Tullow - Merger opportunities - Positioning

All,

Please find our unchanged analysis here.

The announcement of a proposed Tullow/Capricorn merger earlier this month provided Tullow debt investors with some relief in the current market malaise. There is no doubt there will be instant deleveraging of the Tullow balance sheet on the completion of the deal expected in Q4. However, recent speculation has raised the possibility of the deal not completing, or at least not on the current terms.

We have reevaluated our position given the risk-reward and the possibility of the deal collapsing.

The Merger:

- The proposed merger enables Tullow to deleverage bringing the combined business to less than 1.0x leverage at year-end. This reduction in leverage will remove the uncertainty brought by Tullow’s high leverage and, more importantly from an equity perspective, will remove the necessity of Tullow’s hedging strategy which has reduced the impact of the high oil prices in the market today.

- Capricorn is effectively a cash shell (having benefitted from their recent tax settlement in India) with relatively small oil & gas producing assets in Egypt. They are seen as vulnerable given their cash balances (c.$700m net cash position).

Potential failure:

- However, it is apparent the deal is more favourable to Tullow shareholders than Capricorn. The merger is effectively a no discount rights issue by Tullow to de-lever but retains significant upside to the current oil price.

- At current equity levels, Capricorn shares are trading through fair value, implying the deal may have to be restruck. Additionally, there are increased press reports from existing shareholders in Capricorn who are opposed to the deal. LGIM, who is a shareholder in both, with 3.9% in Capricon and 1.7% in Tullow have indicated they see no clear strategic rationale” for the merger and have "strong reservations” about the proposed deal.

- One of the big unknowns for both investors is the Kenyan operations. At the current time, Tullow is in discussions with potential partners to farm down their interest in the Kenyan fields. However, these discussions have been ongoing since late last year and no progress has been made. Additionally, Tullow, and its JV partners, still await Kenyan approval for the Field Development Plan which was submitted in December 2021. We don’t view the approval as a stumbling block to Tullow’s effort to farm down its interest, but it is likely to be a pre-condition.

Tullow as a stand-alone:

- We sound like a broken record, but up to now, we have maintained our positions in both Tullow equity and debt arguing the business will deleverage naturally over the coming 24 months from the current high oil prices, improved reliability and increase in drilling activity in Ghana. There is no doubt that the proposed merger would accelerate the deleveraging, but we fundamentally believe a c.1.5x balance sheet is achievable for a stand-alone Tullow by December 2024.

- In addition to the potential upside from the Kenyan operations mentioned above, we have to acknowledge that Tullow has made no progress on its potential tax liability in Ghana. The Company has not provided any guidance on the timing of a settlement of this issue.

Positioning:

- Given the recent rise in the bond prices, we are exiting our position at 86%. Fundamentally, we remain bullish on the Tullow situation, either as a stand-alone entity or under a merger (even if the merger ratio changes).

- However, we have to acknowledge that the deal may not conclude and the recent bond price rise may reverse. Therefore, we are exiting our Tullow 2025 bond position.

- In conjunction, we also exit our Tullow equity position. We remain disappointed that despite the refinancing happening, improved operational data and the current oil price, Tullow’s shares remain range-bound in the 45-60p range. If the merger is to conclude, a change in the merger ratio might have to be contemplated.

- However, we will continue to monitor the situation, and in the context, we have arranged a conference call with Capricorn management later this week.

Happy to discuss.

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk