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Afren Plc’s Rescue Plan Means Massive Dilution For Shareholders

Shares in Afren (LSE: AFR) fell by more than 10% when markets opened this morning, after the firm said that a plan to refinance the company would result in “substantial dilution” for existing shareholders, who would be left owning just 11% of the shares in the refinanced company.

What will happen?

Afren has $230m of bond debt due in 2016, 2019 and 2020. Of this, 25% will be converted into shares in a debt-for-equity swap that will see these bondholders acquire 80% of the company’s increased share capital.

The remainder of these bonds will converted into $345m of new bonds due in 2019 and 2020. Alongside this, a further $321m of new bonds, due in 2017, will be issued. These will be used to repay $200m of interim funding that will be provided this month, and to provide a further $100m of cash for Afren.

A further round of new shares will then be offered to certain bondholders, and then finally, a further round of $75m of new shares will be offered to shareholders.

How much will the new shares be?

Afren hasn’t set a price for the new shares yet, but the firm did say that the existing 1p nominal value of its shares would be reduced so that there was no risk of new shares being issued below the nominal value.

To me, this suggests that shareholders should expect new shares to be issued at well under their current price of 5p — and possibly as low as 1p. Afren’s existing shares will also fall to this level when the new shares are issued.

What if shareholders vote against the plan?

This plan can’t go through unless shareholders vote to approve it at a general meeting.

Shareholders might be tempted to vote against this deal, but Afren made it clear today that the only alternative is much worse: the firm’s bondholders have prepared an alternative plan, to be used if shareholders vote against the proposed plan.

It’s a little complex, but the gist of the alternative plan is that Afren will be loaded up with new debt and forced to sell its business to repay this debt. This would almost guarantee that existing Afren shares would become worthless.

Afren’s bondholders can do this because the firm is in default: they could call in their loans tomorrow and force Afren into administration, if they chose to.

Afren is a good example of the level of risk involved in investing in companies that are in financial distress.

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Roland Head has a short position in Afren. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.