Discounted rights issue necessary if Tullow is to fix financial position and grow operations
Companies: Tullow Oil plc
Tullow today announces a proposed discounted rights issue to raise $750m. The share issue put forward offers investors 25 new shares for each 49 shares they currently hold, at a price of 130p for each new share.
The price of the rights issue represents a discount of 45% from yesterday's undisturbed share price. It also represents a discount of 35% from the theoretical ex-rights price of 201p for each new share.
The rationale for the rights issue is that, despite TEN commencing production late last year, the level of debt on Tullow's Balance Sheet is prohibitive. It's banking covenants were set such that net debt should not exceed 2.5x EBITDAX, which means earnings before interest, tax, depreciation, amortisation, and exploration costs. As of year end, 2016 Tullow's net debt to EBITDAX was 5.1x.
A Balance Sheet this stressed will take a long time to pay down, even with the level of free cash generation expected from the TEN field. Founder/CEO Aidan Heavey is passing the reigns to his long-time COO Paul McDade shortly, and the new CEO needs to be able to invest in order to grow the business. This means investment in exploration, production and development. Mr McDade's ability to do this is considerably stifled by the high level of debt, and so an injection of capital is a necessary step and should be welcomed by investors who believe in the business model of a full cycle E&P.
Tough few years for Tullow and other E&Ps
It has been a tough few years for Tullow. As oil prices tumbled from late 2014, its share price has fallen over 80%. Like many companies in the sector, it was geared up for a world of oil prices far higher than where they are today.
The nature of Tullow and other similar companies is that of multi-year, high-cost development projects and expensive exploration. This works when oil prices are high, and operating cash flow from producing fields are healthy enough to provide organic funding for future investment. However, cash generation has been severely impacted with the slump in Brent, and companies have moved as quickly as they can to manage costs, but these can not move as quickly as the oil price.
Tullow has cut its workforce by a staggering 44% since 2014. Exploration budgets, which were running at £1bn per annum in the high oil price days, effectively ground to a halt. Non-core assets were sold off, and Management put through some sizeable impairments to intangibles as it became apparent that the costs associated with exploration and appraisal of certain assets were never going to be recovered in the new, low oil price regime.
How will Tullow use the proceeds?
Management intends to focus on near-field exploration around its Jubilee and TEN fields. Discoveries here are higher margin barrels and can be brought to market far quicker than greenfield discoveries because of the proximity to Tullow's producing fields.
Another source of funds is ongoing exploration and appraisal in Kenya.
Tullow also raises the prospect of acquisitions with the following sentence: Tullow intends to "take advantage of other opportunities that industry conditions offer".
However, I would rather the capital is used primarily to improve the Balance Sheet and focus on lower risk, higher value near-field opportunities, than launch into further acquisitions or high-risk exploration.
Overall
Today's announcement should see the Tullow fixing its Balance Sheet issues and moving forwards. It does not benefit shareholders for companies like Tullow to be stuck in zombie mode, held back by week Balance Sheets, and so addressing this ahead of the new CEO taking the reins is a sensible move.
Shares opened down 15% in early trading and below shows the price history over the last five years.
