Seplat's Navigation of Funding Options, Dual Listings, Eurobond and the Cardinal Drilling Loan

Sunday, December 20, 2020 / 01.57PM / By ProshareResearch / Header Image Credit: Ecographics

With the nairastuttering over the last twelve months, corporations with dual listingsin domestic and foreign markets and have Eurobond Issues outstanding may findthemselves in a bit of a jam. The declining foreign exchange rate(s) haveincreased the nominal values of Eurobond Issues leaving Issuersstruggling to meet payment obligations. For Nigerian companies like oil and gascompany SEPLAT Plc andfinancial service provider Zenith Bank Plc,the coronavirus has been more than a physical health challenge, it has been afinancial squeeze.

Both companiesshowed unusual foresight and strategic thinking when they listed in foreignstock markets in the middle 2000's. They became even more daring by floatingEurobond Issues that were heavily oversubscribed but inevitably launchedNigerian companies into the rarefied arena of international corporate finance.

Right up until2018, SEPLAT Plc haddone an impressive job of growing top and bottom lines earnings while alsocovering its foreign financial market obligations.

The question thisanalysis sought to look into, in the light to the questions raised aboutSeplat's information credibility - which of its two statements are true;arising from the press releaseit issued; relates to two questions:

Is SEPLAT Plc an able but unwilling debtor; based on information known to it; but not publicly available; or
Is SEPLAT Plc having issues that should interest analysts and creditors alike?

Find belowour preliminary submissions, based on publicly available informationsourced.

The upstream oilgiant has seen its local Nigerian share price fall steadily over the lasteleven months as COVID-19 troubles and a fall in the international oil pricesseems to have created a perfect storm. SEPLAT'sLondon Stock Exchange (LSE) price has fallen from GBP125 per share inJanuary 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 NigerianStock Exchange (NSE).

SEPLAT Plc's shareprice has dropped from N592 per share in January 2020 to N4o2.3 per share inDecember 2020 representing a tumble of -32.04% overthe last twelve months (see chart 1 below).SEPLAT's share price drop must equally be connected to its recent profitweakness. 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 months2019 to N135.6bn in 2020. The company's profit numbers have not fared anybetter as profit before tax for 9 months 2020 slipped to a loss of N45.5bn froma profit of N56.7bn in 9 months 2019 (see table 1below).

Chart 1: SEPLATPlc's Price Movement January to December 2020

Source: Nigeria Stock Exchange (NSE), Proshare research

Table 1 SEPLAT's 9 Month 2020 Financial Scorecard

Proshare Nigeria Pvt. Ltd.

Source: The Nigeria StockExchange (NSE), Proshare research

The underlyingweakness of the company's operating performance in 2020 puts it under pressureconcerning its global credit rating which Fitch put at B- at the time of theBond Offer in 2018, Standards and Poor (S&P) rated the Offer at B whileMoody's rated it at B2. The below investment grade status of the Offer explainsthe bond's relatively high coupon rate of 9.25% (seetable 2 below).

Table 2 SEPLAT's Eurobond Offer: A Dash of Anxiety

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With SEPLAT Plcâ€™soperating numbers looking far more modest than in 2018 the O&G company mayhave to take a second look at its Bond Issue which is expected to mature inApril 2023 (i.e. 28 months to maturity). The pressure on the Eurobond Issue isreinforced by the devaluation of the local currency, the naira.

In its report forthe 9 months 2020 the company noted the following:

"Totalrevenue for the period was US$387.8 million, down 21.6% from the US$494.8million 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 realisedoil prices of US$38.6/bbl for the period (9M 2019: US$64.2/bbl) offset by addedproduction from the Eland assets. A US$39.1 million oil underlift was recordedunder other income in the period, compared to US$30.5 million in 9M 2019.

Totalworking-interest production volume for the period was 13.9 MMboe (9M 2019: 12.9MMboe) 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 maidencontribution from OML40 and Ubima, and higher production from OML 53. TheCompany experienced TFP reconciliation losses of 8.6% for the nine-monthperiod, but we expect these to fall when the delayed Amukpe-Escravosunderground pipeline comes onstream.

Gassales revenue decreased by 21.8% to US$82.2 million (9M 2019: US$105.1million), due to lower gas sales volumes of 27.5 Bscf compared to 37.2 Bscf in9M 2019. The lower volumes reflect higher downtime at third-partyinfrastructure and a planned 15-day shutdown of the Oben Gas Plant forturnaround maintenance in March. There were no gas processing revenues in theperiod, compared with the one-off gas processing revenue of US$66.9 million in2019, which was the Oben gas plant tolling payment by NPDC. Gas salescontributed 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&Gcompanies, SEPLAT has had a hard time keeping revenue and profits on an upwardpath but the harsh headwinds could be temporary if oil and gas prices rise anda quick-fix vaccine-aided recovery from the coronavirus pandemic occurs in 2021as global economies grow faster than earlier analysts' forecasts.

Indeed, althoughthe equity market in Nigeria has been modestly bearish tending towards a mildoverall decline, SEPLAT's share price tumble has been more severe than both theNigeria Stock Exchange (NSE) All Share Index (ASI) and the decline in theExchange's Oil and Gas Index (see charts 2,3 and 4).

Chart 2 SEPLATSliding Down A Recovery

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Source: NSE, ProshareResearch

Chart 3 NSE ASI 2020; AMild Rise and A Reversal

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Source: NSE, Proshareresearch

Note: NSEASI Movement as of18 Dec. 2020

Chart 4: O&GSector Yields 2020; Closing The Year on A High

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Note: Oiland Gas Sector Index Yields as of 18 Dec. 2020

Source: NSE, Proshareresearch

Troubleat The Rigs

SEPLAT Plc'soperating performance has opened up concerns amongst investors and analystsalike about the underlying strength of the business in the face of decliningoil and gas prices caused by coronavirus-induced lockdowns and manufacturingstoppages. 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 andthird-party obligations which have added fresh layers of care. Halted Jackpumps have led to lower revenues and shrinking cash flows, but of equalconcern is the fact that contingent loan obligations may worsen an alreadydifficult situation (see Proshareâ€™s recentreport, SEPLAT, and Its Access Bank Nemesis -Plugging the Governance Gap).

A court ofcompetent jurisdiction will give final judgment over the betweenSEPLAT/Cardinal Drilling Nigeria Limited and Access Bank Plc case but in theinterim, best corporate governance practice may require proper accountingguidance over the possibility of the debt crystalizing against SEPLAT andrequiring the company to provide for this outcome.

The amountinvolved, US$86m, is sufficiently material that shareholders of SEPLAT Plcwould need to be informed of developments in respect of the case to guide theirfuture asset portfolio choices. This becomes important in the light of theinternational accounting standard (IAS) rule 37 on contingent liabilities.

It is noteworthy topoint out that we understand that a deal was once agreed for under $40m as fulland final settlement of the sum under dispute, but negotiations broke down oncepayment plans were not met. SEPLAT Plc'shas publicly maintained a consistent position on the matter and has neveracknowledged these fact; a point that lends credence to the characterdisposition towards the debt saga.

Bondholders, inparticular, 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 Plcmay reasonably argue that it does not need to make contingent liabilityprovisions against the debt owed Access Bank Plc by Cardinal DrillingNigeria Limited (a related party and operationally sensitive companypublicly acknowledged) and IAS 37 allows such discretion.

However, the closerelationship between Cardinal Drilling Nigeria and SEPLAT by way of beingrelated parties (IAS24) may require a need for pause and reflection overthe prudent accounting and governance conduct required to bolster investorconfidence in the O&G company's shares and its Eurobonds (see evidenced screenshots here).

AMerry Eurobond Market

SEPLAT'sEurobond Issue was a commendable and brave move at improving thecompany's liquidity and rebalancing its corporate debt profile to reduceoverall financing cost in 2018. Since 2018 however, both internationaland local market rates have changed significantly, resulting in the need foranalysts to revisit the oil and gas company's debt to equity structure and itslocal to foreign debt mix; as an indicator of financial health.

Up until 2019 SEPLAT Plc'scorporate pre-tax earnings and topline sales figures have been impressive (see chart 2 below). The strong upside growth ofgross earnings and after-tax profits have assured bondholders of a decentinvestment return with modest risk. But recently that tide seems to haveturned.

SEPLAT'sfinancials have been hard hit by the coronavirus pandemic which has led to afall in global industrial activity and a drop in demand for gas and associatedproducts thereby causing a fall in the prices of both gas and crude oil. Thefall in price and the volume of products sold has meant a slide in SEPLAT'srevenues.

The double whammyhas reflected mildly in a decline in SEPLAT'srecent topline tumble. Turnover fell from N228.39bn in 2018 to N214.16bn in2019 (before COVID-19 problems emerged). On a nine-month basis SEPLAT'sturnover dipped from N151.88bn in 9 months 2019 (before the pandemic) toN135.62bn 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

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Profit Pains

SEPLAT'sunderlying business profitability took a slightly different course. In 2018 thecompany'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 profitnumbers seem to have turned downwards. 9months 2019 saw the group post a profitbefore 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 (seechart 3).

Nevertheless, withcoronavirus lockdowns eased in the Americas, Europe, and Asia, last quarterrevenues may reduce the profit pains as factories pick up modestly. A lot willstill depend on the ability of economies to cope with a second or third wave ofvirus spread.

Economies in Europehave already commenced lockdown protocols that could slow gas and oil use in Q42020. However, with Asian economies sustaining economic recovery, the oil andgas market may not witness a major price and volume slump as O&G companieslike SEPLAT hope to see better top and bottom-line earnings, as the year windsdown.

Chart 6 SEPLAT; Of Profits and Bungee Jumps

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The Bond Look Up

SEPLAT'sEurobond Issue of US$350m still has 28months before maturity and the B ratingof the bond could come under severe pressure if the coronavirus challengepersists into 2021 as the companies operating and free cash flows begin toshrink.

Investors in thecompany's Eurobond would, therefore, be unappreciative of a US$86mcontingent liability hanging over its head. In this light, analysts have arguedthat the company should come into some sort of negotiated settlement of thedebt in collaboration with its principal drilling firm, Cardinal DrillingNigeria Limited, the principal obligor on the loan. A speedy resolution of thematter would ensure that the oil and gas major can concentrate on its corebusiness and bring its activities to focus on a reversal of its decliningprofitability and a reimagining and strategizing of its business policies,processes, and programs for 2021.

The year 2021 willrepresent a crucial year for the Nigerian and global economies for differentreasons. Exchange rate devaluation will mean that companies that generateearnings in dollars would have greater foreign currency translation protection,hence improving their naira earnings in their currency of presentation. ButEurobond nominal values would also go up in naira terms (see table 3 below)

Table 3 SEPLAT's Changing Eurobond Naira Value

The Eurobond markethas created great opportunities for African companies to raise large sums ofmoney at relatively lower costs in local financial markets after adjusting forforeign currency translation costs. Nigerian companies have accessed theEurobond market since 2016 and have had relatively desirable outcomes. But in aCOVID-19 environment and post-COVID-19 African companies' access to theEurobond market may pivot in different directions as earnings become challengedand cash flows stutter.

Nevertheless,asides from raising debt, African companies have also moved into foreign equityIssues on international bourses (Equity exchanges). This has resulted in a fewdual listings. SEPLAT was listed on the London Stock Exchange (LSE) in 2014 (see illustration 1 below).

Illustration1 SEPLAT: A DoubleBlast of Equity

The total equityraised by African firms on the London Stock Exchange (LSE) since 2008 has beenGBP16bn while total debt raised has been GBP50.3bn (seeillustration 2 below). Going forward, African companies wouldperhaps raise a lot more money from abroad but how successful they will be willdepend heavily on the efficiency and profitability of their domestic operationsand their overall adherence to global best governance practices.

Illustration2 The African ForeignCapital Raise Journey

It is in this lightthat SEPLAT Plc needs to quickly resolve the Cardinal Drilling NigeriaLimited matter with Access Bank Plc to enable it to strengtheninvestor confidence and improve its credit rating in global capital markets,thereby enabling it to raise funds at lower marginal coupon rates.

While SEPLAT's bondtrades at a coupon rate of 9.25%, Zenith Bank Plc, another Nigerian company butin the financial services sector, has a Eurobond Issue trading at a coupon rateof 7.375% (see table 4 below).

Table 4 Zenith Bank's Eurobond Play

ZenithBank Plc initiated a US $1bn global medium-term Bond programme in 2014the bankraised a 5-year term instrument worth US$500m under the first tranche of Noteswith coupon rates at 6.25%. The Issue was oversubscribed by 160%. Investorsfrom the United States of America (USA) accounted for 44% of the Offer, while35% of the Offer was subscribed to by investors from the United Kingdom (UK)and 9% of investors came from the European Union (EU).

In2017, the Nigerian lender sold a second tranche of instruments worth US $1bnwhich was listed on the Irish Stock Exchange, the 5-year Eurobond Issue wasoversubscribed by 320% at a coupon of 7.375% and maturity due in 2022.

In2019, Zenith Bank repurchased US$392.6m worth of the second tranche issued in2017 and currently has an outstanding bond size of US$107,404,000 due to maturein May 2022. The bank paid for the notes accepted by it in line with a tenderoffer in cash equal to US$1,085 per US$1,000 in principal amount of the notesplus the accrued interest amount.

Thiswas a move to reduce the exchange rate risk of the debt.

With the localcurrency the naira sliding persistently, Eurobond Issuers need to take note ofthe rise in the nominal value of the bonds and protect themselves from adverseforeign exchange translation costs by hedging their currency exposures throughoptions and currency swaps. SEPLAT in particular needs to take heed.

Closing Thoughts: Able but Unwilling

Nigerian banks havehad several interesting and at times frustrating running battles withdefaulting customers, but the SEPLAT/Cardinal Drilling Nigeria Limited versusAccess Bank Plc legal slugfest adds interesting colour to the dimensions of thecanvass of how good loans could go bad, thereby making loan recovery a livingnightmare.

In SEPLAT Plc'scase, the matter dons an interesting toga as SEPLAT claims that it was not anobligor to Access Bank concerning the loan taken by Cardinal Drilling and thatit also did not represent as a guarantor of the loan. In this situation, therule of privity of a contract becomes a matter of determination. The legaloutcome of the case would provide lenders with insight into how credits couldbest be structured in situations where a customer provides a bespoke technicalservice to a client almost exclusively. Is the client responsible for the loanof the customer? And under what circumstances would the courts consider the principaloff-taker of a company's goods or services liable in the event of loan default?

Is CardinalDrilling Nigeria Limited/SEPLAT Plc ablebut unwilling to pay the bank loan? Resolution of the issue would add to thebody of knowledge bank credit and legal officers would need in taking creditappraisal and approval decisions. Bankers are usually caught in a bewilderingmaze that is beyond the underlying strength of a credit facility, the creditofficer 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", bankcredit officers are left with the art of cognitive discernment (using theirguts!).

With its strongunderlying corporate outlook, the jury seems weighed heavily on the side ofSEPLAT's capacity, but its unwillingness, to pay Cardinal Drilling Nigeria Limited'sAccess Bank debt, the reason for this could not be established at the time ofthis 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 afat bonus at the end of the financial year but if the gut feeling goes onholiday in the face of a bad borrower's clever charm, then the result could bevery unpleasant for everybody; the bank, the credit officer and the borroweralike. Proshare's character-capacity matrix is a great theoretical constructbut a difficult practical tool (see illustrationbelow).

Illustration3 A Lenders Dilemma

Nevertheless, thematrix provides a framework within which a credit officer can discern theoutcome of a variety of potential character vs capacity conflicts.

Conclusion- Making the Complicated Easy

In a critical yearsuch as 2021, SEPLAT Plc andAccess Bank Plc,both reputable companies listed on the Nigeria Stock Exchange (NSE), must cometo a resolution of the US$86m indebtedness of Cardinal Drilling in sucha way as to protect the confidence of foreign investors in SEPLAT's EurobondIssue as well as to ensure that the lending bank is provided a reasonableleeway for its loan book management.

The three partiesengaged in the loan resolution process may find a better turn to the matter bythinking from the mindset of a win-win rather than a win-lose outcome.

Battles, legal orphysical, might be exhilarating for a while, but after the testosterone-inducedjoy of combat is over, the bruises and pains that follow are no less real.