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HKN Energy: Upgrading to Buy as new loan raises liquidity and boosts resilience

  • New US$49mn loan will increase liquidity and strengthen bond covenants

  • The company has sufficient cash reserves to operate for more than 12 months in a stress scenario

  • We upgrade HKNENG 24s to Buy and expect them to converge with GULFKY 23s

HKN Energy: Upgrading to Buy as new loan raises liquidity and boosts resilience
Tellimer Research
4 May 2020
Published byTellimer Research

HKN increases available liquidity. HKN Energy has agreed the terms of US$49mn which can be available already in Q2 20. The company has sufficient liquidity through accumulated cash reserves and cost-cutting, but the new long-term facility adds an extra layer of protection in a stress scenario. Besides, the terms of the loan agreement require certain amendments to the original bond documentation, which, in our view, benefit the bondholders. We believe that accumulated cash reserves and the new facility make HKN at least as resilient as Gulf Keystone in a severe stress scenario. By resilience, we mean a company’s ability to continue operation without receiving payments from the KRG, measured as a ratio of cash reserves to monthly opex, G&A and annual interest payments. GULFKY 23s are indicated at a mid price of 88 (YTM -14.5%), while HKNENG 24s are indicated at 71.5 mid price (YTM – 22.4%). The companies are exposed to similar industry and regional risks, but HKN is more cost-efficient and is quickly closing the gap in terms of liquidity. If bond prices were to reflect these developments, we expect HKNENG 24s and GULFKY 23s to converge.

New loan agreed and amendments to the terms of HKNENG 24s. HKN Energy has finally agreed a US$49mn loan which was included in the permitted indebtedness under HKNENG bond documentation. The final approval of the loan is expected in May 2020. The process has taken long enough for the lender to be renamed from Overseas Private Investment Corporation (OPIC) to US International Development Finance Corporation (DFC). The US$49mn loan will have a 9-year tenor and be repaid mostly after bond maturity, in equal quarterly installments starting from Q3 2022. The interest rate on the loan is expected to be set at 575-675bps over US Treasuries, significantly lower than interest on the bonds or their yield to maturity. The debt service reserve account (DSRA) will be created in order to keep cash equivalent to six months of interest payments on the loan – a similar account is proposed to the bondholders. Other terms of the loan encourage an early refinancing of the bonds, 12 months before maturity. Bondholders have to submit their votes before 18 May 2020.

US$49mn loan will increase HKN’s liquidity. According to the most recent management update, HKN had US$72mn cash on the balance sheet as of 20 April 2020. The company has suspended drilling and all discretionary capex, and is working on opex and G&A reduction. We estimate HKN’s monthly spending at US$4mn to cover opex and G&A and at cUS$6mn if interest and production bonuses due in 2020 are included (assuming equal monthly accrual). According to our calculations, HKN needs Brent to be at US$27-29/bbl to cover those costs and break even on an FCF basis. If Kurdistan is unable to continue settling receivables monthly, HKN's cash reserves could cover operating and financing costs for more than 12months. With the new loan, the company will become even more financially resilient. We don’t know whether the new loan facility has restricted use or can be spent on general corporate purposes, but it will most likely be available should the company resume capex. As of 20 April 2020, the KRG owned HKN US$69mn for oil sales from November 2019 to February 2020. The payments were deferred until the end of the year, but the oil price has to recover to US$50/bbl before payment plans can be agreed.

Summary of FY 19 financial results. In FY 19, HKN Energy’s working interest production came to 14,500boepd, with the company booking US$190mn in revenues and US$122mn in EBITDA. Debt stood at US$100mn and was represented by US$100mn 11% notes due 2024, while net debt was at US$17mn. HKN was FCF-negative during the period as its big capex programme program required US$130mn to ramp up production at the Sarsang field. Sarsang’s 2P reserves were estimated at 380mmboe at the start of 2018 making it one of the biggest fields in Kurdistan. HKN is the field operator with a 62% PSC interest.