pdvsa-offering-circular-portada-webWe have gone through the 442 page PDVSA exchange document and, if you do not have a copy, you can access it in LAHT’s online library here:


1. The Exchange is only for the $3 billion of PDVSA 5.25% of 2017 and the remaining $4.1 billion of the $6.2 billion PDVSA 8.5% of 2017. Although PDVSA’s head has said conflicting things over the past month, the $1 billion PDVSA 16 maturing next month is not included.


The PDVSA 16 is said to have a large government ownership already, so at different times they have said that they were not worried about it. Those who follow our Reports may remember in June that one of the gems that we discovered in the 2015 debt financials is that PDVSA wrote an IOU to its Pension Fund for $900 million of the $1.4 billion PDVSA 2015 bond maturity, meaning they only paid $500 million to other holders.


We had this from the footnotes in one of our June reports:


“In October 2015, for the maturity of the Petrobonos 2015 with a par value of $1,413,000,000 PDVSA paid $515 million in cash and the remainder of these instruments held by PDVSA-related entities were exchanged for promissory notes in the amount of $898 million.”


Well, we find out a little more in this latest sacking of the Pension Fund (including more worryingly that it hasn’t been paid) in the latest Prospectus:


“In October 2015, following the maturity of the Petrobonos due 2015, PDVSA paid U.S.$515 million in cash and exchanged the remaining bonds held by PDVSA’s related entities were for one-year promissory notes for an aggregate amount of U.S.$898 million with a 10% rate per annum payable semiannually, subject to automatic renewal.” (page 71).


2. The Exchange Bond being offered is a 4 year amortizer, paying 25% of principal each year beginning next year, and maturing in 2020, with an 8.5% coupon and being collateralized “by a first-priority lien on 50.1% of the capital stock of CITGO Holding, Inc. ” That language is peculiar and legally specific and I will explain why in a later point.


3. Paying Agent. After all the sturm and drang with Citibank quitting as paying agent and the resulting mystery, the paying agent here is Law Debenture Trust Company of New York. They are also the Transfer Agent and Registrar. The notes will be listed on the Luxembourg Exchange and Banque Internationale À Luxembourg, Société Anonyme is also listed as the Luxembourg listing Paying Agent.


4. The Trustee is MUFG Union Bank, N.A.


5. The Collateral Agent is GLAS Americas LLC


6. No Attorney, Law Firm or Counsel listed. Although the 442 pages of the document were clearly drafted by lawyers, on the back page of this document where they normally list them, there are no attorneys or investment banks listed. This is a worrying sign, in that no counsel for PDVSA, no counsel for Citgo, no counsel for the bondholders, no counsel for Venezuela and no counsel for the any of the Collateral Agents, Paying Agents, or Trustees is putting their name on this document, except these 2 sentences on page 176:


“Certain legal aspects of U.S. law and New York law and the issuance of the New Notes offered hereby will be passed upon for us by Hogan Lovells US LLP as our U.S. legal counsel. Certain legal matters with respect to Venezuelan law will be passed upon for us by Despacho de Abogados Hogan Lovells, S.C. as our Venezuelan legal counsel.”


7. No Investment Bank Listed. Likewise, there is no mention of the investment bank on the front or back pages of this deal. However, on page 43, Credit Suisse Securities (USA) LLC is named as the “financial advisor for the Exchange Offers.” (No counsel for them is listed there either, by the way). Among other caveats, the Credit Suisse portion also warns that

“The financial advisor is not being engaged to and will not solicit any holders of Existing Notes in connection with the Exchange Offers. The financial advisor does not make any recommendation to holders of Existing Notes as to whether to exchange or refrain from exchanging their Existing Notes.”


The first “tell” in the above is that the cast of agency players in numbers 3-5 are not your normal A-list for a company of PDVSA’s size. For example, Glas – Global Loan Agency Services – is a relatively new entrant, having just been founded 5 years ago. On the other hand, Law Debenture, though it has been around since 1889, has lately been largely involved in large bankruptcy situations, including GM (Chapter 11), Lyondell (Millenium America) (Chapter 11), American Home Mortgage (Chapter 11) and General Growth Products (Reorganization), which is not a good sign. Further, just last month Law Debenture announced it was selling “substantially all of its corporate trust business to Delaware Trust Company” — so Law Debenture may not even be the Paying Agent in the end.


The second “tell” comes in numbers 6-7. When the lawyers and investment banks on your payroll wont put their name on the legal document, that is a huge flag. When not even the investment bank you are paying will recommend or sell the resulting financial product they created, well, either the standards on Wall Street are improving or the deal smells so bad even they can’t stand it.


8. The Exchange Valuation. Although most of us eggheads on the street were analyzing net-present values (NPVs) of the bonds and future exchange 2020 bonds and trying to configure somewhat complicated models based on what each Exchange Ratio and coupon could be and what it would mean for ultimate yields, we gave PDVSA too much credit. THE OFFER? 1 to 1. Yep, you can exchange your $1000 of PDVSA 5.125% April 2017 bond in which you will get all your money back in just 7 more months for the exact same amount of a bond ($1000) in which they will pay your money back in 2020 instead. Oh, and if you don’t jump at this offer by September 29, PDVSA is willing to let you in before October 14, but you will only get $950 of that new bond (ie not even the full amount of $1000 you previously had).


9. The Citgo Collateral. If you thought the 1-for-1 exchange was a pathetic offer, the execution of what could have been some interesting financial engineering has turned it into a weapon of financial mass destruction. First of all, let me say that I began warning about Citgo when Venezuela was sucking $2.8 billion out of the company in January of last year (“Citgo and the Revolution’s Praying Mantis School of Business” in the Financial Times here: http://on.ft.com/1JOPbEX). Crystallex, which is owed $1.4 billion for the expropriation of its gold mining operation and has an award for that amount from the World Bank’s International Center for the Settlement of Investment Disputes (ICSID), is currently suing Citgo and PDVSA in Delaware federal court in an innovative suit using the Delaware Uniform Fraudulent Transfer Act to try and force PDVSA to return the $2.8 billion Venezuela sucked out of Citgo (We are quoted in the suit and follow it carefully. It is mentioned on pages 120-121 of this Offering Circular).


Second, as noted above, the use of the terms “collateralized by a first-priority lien on 50.1% of the capital stock of CITGO Holding, Inc” is not an accident. Should PDVSA default on this bond, PDVSA 8.5% of 2020 bondholders get to take the 50.1% of the shares of Citgo Holding (the other 49% are collateralizing the Citgo Holdings 10.75% 2/15/20. Bloomberg does not have that Citgo Holdings Prospectus, but you can find it in our library here: https://www.scribd.com/doc/254819229/CITGO-Holding-2020-Offering-Memorandum).


But, and here is where the weaponization takes place, 50.1% of the shares means a change of control (CoC), which triggers bond and debt covenants on much of the $5 billion in Citgo debt, making all $5 billion immediately due and fully payable BEFORE PDVSA 2020 bondholders, who are now shareholders in Citgo. As a Citgo shareholder, PDVSA 2020 bondholders would stand at the back of that line behind the Citgo debt holders.


And, as mentioned above, it is a line which could also include Crystallex ($1.4 billion), ExxonMobil ($1.6 billion), Rusoro ($1.2 billion), Gold Reserve ($769 million), Owens Illinois ($485 million) not to mention those coming down the pike, including ConocoPhillips (potentially around $5 billion), Koch, etc, if they are able to pierce the corporate veil and get judgments against Citgo — which is why Venezuela was trying to sell Citgo in the first place but had to settle for mortgaging it up to the hilt.


Which is a another wrinkle — valuation. In this document, PDVSA gives this generous back-of-the-envelope calculation for their valuation of Citgo.


Recently, PDVSA conducted a valuation of the market value of the equity of CITGO and CITGO Holding. CITGO is the owner and operator of important midstream assets, refineries, inventories and receivables, among others, all of which were taken into consideration during such valuation. This valuation exercise was conducted on the basis of an analysis of CITGO and CITGO Holding’s projected future free cash flows, based on certain assumptions regarding growth and taxes. Such valuation also took into consideration the amount of debt at the CITGO level (approximately U.S.$2.0 billion as of December 31, 2015) and CITGO Holding consolidated level (approximately U.S.$4.2 billion as December 31, 2015), among other factors. Such valuation concluded that the market value of the equity (before taxes) as of December 31, 2015 of CITGO was approximately U.S.$9.3 billion and of CITGO Holding was approximately U.S.$8.3 billion, in each case net of debt. In addition, the enterprise valuation of CITGO was U.S.$11.3 billion with an implied EBITDA multiple of 4.7x (based on an EBITDA of U.S.$2.4 billion for the year ended December 31, 2015 (see “Selected Consolidated Financial and Operating Data” for a reconciliation of net income to EBITDA)), and of CITGO Holding was U.S.$12.5 billion with an implied EBITDA multiple of 5.1x (based on an EBITDA of U.S.$2.4 billion for the year ended December 31, 2015 (see “Selected Consolidated Financial and Operating Data” for a reconciliation of net income to EBITDA)). There can be no assurance that such values with respect to a sale of shares of CITGO Holding or CITGO would be achieved.


In the whole Offering Circular, there is no Professional Appraisal made by a Professional Appraiser – just the above “here is what we think Citgo is worth.”


While we don’t have an independent appraisal of Citgo, we do have an appraisal on Citgo done at their request from an earlier Citgo offering, the Citgo 6.25% of 2/15/22 (you can find the Prospectus in our library here: https://www.scribd.com/doc/235590994/Citgo-6-25-of-2022-Offering-Memorandum ):


Turner, Mason & Company (“Turner Mason”), an independent petroleum consulting firm, was engaged to complete an appraisal estimating the value of our three refineries, which will comprise a substantial portion of the collateral securing the notes. Turner Mason estimated the total asset value of our three refineries to be $7 billion (excluding related working capital assets) as of June 1, 2014, based on typical industry valuation methodologies. Although the appraisal is based upon a number of estimates and assumptions that are considered reasonable by Turner Mason, these estimates and assumptions are subject to significant business and economic uncertainties and contingencies, many of which are beyond our control or the ability of the appraiser to accurately assess and estimate. An appraisal that is subject to different assumptions and limitations or based on different methodologies may result in valuations that are materially different from those contained in Turner Mason’s appraisal.


Citgo, of course, chose and paid the firm that did the appraisal, but never provided a copy of the appraisal, just the blurb above.


Last year, PDVSA and ExxonMobil sold their jointly-owned Chalmette Refinery in Louisiana with 189,000 bpd capacity and a host of pipeline assets for $322 million. Citgo can refine 749,000 bpd from its 3 refineries (including one close to the Chalmette refinery in Lake Charles, Louisiana) — in other words, about four times the $322 million Chalmette refinery amount — which might be closer to a more market-realistic valuation than PDVSA’s back-of-the-envelope “enterprise” calculation.


10. PDVSA Debts. One of the reasons the Offering Circular is so interesting is because it is a goldmine of legally obligated information and revelations from Venezuela, PDVSA and Citgo — entities into which we generally have very little transparency.


There are many, but of the top ten answers I first sought from the prospectus, the amount of promissory notes was the last in my top ten list. I found this gem:


PDVSA has implemented different transactions that allow to partially convert the outstanding commercial debt maintained with certain commercial suppliers into financial debt. This conversion is achieved by the execution of several note agreements which provide for (i) the assumption by PDVSA of a portion of its affiliates’ debt (evidenced in outstanding commercial invoices and contracts) with certain strategic suppliers; (ii) the novation of said commercial debt into a financial debt that cancels the former one; and (iii) the issuance of a three-year note (or several notes) regulated by a Note Agreement, with quarterly amortizations and an annual interest rate of 6.5%, to each of the participating strategic suppliers.
From May 2016 to the date of this offering circular, the aforementioned transactions have been successfully executed with GE Capital Financing, Inc., Cementaciones Petroleras Venezolanas, S.A., Petroalianza, C.A., Maritime Contractors de Venezuela, S.A., Weatherford Latin America, S.C.A., Servicios Halliburton de Venezuela, S.A., Environmental Solutions de Venezuela, C.A., Proambiente, S.A., Elecnor, S.A. and Servicios Picardi, C.A. for a total amount of U.S.$1,151 million.


The promissory note debt was previously pegged at just over $800 million and is now $1.151 billion in just 4 months, so it is growing and we now have a list of some of the unpaid entities that are converting some of their invoices to promissory notes that are being traded on Wall Street.


Given the 1-to-1 conversion offer along with the weakness of the underlying Citgo collateral and the resulting destruction of Citgo from its execution, it is difficult to see many takers of this deal. I should note that the terms require a 50% tender rate, although PDVSA reserved the right to waive that condition (and others).


What this means for PDVSA is that default is ever more likely. PDVSA needed to get this right and they didn’t. Venezuela has less than $12 billion in its Reserves, and not all of that is really readily convertible to cash. They owe $5 billion more this year and another $10 billion next year.


The real worry now is, given the lack of cashflow and shortage of dollars that we have pointed out previously, how will Venezuela and PDVSA be able to pay the October and November payments of $4.8 billion if they are not able to get a significant amount of holders to swap out of the shorter date into longer maturities? To be able to pay, they could sell from their remaining claimed gold holdings of $7.4 billion, leaving them with $2.5 billion, but then in April they will also owe $3.8 billion, which includes the maturity of the $3 billion PDVSA 5.25% of 4/12/17, and then another
$2.8 billion in November. In between those payments, they will also have the other regular debt service payments, including of the larger ones, $725 million in February, $310 million in March, inferno$800 million in May, $725 million in August, and $750 million in October. And speaking of writing checks that you can’t cash, after repeatedly losing in court, last month PDVSA even agreed to pay Gold Reserve $600 million by October 31 and the remaining $169 billion on Gold Reserve’s court award by December 31.


In our last Report, we alluded to Dante. We close where Dante began: “Abandon all hope, ye who enter here.