Afren (LSE: AFR) has managed to push back debt and interest repayments, and a few investors are happy to bet on takeover speculations, but to me it doesn’t look good — and it does not look like a solution is around the corner, either…
After all, why would Seplat (LSE: SEPL), the most likely acquirer, spend more than 5p a share for Afren’s equity? Am I being too bearish? Here’s what you should know about a possible merger between Afren and its suitor.
Way Out
Afren was up almost 100% in late trade on Monday, closing at 10p, up 88.7% on the day. It surged 44% on Tuesday morning at the time of writing, but its shares still show signs of distress. Technically, Afren has not defaulted on its debt — it has just agreed to push back repayments in order to save about $65m. That’s not a lot when you consider Afren’s debt pile is about $1bn.
As you may know, Afren may not have much time to get things right, and while a huge cash call north of $500m would help it continue to run its operations for about a year, such an outcome is highly unlikely, in my view. Then, there remains only one way out: a takeover by Seplat, an independent exploration and production company, which has time to come up with an offer by 13 February.
The Deal
Afren is not much bigger than Seplat, which should generate revenues of about $900m in 2014, and has a market cap of $1.1bn. Afren will likely turn over about $1bn in 2014, but its equity is worth less than $200m, given that the company is fighting for survival. If Seplat walks away, Afren will be in serious trouble…
Seplat secured $1bn worth of refinancing in mid-January, and that’s about the total enterprise value of Afren (market cap plus net debt). Combining the balance sheets of the two — and considering Afren’s $1.5bn of debt and Seplat’s latest revolver plus additional $500m of existing debt on its books — yields a pro-forma gross debt position of $3bn for the combined entity.
Afren’s gross cash position is negligible, while Seplat has about $400m of cash on hand. So, the combined entity’s net debt should come in at about $2.6bn in 2014, with Ebitda at $1.2bn, excluding synergies. This implies manageable net leverage, although the problem is how much cash will be needed to fund capital expenditures on an annual basis — which should comfortably come in at more than $1bn a year.
While there remains a reasonable doubt that the parties may reach agreement, Afren can be sold only if Seplat continues to have easy access to capital markets and raises more debt… but, to do so, Seplat will likely want to negotiate a hard bargain for Afren’s assets, and there is no reason why it should pay more than 7p for Afren’s equity, i.e. roughly last week’s level of 5p plus 2p for additional cash savings.
Outlook
Afren said in its H1 2014 results that it was targeting a five-year double digit production growth. The balance sheet remained strong, with net assets of US$1,972 million (H1 2013: US$1,498 million).
“Production ramp up starts in 2H 2014,” Afren added, listing a very healthy pipeline including projects known as Ebok (“6 new producers planned,” it said), Okoro (“1 infill well and 1 side-track well”), OML 26 (“3 new producers planned, currently logging while drilling (LWD) on first well”) and Okwok (“commence fast-track development drilling”).
On top of that, it predicted positive outcomes for Ebok deep exploration and “transformational reserves potential” (“only 26% of total discovered 2P/2C barrels in production or under development”).
For a company running the real risk of going out of business, such a pipeline is worth very little… but retail investors are mopping up the penny stock. They’ll have only themselves to blame if things go bad.