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Gulf Keystone determined not to go the way of Afren

By Ben Turney | Tuesday 31 March 2015

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Gulf Keystone’s (GKP) board might not be popular among shareholders at the moment, but it’s been left with little choice. The likely trigger of the Book Equity Ratio (“BER”) Put Option, when the company announces its next set of results, is a looming disaster for the company. If activated, Gulf will be required to make an offer to repurchase all of its $250million 13% Notes, issued last April, for $252.5million plus accrued and unpaid interest, at around the end of September. Given that Gulf had cash of $86.3million prior to this morning’s placement, and appears to be burning about $4million a month, shareholders were facing an Afren’esque (AFR) wipeout. After this morning’s actions, at least there is a glimmer of hope.

Though I see hope Tom Winnifrith, who has called this 100% correctly so far as a sell, does not and he puts the bear case HERE

Although not afflicted by the rose tinted glasses of many others, I’ve been supportive of Gulf for most of the last year. The fall in Gulf’s share price says I’ve been wrong in this, but I remain convinced that CEO John Gerstenlauer has made the best of an awful situation. He cannot be blamed for the implosion in the oil market and rise of Islamic State. However, I do not believe he’s received enough credit for containing and controlling the legacy of toxic corporate issues he inherited, when he took the helm.

Gulf hit its 40,000bopd production target by the end of 2014, despite rampaging lunatics marauding through the region. Then, through some adept negotiating tactics, Mr Gerstenlauer was able to squeeze some of the money Gulf is owed out of the Kurdish Regional Government (“KRG”). Having halted production for international oil sales, apparently to force the KRG’s hand, Gulf appears to have recommenced production for export and steps have been taken towards establishing the long-awaited regular payment cycle.

Considering the significant progress he had made, in the face of such adversity, Mr Gerstenlauer must have wondered what he had done to upset the Fates so, when the latest calamity hit his company.

Dismissed by some as a technicality, the BER was a threat to Gulf, which nearly everyone seems to have missed. Clearly described in last April’s bond prospectus, the maths behind the trigger of the BER are simple enough. If the ratio of total equity to total assets fell below 0.4 for sixty days after the filing of a financial report, then Gulf is required make the offer to repurchase its $250million 13% Notes, as described above.

On March 12th, we learned that Gulf had received warning from its auditors that the company’s book to equity ratio was likely to be below 0.4, in the Annual Results for 2014. Gulf is due to release these results on April 9th.

The official explanation for the fall in Gulf’s book to equity ratio is apparently down to a write-down in the Akri-Bijeel Block. We still need to see confirmation of this in next week’s results, but a quick look at the last set of figures reveals the tightrope Gulf was walking on.

At the end of 2013 Gulf’s book to equity ratio was 0.57, comfortably above the BER trigger. Total equity was $562.37million and total assets were $980.82million. However, according to the unaudited results for H1 of last year, Gulf’s book to equity ratio had fallen to 0.46. Total equity increased slightly to $558.75million, but total assets grew to $1.215billion. This left Gulf exposed to a write-down. In light of what has happened since in the oil market, the pending trigger of the BER was sadly all too predictable.

Of what a wonderful thing hindsight is…

There are some vocal critics of the terms of the $250million 13% Notes, but the reality is this was high-risk funding. With all that has happened since, the bond market has, once more, shown itself a better predictor of future prospects than the equity market.

But where does this now leave Gulf?

As of writing it doesn’t look like Gulf has yet secured the agreement it needs from 75% of the holders of the $250million 13% Notes, to gain approval for removal of the BER, at the EGM on April 7th. Yesterday morning, Gulf announced it had extended the deadline of the Early Consent Time and Expiration Time, for note holders to submit their acceptance. This made yesterday’s 3.25p (8.72%) rise in shares of Gulf all the more mystifying, as the suggestion was there was material uncertainty whether or not the company would gather enough support.

Then came the announcement of the placement, after hours.

As unpalatable as this has been for many, it looks like another astute move by Mr Gerstenlauer. The placement is dependent on Gulf securing the votes it needs to remove the BER. If there are any note holders attempting to hold the company hostage, the message is clear. Accept the offer or face a much larger loss, when Gulf defaults, which it surely must if the BER is triggered.

While waving this stick, Mr Gerstenlauer has also offered note holders a little carrot. By proposing to dilute shareholders at this stage, Mr Gerstenlauer has given note holders added incentive to accept the new terms, not least because Gulf will emerge with a much stronger balance sheet. This, in turn, increases the prospects of the company surviving its difficult period and repaying its bondholders in full, through an asset sale or, dare I say it, operational delivery.  Last night Gulf’s 13% notes traded at 66c and its 6.25% notes at 40c. The potential for upside for bondholders is clear.

Now it is a case of Mr Gerstenlauer successfully navigating Gulf through next week’s EGM. The retirement of Gulf’s Non-Executive Chairman, Simon Murray, could be an indicator that he is going to achieve this. Arguably one of the legacy issues of Gulf, Mr Murray’s timely departure is likely going to please certain key shareholders. Their ongoing support should prove vital for Gulf in the coming weeks.

So long as Mr Gerstenlauer can prove he has sufficient backing for Gulf, it must surely be in all stakeholders’ interests to avoid a default. At 35p, there is plenty of downside if the BER is triggered, but for some this might be a gamble worth taking. 

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  1. Why an earth would anyone choose to put good money in here , knowing what we know . If you give me your money I will burn it in the incinerator in my backgarden for a small fee ( say 5%) and you can cut out the middle man . Or just put it in a safe country with news coming soon . LGO in Trini fits the bill ………… at the bottom of its range , unwound from last year and first drill news of 2015 coming soon ……… of eight wells being drilled in 2015 .

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