For a risk taker, the obvious opportunity with Afren (LSE: AFR) would be to negotiate a hard bargain to buy part of Afren’s distressed debt, rather than any of its equity, which lost 71% of value on Tuesday after the oil explorer issued an update “regarding the review of its capital structure, liquidity and funding requirements”.
However, the shares are up almost 40% on Wednesday in early trade.
Afren is running out of cash and will likely default on debt payments, in my view. So, it will have to try and raise fresh equity or sell itself, neither of which may turn out to be a fantastic outcome for shareholders, whose holdings are worth peanuts right now.
“Afren continues to be in discussions with Seplat,” the company said on Tuesday. You bet it does.
Mr Banker
“What a great opportunity to add exposure and buy Afren’s equity,” ‘Mr Banker’, who has been working in restructuring for 30 years, told me when the news emerged on Tuesday. That caught me off guard. I knew what Mr Banker meant, but is Afren really a great opportunity at this price? Other oil explorers — such as Premier Oil and Tullow Oil — for instance, seem safer investments, so I am not sure why anybody would invest in Afren… even at 5p/7p a share.
Much depends on whether the banks and bondholders will show mercy, and how quickly Afren is burning cash these days, which in turn will determine the amount of new equity needed to fund the operations. Afren doesn’t have enough cash on the books, so it needs to negotiate a waiver and amend its existing debt obligations with its bankers, who may provide it with the funds needed.
After all, cheap liquidity can be had in this environment. So, how much cash would Afren need to survive?
Time For A Brave Call?
Afren runs a business that costs between $2m and $3m a day, according to my best guess, which is based on Afren’s financials and cash flow statements.
Operating cash flow before adjustments in working capital came in at $496.2m in the nine months to 30 September 2014 (Q3 2013: $859.9m). After adjustments in working capital are made, including tax payments of $53m, net cash generated by operating activities was $454.8m (Q3 2013: $880.3m), Afren said last year.
That was just enough to cover investment in “producing” and “development” assets, “exploration” and “evaluation projects”, according to Afren figures.
“The company had a cash balance of approximately $235m at 31 December 2014,” Afren said yesterday. If I am right, and Afren is burning $2m/$3m a day, its gross cash pile would have come down to about $155m — which is consistent with Afren’s latest statement, according to which “liquidity available to the Company is significantly lower” now than at 31 December.
45/60 Days Of Life Left?
So the business has room to run as a going concern perhaps until late March. Of course, Afren has the cash to repay outstanding debts — but it must avoid debt repayments. It’s troubled and will default on its debts — which is not a big deal, really, if a company can successfully execute a recap.
The problem, however, is that even if it cuts back on capex to, say, $500m a year (about half the level of heavy investment in 2013) it’ll still need to raise about half a billion dollars from the equity market to survive for about a year or so…
