Tullow - comment

Press reports that a group of senior secured bondholders are working with Cleary Gottlieb to attempt to stop the Company from doing further buybacks of the unsecured bonds. We have highlighted this possibility in the past, and with the NPV Coverage Ratio exceeding 2.5x (2.0x is the upper limit on the covenant, where 100% of FCF can be added to the restricted payments basket) we expect the Company will consider further distressed tenders of both the secured and unsecured bonds. 

The Company is obliged to purchase $100m of the Secured bonds every year in May, which currently stands at $1.6bn from its original size of $1.8bn. The Company also bought back $167m subordinated bonds, due in March 25), at an average price of c.60% using $100m of cash under the restricted payments basket. 

We see no legal restriction on further tender of the unsecured, subject to FCF of the Company, but view the actions of the rating agency, which downgraded the bonds on the back of the opportunistic tender, as the main restriction. In conjunction with the downgrade, S&P also warned that if the Company launched further buybacks at prices significantly below par instead of refinancing them, they may treat it as a distressed debt exchange and tantamount to a default. In such a hypothetical scenario, S&P would likely downgrade tomorrow to D and lower the issuer credit rating to Selective Default. 

There is a balancing act between generating equity value by buying back bonds subpar and any further rating downgrade and we suspect the Company are trying to clarify what exactly is a price “significantly below par”. With oil prices currently at $90/bbl we expect leverage to end the year below 1.5x, and therefore further incentivise management to do further liability management.