact that contingent loan obligations may worsen an already difficult situation (see Proshareâ€™s recent report, SEPLAT, and Its Access Bank Nemesis - Plugging the Governance Gap).
A court of competent jurisdiction will give final judgment over the between SEPLAT/Cardinal Drilling Nigeria Limited and Access Bank Plc case but in the interim, best corporate governance practice may require proper accounting guidance over the possibility of the debt crystalizing against SEPLAT and requiring the company to provide for this outcome.
The amount involved, US$86m, is sufficiently material that shareholders of SEPLAT Plc would need to be informed of developments in respect of the case to guide their future asset portfolio choices. This becomes important in the light of the international accounting standard (IAS) rule 37 on contingent liabilities.
It is noteworthy to point out that we understand that a deal was once agreed for under $40m as full and final settlement of the sum under dispute, but negotiations broke down once payment plans were not met. SEPLAT Plc's has publicly maintained a consistent position on the matter and has never acknowledged these fact; a point that lends credence to the character disposition towards the debt saga.
Bondholders, in particular, would need to find comfort in the company paying as much as 24.57% of the bond value in issue as of 2018 as local judgment debt.
Of course, SEPLAT Plc may reasonably argue that it does not need to make contingent liability provisions against the debt owed Access Bank Plc by Cardinal Drilling Nigeria Limited (a related party and operationally sensitive company publicly acknowledged) and IAS 37 allows such discretion.
However, the close relationship between Cardinal Drilling Nigeria and SEPLAT by way of being related parties (IAS24) may require a need for pause and reflection over the prudent accounting and governance conduct required to bolster investor confidence in the O&G company's shares and its Eurobonds (see evidenced screenshots here).
A Merry Eurobond Market
SEPLAT's Eurobond Issue was a commendable and brave move at improving the company's liquidity and rebalancing its corporate debt profile to reduce overall financing cost in 2018. Since 2018 however, both international and local market rates have changed significantly, resulting in the need for analysts to revisit the oil and gas company's debt to equity structure and its local to foreign debt mix; as an indicator of financial health.
Up until 2019 SEPLAT Plc's corporate pre-tax earnings and topline sales figures have been impressive (see chart 2 below). The strong upside growth of gross earnings and after-tax profits have assured bondholders of a decent investment return with modest risk. But recently that tide seems to have turned.
SEPLAT's financials have been hard hit by the coronavirus pandemic which has led to a fall in global industrial activity and a drop in demand for gas and associated products thereby causing a fall in the prices of both gas and crude oil. The fall in price and the volume of products sold has meant a slide in SEPLAT's revenues.
The double whammy has reflected mildly in a decline in SEPLAT's recent topline tumble. Turnover fell from N228.39bn in 2018 to N214.16bn in 2019 (before COVID-19 problems emerged). On a nine-month basis SEPLAT's turnover dipped from N151.88bn in 9 months 2019 (before the pandemic) to N135.62bn in 9 months 2020, representing a slide of -10.71% year on year (Y-o-Y) (see chart 2 below).
Chart 5 SEPLAT: The Changing Revenue Escalator
SEPLAT's underlying business profitability took a slightly different course. In 2018 the company's pre-tax profit stood at N80.57bn and rose by +11.59% in 2019 to N89.91bn, however, in 2020 the gas mining group's profit numbers seem to have turned downwards. 9months 2019 saw the group post a profit before tax of N56.71bn which fizzled into a loss of N45.49bn in 9 months 2020. The likelihood of a full-year loss is palpable (see chart 3).
Nevertheless, with coronavirus lockdowns eased in the Americas, Europe, and Asia, last quarter revenues may reduce the profit pains as factories pick up modestly. A lot will still depend on the ability of economies to cope with a second or third wave of virus spread.
Economies in Europe have already commenced lockdown protocols that could slow gas and oil use in Q4 2020. However, with Asian economies sustaining economic recovery, the oil and gas market may not witness a major price and volume slump as O&G companies like SEPLAT hope to see better top and bottom-line earnings, as the year winds down.
Chart 6 SEPLAT; Of Profits and Bungee Jumps
The Bond Look Up
SEPLAT's Eurobond Issue of US$350m still has 28months before maturity and the B rating of the bond could come under severe pressure if the coronavirus challenge persists into 2021 as the companies operating and free cash flows begin to shrink.
Investors in the company's Eurobond would, therefore, be unappreciative of a US$86m contingent liability hanging over its head. In this light, analysts have argued that the company should come into some sort of negotiated settlement of the debt in collaboration with its principal drilling firm, Cardinal Drilling Nigeria Limited, the principal obligor on the loan. A speedy resolution of the matter would ensure that the oil and gas major can concentrate on its core business and bring its activities to focus on a reversal of its declining profitability and a reimagining and strategizing of its business policies, processes, and programs for 2021.
The year 2021 will represent a crucial year for the Nigerian and global economies for different reasons. Exchange rate devaluation will mean that companies that generate earnings in dollars would have greater foreign currency translation protection, hence improving their naira earnings in their currency of presentation. But Eurobond nominal values would also go up in naira terms (see table 3 below)
Table 3 SEPLAT's Changing Eurobond Naira Value
The Eurobond market has created great opportunities for African companies to raise large sums of money at relatively lower costs in local financial markets after adjusting for foreign currency translation costs. Nigerian companies have accessed the Eurobond market since 2016 and have had relatively desirable outcomes. But in a COVID-19 environment and post-COVID-19 African companies' access to the Eurobond market may pivot in different directions as earnings become challenged and cash flows stutter.
Nevertheless, asides from raising debt, African companies have also moved into foreign equity Issues on international bourses (Equity exchanges). This has resulted in a few dual listings. SEPLAT was listed on the London Stock Exchange (LSE) in 2014 (see illustration 1 below).
Illustration 1 SEPLAT: A Double Blast of Equity
The total equity raised by African firms on the London Stock Exchange (LSE) since 2008 has been GBP16bn while total debt raised has been GBP50.3bn (see illustration 2 below). Going forward, African companies would perhaps raise a lot more money from abroad but how successful they will be will depend heavily on the efficiency and profitability of their domestic operations and their overall adherence to global best governance practices.
Illustration 2 The African Foreign Capital Raise Journey
It is in this light that SEPLAT Plc needs to quickly resolve the Cardinal Drilling Nigeria Limited matter with Access Bank Plc to enable it to strengthen investor confidence and improve its credit rating in global capital markets, thereby enabling it to raise funds at lower marginal coupon rates.
While SEPLAT's bond trades at a coupon rate of 9.25%, Zenith Bank Plc, another Nigerian company but in the financial services sector, has a Eurobond Issue trading at a coupon rate of 7.375% (see table 4 below).
Table 4 Zenith Bank's Eurobond Play
Zenith Bank Plc initiated a US $1bn global medium-term Bond programme in 2014the bank raised a 5-year term instrument worth US$500m under the first tranche of Notes with coupon rates at 6.25%. The Issue was oversubscribed by 160%. Investors from the United States of America (USA) accounted for 44% of the Offer, while 35% of the Offer was subscribed to by investors from the United Kingdom (UK) and 9% of investors came from the European Union (EU).
In 2017, the Nigerian lender sold a second tranche of instruments worth US $1bn which was listed on the Irish Stock Exchange, the 5-year Eurobond Issue was oversubscribed by 320% at a coupon of 7.375% and maturity due in 2022.
In 2019, Zenith Bank repurchased US$392.6m worth of the second tranche issued in 2017 and currently has an outstanding bond size of US$107,404,000 due to mature in May 2022. The bank paid for the notes accepted by it in line with a tender offer in cash equal to US$1,085 per US$1,000 in principal amount of the notes plus the accrued interest amount.
This was a move to reduce the exchange rate risk of the debt.
With the local currency the naira sliding persistently, Eurobond Issuers need to take note of the rise in the nominal value of the bonds and protect themselves from adverse foreign exchange translation costs by hedging their currency exposures through options and currency swaps. SEPLAT in particular needs to take heed.
Closing Thoughts: Able but Unwilling
Nigerian banks have had several interesting and at times frustrating running battles with defaulting customers, but the SEPLAT/Cardinal Drilling Nigeria Limited versus Access Bank Plc legal slugfest adds interesting colour to the dimensions of the canvass of how good loans could go bad, thereby making loan recovery a living nightmare.
In SEPLAT Plc's case, the matter dons an interesting toga as SEPLAT claims that it was not an obligor to Access Bank concerning the loan taken by Cardinal Drilling and that it also did not represent as a guarantor of the loan. In this situation, the rule of privity of a contract becomes a matter of determination. The legal outcome of the case would provide lenders with insight into how credits could best be structured in situations where a customer provides a bespoke technical service to a client almost exclusively. Is the client responsible for the loan of the customer? And under what circumstances would the courts consider the principal off-taker of a company's goods or services liable in the event of loan default?
Is Cardinal Drilling Nigeria Limited/SEPLAT Plc able but unwilling to pay the bank loan? Resolution of the issue would add to the body of knowledge bank credit and legal officers would need in taking credit appraisal and approval decisions. Bankers are usually caught in a bewildering maze that is beyond the underlying strength of a credit facility, the credit officer must be able to ascertain the Character of the borrower. Since as William Shakespeare pointed out in his play Macbeth that "there is no art to find the mind's construction in the face", bank credit officers are left with the art of cognitive discernment (using their guts!).
With its strong underlying corporate outlook, the jury seems weighed heavily on the side of SEPLAT's capacity, but its unwillingness, to pay Cardinal Drilling Nigeria Limited's Access Bank debt, the reason for this could not be established at the time of this report and is best explained by the Board and management of the company.
Be that as it may, the consequence of getting it right in a carefully negotiated settlement is a fat bonus at the end of the financial year but if the gut feeling goes on holiday in the face of a bad borrower's clever charm, then the result could be very unpleasant for everybody; the bank, the credit officer and the borrower alike. Proshare's character-capacity matrix is a great theoretical construct but a difficult practical tool (see illustration below).
Illustration 3 A Lenders Dilemma
Nevertheless, the matrix provides a framework within which a credit officer can discern the outcome of a variety of potential character vs capacity conflicts.
Conclusion- Making the Complicated Easy
In a critical year such as 2021, SEPLAT Plc and Access Bank Plc, both reputable companies listed on the Nigeria Stock Exchange (NSE), must come to a resolution of the US$86m indebtedness of Cardinal Drilling in such a way as to protect the confidence of foreign investors in SEPLAT's Eurobond Issue as well as to ensure that the lending bank is provided a reasonable leeway for its loan book management.
The three parties engaged in the loan resolution process may find a better turn to the matter by thinking from the mindset of a win-win rather than a win-lose outcome.
Battles, legal or physical, might be exhilarating for a while, but after the testosterone-induced joy of combat is over, the bruises and pains that follow are no less real.
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