DTEKUA 24s sold off on the worrying headlines regarding an investigation into the Rotterdam+ formula. The formula refers to a pricing mechanism setting electricity tariffs for thermal power plants based on the international coal benchmark price (Rotterdam) plus international and domestic shipping costs. The prosecutors suspect four officials of the electricity market regulator and two employees of DTEK to have caused a loss of US$750mn to electricity consumers in 2016-2017, of which cUS$570mn benefited DTEK. The downside risk to DTEKUA 24s stems from investigation-related news affecting investor sentiment and the actual outcome of the investigation, which could entail a financial consequence for the company. DTEK has limited resources to spare, therefore we expect its bonds to underperform while the investigation risk persists.
The Rotterdam+ case fits into President Zelensky’s anti-corruption agenda. The investigation has been going on for more than a year (since March 2017), but recent developments should be evaluated against a new political backdrop. The current leadership campaigned on anti-graft agenda and the first steps of the new administration included dismissal of government officials allegedly involved in corruption. Incriminating rhetoric from Zelenskiy and his team targeting some of the leading businesses in Ukraine increases the risk of potential prosecution for those companies that have benefitted from regulatory decisions under the previous administration. For DTEK, the recent developments include: 1) naming two of the company’s employees as suspects and 2) assigning a material value to the losses incurred by customers from the Rotterdam+ pricing. The Rotterdam+ case could help Zelensky’s administration increase its political capital.
Limited resources to pay potential penalties. According to the National Anti-Corruption Bureau of Ukraine (NABU), the Rotterdam+ formula cost customers losses to the tune of UAH18.9mn (cUS$750mn) through increased tariffs, of which UAH14.3mn (cUS$570mn) benefited private companies like DTEK that argued in favour of the new system. If we assume that in a negative outcome DTEK is required to pay at least US$570mn in fines (the number can be higher or lower), the company could face difficulties. In Q1 19, the company had an equivalent of cUS$72mn in cash. Other things being equal, a material fine could compromise the company’s ability to continue 1) paying interest on bonds and loans fully in cash without using the PIK option, 2) deleveraging. In the worst-case scenario, it could raise questions about DTEK’s ability to meet scheduled interest and principal repayments.
Upside is limited. In our recent report we argued that softening electricity prices were unlikely to affect the company’s willingness and ability to continue paying cash interest on bonds and loans, and prioritise deleveraging. If the litigation risk were to go away tomorrow, DTEKUA 24s could tighten to 200-250bps over METINV, which implies potential 5-7pts pick-up in price.