There is no doubt about it, fortunes have been made and lost in the shares ofAfren(LSE: AFR) since they hit their low of 4.2 pence per share on 29 January 2015. The company has been hit by a perfect storm the CEO and CFO were dismissed for being up to no good, the price of the black stuff sinking to levels that makesmany producers unprofitable, and huge write-downs in its Kurdistan portfolio. Add to the mix a significant amount of debt, and you could be forgiven for thinking that the shares would have halved again. Well, despite all of these woes, the shares closed at 10.5 pence on Tuesday (24 February). This means anyone who was brave enough to buy at 4.2 pence is sitting on a gain of around 150% (excluding dealing costs). Not a bad return in under four weeks especially afterSeplat walked away from takeover talks.
Where do we go from here?
Well, oil seems to have regained its composure, currently trading around US$59 per barrel. So you may think that things are starting to look slightly better right? Well, you may be slightly surprised to learn thatAfren has a production cost of around US$68 per barrel. You dont need to be a mathematician to realise that when the hedging set at higher prices runs out, the company will be making a loss.
The burning issue, though, is the debt. Afren has bought itself some time with its bondholders and it is currently in discussions as to how to move things forward. Where those discussions will lead and how equity shareholders will be impacted is not currently clear. My best guess would be for a debt for equity swap this, I think, would be at a significant discount to the current price, and leave current investors heavily diluted and possibly erasing any gains made to date.
What would I do?
I think that it is fair to say that there will be some investors that have incurred heavy losses here. On the other hand, there will be some sitting on handsome gains. If I were in either camp, I would be inclined to close my position and crystalise that gain or loss before the price moves down. I think that it is clear that the bondholders have the upper hand here and are in control. Any equity holders will be heavily diluted at best, and there is always the possibility of a total loss if the bondholders play hardball and force the company into administration.
Of course, I could be wrong and there may be a buyer waiting till the 11th hour to strike I think that this is an unlikely scenario, given the huge debt pile and asset write-downs. If I were a potential buyer, Id certainly be looking for a significant margin of safety in order to save me having to make further write-downs after the company was purchased.
The bottom line
One of my first investing books Beyond The Zulu Principle, written by legendary investor Jim Slater is signed by the author, and readsRun profits, Cut losses and watch the story.On that basis, I think anyone who has lost money should sell and, if you are in profit and have been watching the story, take your profits!
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Dave Sullivan has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.