Gulf Keystone Petroleum (LSE: GKP) shares have fallen by 30% this week, after the company admitted that it’s about to run out of cash. In this article I’ll explain what might happen next — and why I believe the shares are still a sell.
The big problem is that Gulf needs “near-term fundraising” to meet its debt obligations and to maintain production. When a company is this desperate, potential investors always drive a very hard bargain.
Here are three reasons why I expect things to get much worse for Gulf shareholders.
1. Cash is very, very tight
Gulf has a $26.4m interest payment to make. This should be paid on Monday 18 April, but the firm is using a grace period option to delay the payment until 2 or 3 May. Doing this has given Gulf another two weeks to try and find some money.
The problem is that although Gulf had $69.5m of cash on 12 April, the terms of the firm’s bonds require Gulf to keep $32.5m of cash in a reserve account. Just $37m is available for the firm to spend. Once this month’s interest payment has been made, about $10m will be left.
Since Gulf’s cash costs are about $8m per month, this will make the firm dependent on its monthly payments from the Kurdish government. In October, another $26.4m interest payment will be due. Gulf seems unlikely to have enough cash for this.
2. Production will fall
The firm has warned investors that oil production from Shaikan will fall this year unless money is spent on increasing output. Gulf says $71m is needed to maintain production at the target level of 40,000 barrels of oil per day.
Falling production means that monthly sales payments could fall. Last month’s payment of $13.2m included $4.3m for March 2016 exports. If production falls, this payment may shrink.
3. The final result
In addition to $71m this year, Gulf will need $575m next year to repay its bonds. These already trade at a big discount to their face value because the market thinks Gulf is likely to default on its repayments.
Refinancing these bonds will probably require bondholders to take a loss. Shareholders, who rank below bondholders, will be left with much bigger losses. There are two likely scenarios, in my view.
The first is a debt-for-equity swap. Gulf’s lenders will swap their bonds for new shares and put some fresh money into the firm. In return for this, they will take a majority shareholding in the firm. This will reduce the value of existing shares to almost nothing, as we saw with Petropavlovsk.
The second option is that a new investor will buy Gulf’s debt from the existing bondholders and take the company private. In this scenario I would expect a total loss for shareholders.
Follow the ‘expert’ money
Earlier this week, Gulf’s last institutional shareholder, M&G sold its 5% stake in the firm.
It may be a bitter pill to swallow, but I believe that selling Gulf Keystone now is likely to minimise any future losses. If the firm is refinanced — which isn’t certain — then there will probably be safer opportunities to buy back into the firm in the future.
