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xCite Energy a company once capitalised at £500m released probably the most inevitable RNS of 2016 this morning, perhaps only narrowly behind that of Gulf Keystones Debt for equity RNS in July. The headline of xCite’s RNS which saw the shares crater was ‘statement of share price movement‘, but the real headline should have been ‘Shareholders left with crumbs’, the real news was the following buried at the bottom of the release:
Whilst terms of the restructuring have still to be agreed, the Company now believes that there will be a minimal residual equity stake attributed to the Company’s existing shareholders following the restructuring.
The shares are down 66% to 2.5p, capitalising the company at £7.7m. What is disappointing is a big jump in the share price on Friday, based on twitter rumour of an imminent farm out. Market abuse which will no doubt go unpunished, but it’s AIM so it’s ok.
The company though has claimed it’s Bentley project has an NPV of over $2bn, how could it have come to this?
xCite Energy used bonds to finance the appraisal of the Bentley field, this is its only significant asset, a heavy oil field reported to contain 267 million Boe recoverable East of Shetland.
The terms of the loan are here but in essence were always a debt for equity swap waiting to happen, in summary the notes are secured and interest rate is 12% per annum with a Payment in Kind interest of 3% on top, which can be paid either in cash or additional bonds at Xcite Energy discretion. This translates to an effective interest rate of 15%, firmly a junk issue which reflects the perceived risk of the company and certainly not xCiteing for equity investors (sorry!). These bonds were issued in June 2014 for two years and thus due for repayment in June 2016. This was delayed until September 2016 to allow Xcite to enter negotiations with the creditors.
Many companies issue debt without hope of repaying it when it becomes due but assuming the company is low risk then the company can reissue further bonds on the same, or perhaps even better terms in this yield chasing environment. However, when xCite’s bonds were issued the oil price was over $100, so if this was a 15% per annum funding back then I can only imagine new noteholders would demand minimum 25% per annum now. This would obviously be totally unsustainable for xCite and in reality I doubt anyone would lend to xCite, without it being conditional on a substantial capital raise or farm out. Here comes the next issue for xCite, it has been trying to find a partner for Bentley since 2012 . The project requires $3.5bn of CAPEX and whilst the OPEX per Boe is relatively low at $13.2 per Boe you have to remember this is heavy oil project at 10-12 api. What does that mean? Difficult to produce, difficult to develop and oils fetching a significant discount to Brent. This is a high risk proposition for any investors.
The NPV of Bentley is stated by xCite at $2.3bn, with an IRR of 39%, however I have not seen the long term oil price assumptions used nor how sensitive the project is to CAPEX overuns and reductions to the oil price. Given that the data room has been open since 2012, what is it exactly is it that is putting potential investors off? Given that Hurricane Energy was able to raise £50m at a premium recently suggests to me it could be the that the Bently asset is unappealing rather than the market per se. So with no other method of raising funds all the cards are with the bondholders…
So can bondholders take everything from here and how much will be left for equity holders?
What many equity investors fail to understand properly is that bond holders demand lower returns than equity holders, but consequently also demand lower risk. This requirement is the basis for the order of preference of creditors in the event of liquidation or administration, as defined by UK law. I’ve listed the order below and for avoidance of doubt I have underlined the category that xCite’s bond holders fall into.
- Fixed charge holders.
- Liquidators’ fees and expenses.
- Preferred creditors.
- Floating charge holders.
- Unsecured creditors.
- Interest incurred on all unsecured debts post-liquidation.
Once a company gets into default on their debt the bondholders can petition the high court for the company to be placed in administration. The administrators will then find try and recover as much value as possible in the order stated above. Under this process shareholders will typically get £nil. This process is time consuming and expensive though and therefore bondholders typically will prefer to offer equity holders a token, enough of an incentive to approve a shareholder resolution to increase the share capital by sufficient amounts to complete a debt for equity swap. However, the above is fundamentally why secured bondholders are always in the driving seat during a restructuring.
In terms oh how much ‘residual’ value equity holders will get, it usually is a good indicator to look at the levels the bonds are trading at, i.e. if the bondholders are expecting a haircut then equity gets nothing, it looks as though this bond issue is highly illiquid and I can’t see any bonds being traded in the last year. However, let’s look instead to the recent Gulf Keystone restructure, where existing shareholders received 4.5% of the enlarged share register. In this case I see between 2.5% and 5% at best.
What is the future for xCite?
The Bentley asset has had little interest so far from third parties and clearly xCite is not in a strong enough position to raise the capital that it needs to go alone. The bondholders though will know it is a real risk that they are stuck with an asset they can’t develop, at least until oil is >$100. In addition by their very nature bondholders are unlikely to want to hold the equity long term. They will therefore be keen on crystalising whatever they can. I think therefore the best opportunity for xCite is a distressed sale post any debt for equity swap, in my view this will probably be most likely to private equity.
Again it is terrible to see private investors lose so much on xCite and I genuinely hope they get as best deal they can, my fear is this will be much lower than current share price…
SELL – Target 0.5p
Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.