Tullow's Punishment for its Convertible Bond is Misplaced

Goldman upgraded the Africa-focused oil producer claiming an 18% fall in its share price is a buying opportunity.
By Paul Whitfield ,

Amidst the rubble of banks, retailers and real estate stocks that populate this week's worst performers on the London Stock Exchange Tullow Oil (TUWOY) stands out both as the only big name oil company and because it probably doesn't merit its place.

The Africa-focused oil producer's stock has fallen 18.5% this week and traded Friday at 214.7 pence ($2.79). It has been battered not by Brexit but by its announcement on July 6, of plans to issue a $300 million convertible bond to provide liquidity for its operations.

The fall means that Tullow's shares have lost some $330 million in market capitalization since the announcement, outweighing the value of the shares that it might have to issue if the bond is converted.

That gap is explained largely by nervousness at the decision to add to Tullow's weighty $4.7 billion of debt. But those worries appear misplaced.

Tullow has about $1 billion of liquidity headroom, meaning that it is in no immediate danger of falling victim to its loans or a cash crunch even if oil prices were to fall. Furthermore, its flagship TEN project in Ghana, is due to come online within weeks, adding about 20,000 barrels of oil a day for the remainder of 2016 and rising to 70,000-80,000 barrels a day in 2017.

Tullow owns 48.75% of TEN and is the operator. Its share of the production will add somewhere in the region of $400 million in annual earnings and will coincide with a sharp fall in expenditure on the project, Goldman Sachs analysts Duncan Milligan and Henry Tarr noted Thursday.

That extra cash should enable Tullow to rapidly deleverage its balance sheet, a process that should receive an extra boost by the end of 2018, when the company expects to receive about $750 million in insurance payouts relating to outages at its Jubilee field.

Increased cash flow and lower debt should provide a boost to Tullow shares in the second half of this year and into 2017. Goldman rates the stock a "buy" and has a 12-month price target of 270.9 pence.

And if all that increased cash and lower debt don't significantly boost the share price then the consolation is that the issue of the convertible bond basically disappears.

The bond has a strike price of $3.52, equal to about 271 pence based on Friday's exchange rate, or 30% above Tullow's current price. If shares don't hit that mark then the bondholders will not trigger the conversion of a single dollar of debt.

Moreover converting the entire bond to debt will dilute Tullow's free float by about 9%. As Goldman point out, Tullow's shares would have to be trading at an implied value of slightly above 350 pence each if they were to absorb that level of dilution and remain above the 271 pence strike price.

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