Gulf Keystone to test debt investors' risk appetite

* GKP plans to raise up to US$250m through bond

* Investors to demand yield well above 10%

* Proceeds to help plug financing gap

By Davide Scigliuzzo

LONDON, March 26 (IFR) - Iraqi Kurdistan-focused oil and gas firm Gulf Keystone Petroleum is walking a fine line with debt investors as it seeks to secure financing to expand production and avoid a cash shortfall that could hit US$100m by the beginning of next year.

The London-listed exploration and production company is looking to raise up to US$250m through a three-year bond, according to a note from the lead managers.

Market participants, however, say the company will have to pay a yield of anything between 10% and 15%, which some say will stretch debt investors' risk appetite to its limits.

Sizeable downgrades to the GKP's oil and gas reserves and recovery expectations have dented investor sentiment in recent weeks, adding to concerns over the company's negative cashflow position.

Its shares have plunged by more than 26% since mid-March, when the company released the results of an independent report on its asset base.

Without additional funds, GKP would have a cash deficit of US$20m by the end of May, which could increase to US$103m by the end of January 2015 in "a reasonable worst-case scenario basis," the company said in an LSE filing last week. Cash resources totalled US$82m at the end of January.

As well as the bond deal, the company said revenue from oil production at its Kurdistan Shaikan field, a potential sale of interests in other assets and reimbursements of £5.6m from a legal dispute could help it bridge its funding gap.

DOUBLE-DIGIT YIELD

"They definitely have a liquidity problem. Whatever funding they received they have used to develop the (Shaikan) field, while revenues have gone into debt repayment," said an investor who met with the company as part of the bond roadshow.

The portfolio manager said GKP would need to offer a yield "well into double-digit" territory to lure potential buyers into the deal, while attempts to raise more than the stated amount might become a deal-breaker.

"They said US$250m, but they are thinking about US$300m. If they decide to become greedy and want to do more ... that is a no-go for us," said the investor.

A banker close to the trade said a convertible bond the company issued in October 2012 would be a "relevant data point" in assessing fair value for the new notes.

The US$325m October 2017 notes have shed more than 20 points since mid-March and were trading at a cash price of 74.85 for a yield-to-maturity of 14.7% on Wednesday, according to Thomson Reuters data.

"The convertible would be subordinated to the new bond, so from that perspective you would think [the new issue] should come inside [that level]," said the banker.

AMBITIOUS TARGETS

GKP plans to use proceeds from the sale to ramp up production at its main Shaikan field, bringing its capacity to 40,000 BOPD in 2014 from 10,000 BOPD. It has planned capital expenditure of US$210m for this year and US$130m for 2015.

Given the sheer size of its investment needs, however, some argue the company might be better off seeking equity funding or lowering its output targets.

"Gulf Keystone (LSE: GKP.L - news) probably should consider equity capital before debt capital raising, or a reduction or delay in its production target ambitions, or a combination thereof," said Richard Segal, fixed-income analyst at Jefferies. "If I can buy your convertible at 15%, shouldn't you be raising capital with that kind of risk profile, meaning equity? They are asking a lot from bondholders."

Deutsche Bank (Xetra: DBK.DE - news) and Pareto Securities are the leads on the transaction.

The company, which is unrated, completes investor meetings on Thursday, when it is also scheduled to publish full-year results for 2013. (Reporting by Davide Scigliuzzo; Editing by Sudip Roy, Luzette Strauss and Julian Baker)