When looking at the oil sector over the last few years Shares has consistently pointed to the most indebted oil companies as being most exposed to the oil price.
For investors with a tolerance for risk these companies offered a means of expressing a positive view on oil but the gravity of the risk is reflected in the announcement from Tullow Oil (TLW) today.
HEAVILY DISCOUNTED ISSUE
The shares are down 14% to 204p as it announces a $750m rights issue priced at 130p, a 45% discount to Thursday’s close. Existing shareholders will receive rights to buy 25 new shares for every 39 shares they own. The funds from the fully underwritten issue will be used to reduce borrowings after net debt hit an eye-watering five times earnings at the end of 2016.
The company says it intends to accelerate the reduction of debt towards its gearing policy of less than two-and-a-half times earnings through the issue, improving cash flow from production plus asset sales and farm-down agreements.
Shareholders looking at the level of dilution might not appreciate this argument but Tullow may not have gone far enough with this fundraise.
Research from Morgan Stanley, produced during the wave of rights issues which followed the financial crisis, suggests the bigger a rights issue is now the better the longer-term outcome for the share price.
IS IT ENOUGH?
The bank’s UK equity strategist Graham Secker and his team noted ‘the median stock that raised cash equivalent to more than 75% of its market capitalization outperformed the market by 45% over the next two years and outperformed its sector by 58%’.
They also found that companies which raised cash equivalent to 50% or more of their market cap saw their share prices rise in absolute terms over the following two years.
Based on the current level Tullow is raising somewhere around a third of its market cap and a relatively modest sum in the context of its total net debt of $4.8bn.
If oil prices recover and production remains consistent then Tullow should be able to pay down its debt but if oil prices crash again, or the company is beset by operational issues, investors might face even greater dilution in the future.
WHAT HAPPENS NOW?
The timetable for the rights issue is below: