Afren’s (LSE: AFR) shares have fallen in value by almost 99% over the past year, as the oil and gas producer defaulted on its interest payments. Its debt burden, which currently stands at $1.65 billion, has become unsustainable with the lower oil price, and the company is now seeking debt restructuring and recapitalisation.
The recapitalisation plan
Bondholders have agreed to a debt-for-equity swap, which will see 25% of existing bonds being converted into equity. This will reduce the company’s debt by $233 million. Afren will raise about $225 million in net cash proceeds through a combination of the issuance of new high yield notes and a share offer to existing shareholders. The proceeds will be used to fund development of its production assets in Nigeria.
Because of the issuance of new high yield notes, total debt will actually rise to $1.80 billion. Afren will face a reduction bank repayments of US$311 million in 2015 and 2016, as debt repayments are shifted further into the future.
Shareholders’ stake in Aften will be diluted to approximately 15% after the recapitalisation plan. However, this assumes that existing shareholders fully take up the offer to subscribe £49.2 million worth of new shares. Shareholders have yet to vote on whether they accept the restructuring plan.
The company warned shareholders that if they rejected the plan, they would likely see no return of value on their investment. “If the proposed plan is not approved then the alternative restructuring process will proceed, with no scope for flexibility” said CEO Alan Linn. The alternative plan would force Afren to take high interest loans and sell its assets by 2016.
Can Afren recover after its recapitalisation?
The fall in oil prices and disappointing exploration results in the Kurdistan region of Iraq led to some $2 billion worth of impairment charges in 2014 alone. After recapitalisation, Afren should focus on the cash generative business of production and sell of its diverse exploration portfolio, in order to pay down its debts.
Restructuring the independent upstream exploration and production company wont be easy. But by focussing on its high margin production operations in Nigeria, where production costs per barrel are low and where the company is already producing there, Afren has a chance. The three core producing assets in Nigeria, Ebok, Okoro and OML26, are profitable even if oil prices fall to $50 per barrel.
Afren may not need a high oil price to ensure its production is profitable, but it does need a higher oil price to ensure it generates enough cash flow to keep up with its debt repayments. This makes investing in the shares of Afren seem much more of a leveraged bet that oil prices will recover more strongly, and in a shorter span of time, than what markets currently anticipate.
Otherwise, the high debt burden of the company would likely mean that investors will see little return to their investments. If oil prices stays low for longer, then the recapitalisation plan would only delay its bankruptcy.
So should you buy?
Volatility in Afren’s share price creates short term trading opportunities, and a ‘Yes’ vote from shareholders in favour of the recapitalisation plan will likely give its shares a quick boost. But, the risks of investing just seem too high for me.
