Afren's high-yield bond issue earlier this year attracted interest from emerging market investors as well as specialist energy players, two investor groups who rarely overlap in the bond markets. Moreover, the bond's performance in the secondary markets and the growing comfort of energy investors with high yield risk, could presage more activity in this space.

There are plenty of investors who specialise in emerging markets, and plenty more with an appetite for energy exploration and production (E&P). When it comes to the bond markets, however, these interests do not overlap very often. They did with an inaugural high-yield bond issue from Afren, an E&P company whose business is almost entirely focused on Nigeria. It was the first non-financial corporate bond ever issued by a sub-Saharan African business, and a rare high-yield bond from a European-listed E&P firm.

Afren is quoted on the London Stock Exchange but describes itself as a “pure play African oil and gas company”. Founded by former investment banker Osman Shahenshah in 2004, it has acquired assets in 11 African countries, including Côte d'Ivoire, the Republic of Congo, Ghana and Ethiopia. But almost all of its current production, including the Ebok offshore development now coming on stream, comes out of Nigeria. 

Nigerian familiarity

Growing investor familiarity with Africa in general and Nigeria in particular set the scene for Afren’s first expedition into the debt capital markets. After years of talk, Nigeria finally made its sovereign debut in January, issuing $500m of 10-year paper with a 6.75% coupon. The deal was not exactly a blow-out but it performed sufficiently well in the secondary market to provide an encouraging context for some associated corporate issuance. 

“Three or four years ago, Africa was just Africa for most fixed-income investors,” says Alex von Sponeck, head of emerging market debt financing at Goldman Sachs, joint global coordinator on the Afren deal with BNP Paribas and Deutsche Bank. “Since then there have been sovereign issues from Côte d'Ivoire, Gabon and Ghana, and issuance from corporates with regional interests, such as Anglo Gold. So investors have spent more time understanding Africa and we can now talk region-to-region and country-to-country. Most of the people we saw on this transaction had just seen the Nigerian minister of finance.” 

This rising education curve has been augmented by a growing interest in high-yielding local currency exposure, which has now spilled over to units such as the Ghanaian cedi and the Nigerian naira. “This year and next we will see a large focus on the local currency investor base,” predicts Mr von Sponeck, “although a lot of it won’t be in big bond format but will use synthetic structures.” 

Assessing the options

When E&P companies are still very much in the ‘E’ stage of their development, the attendant risks force them to rely on equity finance. As they mature and start to produce real oil, debt becomes a more viable option. In the US, this often takes the form of high-yield bonds. Europe-based companies, however, generally go for asset-backed bank lending. Afren’s production profile is growing and the Ebok field promises to more than double the company’s output. It has been picking up Nigerian assets as the major oil companies, nervous about local security, scale down, and it needs a war chest to be able to move quickly when opportunities arise. The question was exactly how to raise the money and in the spring of 2010, with chatter about a Nigeria sovereign issue still doing the rounds, the company began to consider the bond option. 

While reserve-based loans were still a possibility, the covenants involved can hobble the mergers and acquisitions process. Equity was, as ever, an alternative. “The debt capital markets allow Afren to increase its firepower without diluting the equity upside – which is why people buy the stock,” says Andrew Fry, managing director for Europe, the Middle East and Africa oil and gas at Goldman Sachs. 

In June 2010, the company mandated Goldman and Deutsche Bank to secure a credit rating for both company and issue. Since the rating would turn on whether the deal was secured or unsecured, that decision now had to be taken – and ‘secured’ it was. “We wanted to make sure that the rating was B and not CCC,” says Uday Malhotra, managing director for leveraged finance at Goldman Sachs, pointing out that, for investors, there is a world of psychological difference between the two. The upshot was a B-/B rating from Standard & Poor’s and Fitch – Moody’s does not rate Nigeria. 

An offering circular was drawn up in mid-November. “It was unclear whether or not the Nigeria sovereign would come before year-end,” says Mr von Sponeck. “Our deal was not 100% contingent on it, but we believed it would be good to issue on the back of a successful Nigeria issue, if the secondary market traded well.” 

A head start

As it turned out, Nigeria put matters off until January and Afren decided to do the same, using the intervening period to get a head start on marketing. In a 10-day roadshow, Afren and its advisors took in London, Zurich, Geneva, Boston, Los Angeles and New York. “We expected January to be very busy, and this meant we would not be stuck in a queue, because we had done the ground work already,” says Dolph Habeck, executive director, emerging market syndicate at Goldman Sachs. 

The prospective deal was looking at two distinct types of investor. One was the emerging market investor who understood Africa but would need to get their heads around E&P. The other was the high-yield investor who got E&P, but would need to feel at ease with Africa. Nigeria’s successful transaction in January raised the comfort level of the high-yield contingent somewhat. 

The Afren deal was announced in the third week of January – by mid-February the financial figures would have gone stale. Pricing was not exactly straightforward, given the absence of strictly comparable credits, but E&P names from other emerging markets, such as Zhaikmunai (Kazakhstan) and Alliance Oil (Russia), were yielding in the 10% to 11% range. Feedback suggested somewhere inside 12% to 12.5% so initial price talk was in the 12% area. There were still some residual anxieties over Nigeria and the team was inclined to err on the side of generosity though some price compression was possible as it built the book. There was no overwhelming consensus on size. “Some accounts didn’t want too large a size, while some wanted a certain minimum size,” says Mr Habeck. “Like most challenging trades, this transaction was more art than science.” 

In the end, Afren went for $450m in five-year paper, with an 11.5% coupon but priced to yield 11.75%. The geographic split saw equal 40% shares go to the UK and the US, with 11% going to Africa, 8% to Europe and a mere 1% to Asia. By type, emerging market investors took 85% of the deal, with only 15% going to high-yield specialists who, in the US, were clearly still a bit jumpy about Africa. European high-yield investors were less fussed about Africa but unfamiliar with E&P. There was a significant bid from those who had already bought the Nigeria issue. Then something interesting happened. 

Change in attitude

As the price tightened in the secondary market, it was decided to tap the issue for another $50m a couple of weeks later, to give the borrower a little extra at lower cost. This time the bonds were priced to yield 11.125%, and the order book had a rather different profile. US investors now took 63% of the tap. “Some of the US high-yield names had got more comfortable with the idea in the meantime,” says Mr von Sponeck. 

The same can surely be said for others, as the bond’s yield tightened to within 9.5% in later trading. Does that presage a flood of corporate issuance from Nigeria? Yes and no. “Blue-chip Nigerian corporates have the domestic bank market open to them,” says Mr von Sponeck. “And very few have the disclosure standards of Afren, which gave the ratings agencies a degree of comfort. But we will see follow-on from some of the bigger names, mainly among the banks.” 

The deal may stir the wider world of non-US E&P. “Some have definitely got high yield on their radar screens now,” says Mr Fry. “The biggest follow-on potential is from London- and Canadian-listed companies focused on Africa. The threat of rising interest rates should help any potential issuers to come to market sooner rather than later.”

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