- A sovereign debt hedge fund is reported to have taken a 25% stake in a gas company with a US$9.0 billion claim against the Federal Government of Nigeria (FGN).
- If successfully applied in US court, the Nigerian Government could be forced to pay the company, P&ID, US$9.0 billion, or otherwise face freezing of US dollars.
- This begins to raise the question of how the Federal Government of Nigeria could reach a settlement with P&ID or, if the worst comes to the worst, finance a US$9.0 billion liability.
Cause for worry
According to Bloomberg, a subsidiary of hedge fund VR Group has purchased a 25% stake in Process and Industrial Developments (P&ID), which has an approximate US$9.0 billion claim against the Federal Government of Nigeria.
The P&ID case has been featured in the Nigerian and international press over the past year. However, the fact that VR Capital Group (a hedge fund that specialises in distressed sovereign debt) has taken a stake in the claim, underlines the serious implications of the matter.
The original (English court) arbitration favoured P&ID, and was upheld in 2017 with a final award of just under US$6.6 billion (naira 2.4 trillion at today’s exchange rate). But with interests accruing, that award is currently close to US$9.0 billion (N3.2tn). The English court award is currently being applied in the US courts.
For comparison, the FGN’s 2019 budget (as currently proposed) is N8.8tn (US$24.4bn) and the foreign exchange reserves of the Central Bank of Nigeria (CBN) are US$42.9bn. An award of this size, if upheld and applied, could have serious implications for Nigeria’s fiscal position, borrowing costs, and even its foreign exchange position. In our view, it represents a significant new risk.
P&ID versus the FGN: Origins of the case
P&ID is reported to have entered into a contract with the Ministry of Petroleum Resources of the Federal Government of Nigeria (FGN) in 2010. According to reports, the agreement obliged P&ID to build a natural gas processing plant, while the FGN would build pipelines to bring untreated gas to the plant. The gas is, otherwise, flared in the course of oil production.
P&ID alleges that it invested US$40m in the project, although it did not actually build a plant. The company also alleged that the FGN did not build the pipelines specified in the agreement. Therefore, it (P&ID) is entitled to compensation for lost earnings as a result.
The governing law is English
P&ID applied to an English tribunal in 2012 and won a ruling in 2015. This was upheld by the English tribunal in 2017 with an award of US$6.597 billion, and interests accruing.
In order to enforce this award, P&ID’s next step was to start applying it in the United States (US), with the intention that, ultimately, some of the FGN’s US dollar assets could be frozen if the FGN did not either pay in full or reach a settlement. Such cases follow the New York Convention which allows winners of arbitral awards to enforce them in signatory countries.
The case for enforcement was heard last year by the District Court for the District of Columbia. P&ID were represented by Kobre & Kim, a US law firm that specialises in international contract disputes. Lawyers for the FGN argued that the FGN is protected under the Foreign Sovereign Immunity Act (FSIA), and the FGN was given leave to appeal to the US Court of Appeals for the District of Columbia Circuit.
VR Group gets involved with its specialist knowledge in distressed debt
It is not clear to us, at this stage, how the FGN’s appeal citing the FSIA has progressed. However, it was about the time of the FGN’s decision to use this defense that VR Capital Group was reported to have involved itself in the case by buying, according to Bloomberg, a 25% stake in P&ID.
VR Capital Group, founded and run by London-based hedge fund manager Richard Deitz, has a history of buying distressed sovereign debt, having done so in the case of Russia (1998), Argentina (2001), Greece (2012) and Ukraine (2014) among others. While P&ID clearly had resources to mount legal action from 2014 until now, the involvement of a sovereign debt specialist like VR Capital Group suggests a degree of renewed confidence in the progress of P&ID’s case.
The FGN has several options open to it, in our view. It is not ignoring the case (ignoring it could hasten the process leading to freezing of US dollars) and vigorously contests its validity. But the FGN could also negotiate. Indeed, many cases of this sort are settled. Even then, however, a negotiated settlement could still be costly and might necessitate the FGN raising money to pay it.
One way of raising money would be to borrow in the international markets. As the table on page 1 of this report shows, Nigeria has proven adept at this. The obvious problem in this instance, however, would come under the heading ‘use of funds’ in any related debt prospectus. To borrow money to pay a large debt which arguably should not have been incurred in the first place sounds weak, we believe.
This suggests that some kind of special purpose vehicle (SPV) could be created to raise money, with the FGN obliged to service the liability. Creating such vehicles is stock-in-trade of certain sovereign debt advisory practices, and it is not difficult to imagine that they are already offering their services to the FGN.
Another way to raise money would be to privatise state-owned assets. The irony here is that privatisation is not a policy favoured by the recently re-elected administration of President Muhammadu Buhari. So, if this option is selected, it would represent a policy reversal.
The state and the people
One point worth raising, in our view, is that if P&ID’s case succeeds it would be a problem for the FGN in the first instance rather than a judgement served on the private sector in Nigeria. In some instances freezing orders against governments have exemptions for payments under existing contracts and essential humanitarian items. However, these exemptions do not go so far as to let governments off the hook: they feel the pinch, especially when it comes to raising money.
The question, therefore, is to what extent a government feeling the pinch would be able to turn to the private sector for help. US dollars play a critical role in Nigerian private sector entreprise. Nigerian oil companies and some agricultural producers are important sources of US dollar revenues for the economy. Foreign remittances to Nigeria run at some US$25.0bn per annum and are important to Nigerian households. US dollar deposits account for up to half of deposits held by Nigerian banks.
Note on sources
Progress of the case brought by P&ID against the FGN can be followed by accessing court records stored by private sector companies. One source is the Law360 website which is owned by Premium Media Inc of the US, whose parent company is LexisNexis. This website has details of the cases in the District Court for the District of Columbia. Records of these cases are also held by Bloomberg Law.
The US District Court for the District of Columbia does not itself, at the time of going to press, post records of the P&ID case on its website. As for the original ruling against the FGN, arbitration under English law is private although it can become public through disclosures in other courts.
Buy what? Dangote vs BUA Cement
Dangote Cement has a market capitalization of N3.65 trillion, while BUA posts a N2.49 trillion capitalization, but does size win?
I want to review the performance of the largest quoted companies in Nigeria.
On the Nigerian Stock Exchange, they don’t come any bigger than Dangote Cement (Dangote) and BUA Cement (BUA). Only MTNN stands with both cement companies in terms of market capitalization. Dangote and BUA are both blue-chip companies, in the same sector and both enjoy federal import protection, they also both serve a local market with huge demand for cement.
Which is a better investment? Let us assume I have N100,000.00 (One Hundred Thousand Naira,) which should I buy? Let us review both stocks with FY 2020 results they posted. For consistency, I am going to use my trading view terminal numbers.
First, we talk about capitalization, (Market cap is the number of shares issued x market value of shares ). Dangote Cement has a market capitalization of N3.65 trillion, while BUA posts a N2.49 trillion capitalization. Does size win? Dangote is bigger? Not yet!
With N100,000 I can buy about 465 shares of Dangote at N215 a share and 1,360 shares of BUA at N73.50 per share. Is BUA cheaper? do we have a winner? Not quite. Let us dig deeper.
Dangote Cement posted a Net Income figure of N276 billion, if we divide this earning by the number of issued shares which is 17 billion, we get an Earnings Per Share (EPS) of N16.14, so every share of Dangote Cement earns (not pays) the investors N16. Similarly, the Earning Per Share of BUA is N2.0
Thus when I buy Dangote Cement N215 per share, I am buying 16 times the earnings of Dangote. We can simplify this by simply comparing the price I pay per share of Dangote to the EPS of Dangote (Price to Earnings Ratio), thus I invest my cash of N215 to buy 16 times the earnings of Dangote, thus the Price to Earnings Ratio of Dangote is 13.31 (P/E). Using the same calculation, the price for each earnings of BUA (the P.E.) is 35.38. This means even though I am paying more cash for each share of Dangote, I am paying less to buy the earnings of Dangote, thus Dangote is cheaper than BUA.
So our first milestone is reached, we have used the Net Income, Market Price, and Number of Issued shared to get the Earnings Per Share, we have then determined what amount of earnings we are buying to determine which stock is at a bargain.
Let us look at the earnings that will be paid in cash. Remember, Earnings, is just the Net Income of Dangote, we as equity holders have the opportunity to share in any portion of the Net Income.
Dangote in 2020 paid out from earnings N272.69 billion as dividends, this translates to about N16 per share or in terms of returns 7.44%. We get this Dividend Yield return by comparing the dividend paid to the market price per share (D/P). BUA also in 2020 paid out N59.26 billion as dividends from earnings, this translates to a dividend yield of 2.81%.
So, if I invested N100,000 in shares of Dangote Cement, I would earn a cash return of 7.44%, if I did the same with BUA I would earn a cash return of 2.81%.
Let us go a bit deeper…
When you buy a stock, you are buying into the earnings and cash flow. Dangote Cement in 2020 earned N276 billion and paid N272 billion as dividends meaning they retained about N3 billion for that FY while generating over N248b in Free Cash Flow. Similarly, BUA earned a net N71.52 billion, paid out N59 billion in dividends, retained N19 billion but posted a negative Free Cash Flow of (N95.49 billion). Should BUA cement have simply used that cash to finance working capital rather than paying it as dividends? Perhaps. Let us speak more of Cash flow.
Cash retained is cash not paid to you the investor. You have to ask how well your company is utilizing that cash retained. Should it all be paid out as dividends? Or retained in the company to fund expansion and growth?
Look at it this way, if Federal Government Bonds were offering a Yield of 15% and we see that Dangote is offering a yield of 7.44%, then as shareholders you should demand that Dangote pays more cash to you to allow you to invest in FGN bonds because you get a higher return (at lower risk). The point is any company retaining cash or paying cash at a lower yield than the market is hurting the investors, who are missing the opportunity of investing higher elsewhere.
Let us score both company managers by how well they have managed the revenues and capital of the companies
|Return on Assets %||Return on Equity %||Return on Invested Capital %||EBITA Margin %||Net Margin %||Debt to Assets||Long Term Debt to Assets|
Across the board, the management of Dangote Cement has done a better job when compared to BUA Cement in managing the assets of the company. Dangote Return on invested capital is higher with a much lower recourse to debt and of course a higher FCF number.
Overall, on Earning, Returns and Efficiency, it appears Dangote Cement posts better fundamentals…
Do follow @FinPlanKaluAja1
This is not investment advice, this is not a recommendation to buy or sell. Past performance is not a guarantee of future performance. Speak with your adviser before investing. Equity is risky.
Is something fishy going on at Custodian Plc?
Custodian stock hit a year high just as it announced a Convertible Loan Instrument set to be approved at its AGM.
Custodian Plc, one of the largest insurance companies in Nigeria is currently trading at a new year high of N7.10 and is up 21% year to date. Nairametrics Blurb team has in recent days noticed an upsurge in its share price especially since the company announced its AGM.
As we pen this article, about 2.9 million units have exchanged hand at a share price of N7.
The stock is included in the Pension Index and by some measure quite illiquid. It is also one of the stocks recommended in our Premium Service Stock Select Newsletter thus the need for further introspection.
Custodian Investment AGM
Typically, when companies announce AGMs we are keenly curious as this is where decisions that can ultimately affect shareholders (especially smaller retail investors) are approved.
In its recent filings, the company stated as follows in item 10.
That the Board of Directors of the Company be and is hereby authorised to:
(a) raise the Naira equivalent of up to $15,000,000.00 (Fifteen Million US Dollars), as additional capital through a convertible loan instrument;
(b) convert the loan in the Naira equivalent of up to $15,000,000.00 (Fifteen Million US Dollars) into shares in the Company (the “Conversion Shares”) at a conversion price, being the higher of N6 per share or the 12-month historical average daily share price of the Company derived from the Daily Official List of The Nigerian Stock Exchange (for the period ending on March 23, 2021), subject to adjustment upon the occurrence of certain adjustment events;
(c) allot the Converted Shares to the Lender upon the exercise by the Lender of its right to convert the Loan into shares in the Company, subject to applicable law; and
(d) take steps necessary or reasonably desirable to give effect to the foregoing resolutions and for effecting any transactions pursuant thereto, including the appointment of professional advisers, and the obtention of relevant regulatory approvals.
What this means?
In simple English, the directors of Custodian are seeking the approval of its shareholders to borrow $15 million (N6.1 billion) in convertible loan instrument.
A convertible loan instrument is simply a loan that you can convert into shares if the lender so wishes. The share price for conversion are predetermined and in this case, they stated N6 per share or the 12-month historical average daily share price of the company’s stock.
If the lender does decide to convert the loans to shares at the current share price of N6 per share, it means about 1 billion shares will be offered to the lender, an equivalent of 17.4% of the total outstanding shares of the company. This loan is in effect, a potential dilution of existing shareholders of the company if it is approved at the AGM.
So why is the company seeking a convertible loan or even diluting its shareholders?
Fishing around for why
Typically when a company decides to raise money via a convertible loan instrument, they are looking for lower interest rates, debt that avoids the burden of periodic repayment, and/or looking to delay when the actual equity is issued. There are also tax considerations at play but not as significant as the ones mentioned above.
Except, Custodian is looking to purchase another asset, after it bought UPDC, we do not understand why it will be looking to raise capital huge enough to dilute existing shareholders. It also did not explain why it is seeking to raise the said capital in its AGM Notice, a slight departure from the norm in cases like this.
- Custodian is also highly capitalized with a Net Asset of about N46 billion and a balance sheet size of N176.1 billion (after the acquisition of UPDC) as of 2020.
- Suffice to add that the company recently paid shareholders about N2.6 billion in dividends, making us wonder why it is seeking to dilute shareholders when it could have just ploughed that amount to its capital raising needs.
- In fact, the dividends paid in 2020 was just 21% of profits, meaning it had retained about N10 billion in profits made during the year. Again, why does it need N6.1 billion in loans?
- Custodian also has a thriving insurance business which fetched it about N58 billion in gross premium income out of which N32 billion was from non-life. Again, why does it need N6.1 billion on convertible loans?
- The company currently carries a debt of about N5.5 billion which was inherited from its acquisition of UPDC. The debt is mostly a bond issued at an interest rate of 16% per annum and due for full liquidation in 2023.
- There is no rush to pay down this debt.
We are lost as to why the company is looking to raise this capital and can only now think of two reasons. Firstly, could it be the existing shareholders looking to tighten their stake in the company? Custodian’s majority shareholders are Gratitude Capital Limited and Mikeade Investments Limited with 22.48% and 15.72% respectively.
- The company CEO Oluwole Oshin represents Gratitude Capital while Business Mogul Micheal Ade (Elizade) owns Mikeade Investments Limited. Could it be either of these two investors looking to up their stakes?
- There could also be a reason for this back door approach. About 74.5% of the company is owned by just 20 shareholders so it is clear that increasing majority stake will be difficult to achieve.
- The other reason is perhaps an institutional investor looking to acquire a significant stake in the company through the backdoor. Is this plausible?
Well, these are speculations that only Cusdotian can confirm. We hope they do so as soon as possible.
Nairametrics | Company Earnings
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