By Ghassan Chehayeb of Exotix Limited
A showdown is brewing in Sharjah, the UAE’s third largest emirate. Sharjah-based Dana Gas, a natural gas-focused E&P company, has a $920m sukuk due in five months, yet the issuer is far short of the required funds to repay the obligation. The sukuk’s price has fallen from above 95 in July 2011 to just 68, as restructuring headlines continue to spook investors.
This situation has gained increasing global attention given the involvement of prominent international advisers and foreign investors and there is a high probability that Dana will become the first public bond restructuring in the UAE’s history.
Dana’s liquidity is very stressed. As of 31 March, the company had $143m of cash on its balance sheet and will potentially have just 32 per cent of the cash needed when the sukuk matures on 31 October. While the company’s operational performance has been strong since its inception in 2005, its cash-intensive growth focus combined with its receivables collection headaches have continued to soak up cash. Political upheaval and economic pressures also continue to strain the company’s operations in Egypt and Kurdistan. Refinancing options are also seemingly out of the question, as it would prove very difficult for a distressed borrower like Dana to secure adequate debt capital to plug such a daunting liquidity gap prior to the sukuk’s maturity. Banks in the UAE and Egypt remain very strained, and syndicated lending in the Middle East fell to a seven-year low in 2011, as European banks scaled back to repair their own balance sheets.
Heavyweight international advisers are now battling it out behind closed doors in an attempt to get the best deal for Dana and its creditors, who have reportedly hired Linklaters LLP, the world’s sixth largest law firm, to help negotiate a potential restructuring of the sukuk. In mid-May, Dana issued a press release confirming media speculation that it has hired Deutsche Bank and Blackstone Group to assist on its end of the restructuring negotiations.
Dana’s restructuring will be a hard-fought battle, which is likely to end badly for sukuk holders given their weak negotiating position (sukuk holders only have recourse to Dana’s least valuable businesses). Exotix estimates a recovery of only 52 per cent for sukuk holders in a liquidation scenario – such a low recovery rate lowers creditors’ incentive to threaten a default. To complicate matters further, creditors face a challenge if they attempt to seize control of the sukuk’s collateral in Egypt and the UAE, as both countries have inefficient bankruptcy frameworks and it is doubtful that either government would allow foreign creditors to gain control over energy-related infrastructure.
Any bailout options now seem remote, particularly since Crescent Petroleum, Dana’s deep-pocketed strategic investor and creditors’ last remaining hope for a bailout, has stated that it would not be coming to sukukholders’ rescue. A government bailout also seems unlikely as Dana Gas is not a government related entity (GRE): it pays no local tax revenue, 99 per cent of its EBITDA stems from Egypt and Kurdistan, and the Sharjah government holds only a 2.2 per cent stake in the company. In fact, recent friction between Sharjah and Dana could exacerbate its problems; Bloomberg reported that Sharjah might terminate Dana’s large Zora Gas field concession in the city-state due to the company’s lack of production progress.
Dana’s creditors are now caught between a rock and a hard place. Now that a restructuring is essentially a foregone conclusion, the focus should next turn to the most probable restructuring outcome (ie, the terms). Given creditors’ weak negotiating leverage, it is likely that sukuk holders will draw the short straw. It is highly possible that the full obligation is termed out for a minimum of five years to allow Dana sufficient breathing room for cash flows to eventually recover. In this situation, creditors might receive a slightly higher coupon than the current 7.5 per cent to partially compensate for the extension. In a best case scenario, Dana might be willing to repay 20-30 per cent of the obligation at maturity in October, either in cash or stock, while the remaining obligation is termed-out.
A default scenario should not be ruled out, however, as it is possible that creditors and Dana’s management could fail to agree on restructuring terms. On 19 March, the Bahraini investment firm, Arcapita, filed for bankruptcy protection in US courts having failed to reach an agreement with lenders to reschedule a $1.1bn facility. Like Arcapita, it is not impossible that Dana’s hedge fund creditors could also holdout on a restructuring agreement to seek a better deal for themselves.
The UAE has historically been a friendly and lucrative environment for bondholders. Despite all of the UAE corporate and GRE bank debt restructuring agreements from 2009 to 2012 (e.g. Dubai World), there has never been a sukuk or bond restructuring in the UAE. Thus, a restructuring of Dana’s sukuk would set a precedent in the UAE. Several market participants believe this will raise the risk premium on the country’s non-government related issuers and hurt their access to the capital markets. All else equal, strategic GREs should trade at a lower risk premium to their private peers. However, a future negative bias towards UAE private issuers because of the Dana Gas precedent seems unjustified. Rather, it should instead lead to more efficient pricing in the market. Outside the UAE, many regional public credits of private issuers have either restructured or defaulted since the global credit crisis of 2008/09, including in Bahrain (Gulf Finance House, for example), Saudi Arabia (Saad Group), Kuwait (The Investment Dar), and Oman (Blue City).
Dana’s sukuk offered a relatively high coupon of 7.5 per cent at issuance – a reward that investors surely realised meant greater risk. Bond investors in the UAE have historically been spoiled, and have often relied on the potential for a government bailout as a key criteria in their investment decisions. A restructuring of Dana’s sukuk will likely teach creditors a lesson – traditional stand-alone credit analysis is critical, as we can no longer always expect a free lunch in the UAE.
Ghassan Chehayeb is director of research for the Middle East and north Africa at Exotix