In a regulatory news release at 10.39 a.m. today — innocuously title “Corporate Update” — shareholders of oil company Afren (LSE: AFR) were delivered the final mortal wound in what has been a death by a thousand cuts.
The company announced that its latest discussions with its lenders “have failed to deliver support for a revised refinancing and restructuring proposal that would result in Afren Plc being able to pay its debts as they fall due. As a result, the Board has taken steps to put Afren Plc into administration … The relevant documentation will be filed at Court during the course of the day”.
The immediate precursor to the final nail in the coffin was materially lower near-term production and delays in project implementation announced on 15 July, meaning that production, timing and pricing assumptions used in a restructuring plan announced on 19 June went out of the window.
In truth, though, the writing had been on the wall for some time. Certainly, from 13 February, when Afren rejected a takeover approach, because it was not “n terms satisfactory to all relevant stakeholders in the Company, including the indicated value being significantly below the aggregate value of the debt of the Company”.
I warned readers at the time not to mistake the word “stakeholders” for “shareholders”, and that, due to Afren’s high level of debt, it was almost inevitable that shareholders would be massively diluted with a debt-for-equity swap at a few pence per share at best (the shares were then trading at 10p). It was all downhill from there, as power shifted increasingly from shareholders to debt holders.
Today’s announcement of administration for the plc, amounts to the debt holders — secured creditors — trying to preserving what value they can for themselves. Afren said that none of the group’s subsidiaries has appointed administrators and efforts are being made to continue the operating businesses. Ultimately, any value realised will go to the secured creditors. Equity has been wiped out.
Lessons
As part-owners of businesses, we shareholders tend to think of them as our companies. Indeed, the great Warren Buffett has said that is exactly how we should view ourselves. Of course, in thinking of ourselves as part-owners, we can become emotionally attached to our investment in a way that lenders don’t. Banks and bondholders don’t have the same attachment, and tend to be cold and ruthless if prospects for the cash they’ve loaned a company turn sour.
As such, equity investors should pay a lot of attention to a company’s level of borrowings, rates of interest and maturity dates before buying shares. Companies in some industries can carry a high level of debt without too much risk; for example, regulated utilities. Oil companies, though, can be extremely vulnerable: an oil price crash, asset writedowns and cash flow problems can soon put a company in dire straits.
As shareholders, we should perhaps also be rather more ruthless in recognising when the equity in businesses of which we are part-owners is in a downward spiral and when power is shifting to debt holders. Taking a loss is never easy, but salvaging something from our investment — as when Afren’s shares were at 10p, for example — at least leaves us with some capital to redeploy in a hopefully more successful venture.
