Jilted Tullow Oil must tackle debt as Capricorn picks up another partner

Lowball valuation of Capricorn’s assets outside its cash hoard proves step too far for investors

Tullow Oil pitched its ill-fated engagement to Edinburgh-based Capricorn Energy four months ago as a deal to create “a leading African energy company”. But the Irish-founded group only had one thing in sight: its intended’s dowry.

Following a tumultuous 2019 and 2020 – which saw Tullow’s shares plunge 85 per cent amid a series of drilling and production disappointments, exits of its chief executive and exploration director, massive asset writedowns and warnings about potential cash shortfalls – the company was in much better shape by the time the deal was announced.

Asset sales and cost cutting under its current chief executive Rahul Dhir – together with rebounding oil prices – had helped Tullow pull off a make-or-break $1.8 billion (€1.84 billion) debt refinancing last year and chip $700 million off its net borrowings in the 24 months to June.

However, the $700 million or so of cash on Capricorn’s balance sheet would have put a fair dent in Tullow’s remaining $2.3 billion net debt. It would also have paved a credible path to a return to dividends – something investors in Tullow have only seen once since a decade-long run of annual payments came to an end 2014 as the price of the black stuff crashed.


The engagement party was barely over when there were rumblings that some members of the Capricorn camp weren’t going to stand by and let a £1.4 billion (€1.5 billion) tie-up – that would leave Tullow shareholders with 53 per cent of the wider group – go ahead.

The problem was that the terms of the deal implied that 90 per cent of the equity value in Capricorn – formerly Cairn Energy – was its cash. And it essentially put a $80 million value on its other assets, mainly comprising a half-stake in an Egyptian gas field that had been bought last year for $323 million.

Shareholder value

Legal & General Investment Management, which has a 3.9 per cent stake in Capricorn, and hedge fund Kite Lake, which built up a 6.9 per cent position, came out within weeks to slam the deal. In early August, another London hedge fund, Palliser Capital – which owned about 5 per cent of Capricorn at the time, but has since lifted it to over 6 per cent – said the deal amounted to a “surrender of shareholder value” and a “backdoor” equity raise for Tullow, “incredibly at a premium to its current share price”.

It went on to describe the proposed merger as a “lifeline” for Tullow, allowing it to pay down its outstanding junk-rated, high-cost debt, continue to invest in its crown jewel Jubilee and 10 oilfields off the coast of Ghana and convince potential partners for its $3.4 billion Kenyan oil project that it could fund its share of investment.

While Dhir used the unveiling of Tullow’s interim results two weeks ago to insist that the deal continued to be backed by both boards, it was already dead. By that stage, a blocking minority of more than 25 per cent of Capricorn shareholders were prepared to shoot it down.

Capricorn had even given Tullow a signal the previous week that it needed to up its game, when it said in its own first-half results statement that it was “exploring a number of expressions of interest relating to alternative transactions”.

Capricorn’s announcement on Thursday that it had ditched Tullow for a better offer comes as no surprise.

The new deal will see it merge with Israeli gas explorer NewMed Energy, formerly known as Delek Drilling, in an all-share deal that also involves Capricorn shareholders being paid a $620 million dividend. They will retain a 10.3 per cent stake – worth $338 million – in the larger group.

This deal is being billed as creating a Middle East and North Africa “gas and energy champion”. But the key asset is NewMed’s 45.3 per cent stake in Leviathan, the largest gas field in the Mediterranean.

Israeli group

Capricorn’s Egyptian field is of less importance than its London Stock Exchange quotation to NewMed. The Israeli group was looking early last year at securing a listing in London. However, sources said it had difficulty securing enough interest as stock market investors would only have a minority stake, with the Israeli Delek Group conglomerate remaining 54 per cent shareholder.

Tullow came out late on Thursday with the corporate equivalent of a dumped teenager’s “I’m as well off without you” retort, saying it expects to deliver $1 billion of free cash flow between this year and 2025 with oil prices at $78 a barrel – rising to $2 billion if it averaged $100.

Brent crude oil has fallen from $115 to less than $86 a barrel since the Capricorn deal was announced in June. Ashley Kelty, an analyst with Panmure Gordon, reckons that oil will need to stay at current levels for Tullow to have a meaningful chance to pay down borrowings over the medium term. In the meantime, investors can forget about dividends.

Action in Tullow’s bonds tells its own story. The market value of the group’s $800 million of bonds that fall due in early 2025 slid to 69.3 cents on the dollar from 78.3 cents over the course of this week. They were changing hands at 94 cents in June, though some of the decline since then has been down to wider nervousness in global bond markets driving down bond yields. Tullow’s $1.8 billion of 2026 notes are now trading at 86 cents on the dollar.

Others are more optimistic. While Stifel analyst Chris Wheaton saw Tullow’s failed Capricorn deal as “effectively an equity issue disguised as a merger”, he believes that even in the event of oil prices drifting down to $70 by 2024, the group’s net debt will nearly halve by the middle of the decade.