OGX Petroleo & Gas Participacoes SA’s bonds are falling like never before, a sign that investors are bracing for what would be the biggest company default in Latin America as controlling shareholder Eike Batista struggles to raise cash.
The oil producer’s $2.56 billion of notes due 2018 have plummeted 16.9 cents this week, the most since the debt was issued in May 2011, to a record-low 40 cents on the dollar. The securities are trading below the average of 45 cents for defaulted Latin American corporate debt tracked by Bloomberg and less than the maximum 50 cents on the dollar that Fitch Ratings estimates bondholders would recover in a restructuring. Fitch cut OGX’s credit grade one step to CCC today, or seven levels below investment grade. It has a negative outlook on the rating.
While OGX said it isn’t analyzing a debt restructuring, investors are losing confidence Batista can honor his obligations as an 83 percent plunge in personal wealth pushed him to sell OGX shares and other stakes in his faltering commodity and energy empire, SW Asset Management and Brookshire Advisory & Research said. The company is set to run out of money in about a year at its burn rate as slumping production puts output goals out of reach, even after Batista pumped at least 2 billion reais ($943 million) of his own cash into OGX.
The market “is pricing in some type of restructuring,” Ray Zucaro, a money manager who helps oversee $325 million of emerging-market debt at SW Asset Management, said in a telephone interview from Newport Beach, California. “There are a lot of rumors. Where there’s smoke, there’s fire.”
OGX is not analyzing a debt restructuring, a company press official said in an e-mailed response to questions. Cash generation from current and future production, potential sales of stakes in oil fields and an option that would oblige Batista to purchase as much as $1 billion of OGX shares will all allow the company to continue servicing its obligations, the official said.
Batista said in a statement yesterday that OGX parent company EBX Group Co. restructured debt and now only has long-dated maturities. The restructuring “is clear evidence of EBX’s high level of commitment toward its obligations with stakeholders,” he said without providing further details.
Pacific Investment Management Co., the world’s largest active bond-fund manager, was the biggest holder of OGX’s notes as of March 31. The Pimco Income Fund, which has outperformed 99 percent of peers over the past three years, held $128 million in principal of OGX bonds as of the first quarter, according to filing data compiled by Bloomberg.
Pimco spokesmen Mark Porterfield and Michael Reid didn’t respond to telephone and e-mail requests for comment.
OGX’s 2018 bonds plunged 8.7 cents June 11, a day after Batista said in a filing that he sold 70.5 million shares between May 24 and May 29 for 122 million reais at an average price that’s more than 90 percent below its all-time high.
Fitch citied “increased uncertainty” about Batista’s ability to honor the $1 billion put option available to OGX in its decision to downgrade the company. Bonds rated CCC carry “substantial credit risk,” with default “a real possibility,” according to the rating company.
Last month’s sales of OGX voting shares represent a “minimal one-off adjustment” in EBX’s portfolio and were part of efforts to extend maturities and reduce debt costs, Batista said in the statement, adding that he has no intention of selling more shares.
More than $28 billion of Batista’s personal wealth has evaporated since last year as shares plunged 94 percent since March 2012 and his oil producer struggles to meet output goals.
OGX’s cash holdings fell 68 percent in the 12 months ended March 31 to $1.14 billion, enough to keep it operational into the fourth quarter at the company’s current burn rate, according to data compiled by Bloomberg. While OGX raised as much as $850 million selling an oilfield stake to Malaysia’s Petroliam Nasional Bhd. last month, the amount would only extend cash reserves until mid-2014, the data show.
“It appears restructuring activity is imminent,” Gianna Bern, a former senior director at Fitch Ratings who is now president of risk-management adviser Brookshire Advisory and Research. “Offshore drilling is a very capital intensive business. Bringing the product online has taken much more than investors would have ever hoped for.”
Batista lured investors to his oil startup with promises of output of as much as 730,000 barrels a day by 2015 and 1.4 million barrels a day in 2019. Crude production climbed to 6,800 barrels a day in May after slumping to 1,800 a day in April as the company shut two of three wells at its only active offshore field, known as Tubarao Azul.
OGX has $109 million of interest due in December on its 2018 bonds and $44.5 million in interest due in October tied to its $1.06 billion of 2022 notes, according to data compiled by Bloomberg.
Fitch estimates investors would recover 31 percent to 50 percent of current principal and related interest in the event of default. In May, the rating company cut OGX’s credit grade to B-, or six steps below investment quality, and revised the company’s outlook to negative after it acquired 13 exploratory blocks in Brazil’s first round of oil bidding in five years.
“The liquidity of the company was already at risk,” Ana Paula Ares, an analyst at Fitch, said by phone from Buenos Aires yesterday. “It has a significant capital expenditure program and has faced delays for production to come online. The fact that in this scenario, instead of preserving cash, the company went out and acquired assets, that increased the liquidity risk.”
Michael Roche, an emerging-market fixed-income strategist at The Seaport Group LLC, said OGX’s bonds have the potential to rebound as oil output increases.
“The bond market is in alignment with book value right now,” Roche said by telephone from New York. “That’s why I expect some stability. If they’re drawing 40,000 barrels a day, the bonds would increase. That’s the great optionality.”
The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries was little changed at 217 basis points at 2:45 p.m. in New York, according to JPMorgan Chase & Co.’s EMBI Global index.
The cost of protecting Brazilian bonds against default for five years dropped five basis points to 149 basis points, according to prices compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
The real weakened 1.1 percent to 2.1446 per dollar. Yields on interest-rate futures contracts due in January rose two basis points to 8.74 percent.
A dollar debt restructuring by OGX would be nearly double Banco de Galicia y Buenos Aires SA’s $1.9 billion default in 2002, the largest in Latin America to date, according to data compiled by Moody’s Investors Service.
“It all depends on what’s going to happen in the fourth quarter with” oil production, SW Asset Management’s Zucaro said. “It’s very binary at this point. If that produces oil, the company probably will not need to. If it doesn’t, the current capital structure is unsustainable.”