Hurdles in Debt to Equity Conversions: A Case Study of KQ Restructuring

By gatuyu t.j

Kenya Airways is carrying out a capital optimization program to ensure it keeps being afloat. One of the ways this program is being effected is through capital restructuring by way of debt to equity conversions. But it is not that easy

INTRODUCTION 

KQ is in turmoil. Auditors have cast doubt on its continued operation as going on concern. As of March 2017, KQ had an outstanding debt burden of whooping KES 242.4 billion. The company has to act fast to effect an aggressive restructuring to deleverage the company, through debt to equity conversion. The lenders, who are mostly Kenyan banks and the government, to take equity. The alternative option is scary.

KQ
Will KQ take off? Photo, courtesy 

If the Restructuring is not implemented, there will be no new capital from KLM or the Kenyan Banks. As a result the Company will no longer be able to service its debt obligations as they fall due and the Company will enter into formal insolvency and its shares will no longer be traded on the NSE.

However, this restructuring has faced hurdles. We look at how they have been addressed.

HURDLE 1. The nominal value of ordinary share of KQ is KES 5. Lenders say this is too high and cannot take it. However, the Companies Act disallows issue of shares below the nominal value. What is the way forward?

The authorized and issued share capital of KQ is KES 10 billion divided into 2 billion Ordinary Shares of nominal value KES 5.00 each of which 1.5 Billion Ordinary Shares are issued and fully paid. The Company has no other classes of shares and all of the Ordinary Shares carry equal rights. The lenders are willing to take the issue at KES 1.00 per share. In order not to violate the Companies Act, the KQ will do the following:

a)     Share Split: the one Ordinary Share of the company of KES 5.00 will be split into 20 shares of KES 0.25 each which will create a huge number of shares. Because the Companies Act allows division of shares into various classes, the split shares will be divided into classes of Interim ordinary Shares (carrying all voting and economic rights) and Deferred Shares (carrying no rights and having no economic rights and value).

b)     Thus, each existing ordinary Share will be split into one (1) Interim ordinary Share of KES 0.25 each and nineteen (19) deferred shares of KES 0.25 each nominal value. The split will therefore reduce the nominal value of the existing Ordinary Shares without having a reducing effect on the share capital of the company, an event that would otherwise violate the provisions of the Companies Act.

c)      In debt to equity conversion, the lenders will be allotted only the class of interim ordinary shares at KES 0.25 per share. However, the share split will result to the company having up to 29.9 billion shares in issue. These are too many.

d)     To solve this will necessitate share consolidation. Therefore, and subsequently, and immediately following the Debt Restructurings taking effect four Interim Shares will be consolidated into one Ordinary Share of nominal value of KES 1.00 each; and Deferred Shares that were created before issuance of the new interim ordinary shares will be cancelled for nil consideration. This will leave just Ordinary Shares (with a nominal value of KES 1.00 each following the Consolidation) in issue.

e)     This will lead to an appropriate number of shares and a meaningful trading price for such shares on the NSE will be achieved. The Consolidation will reduce the number of shares in issue but may also increase the market value of each share as compared to immediately prior to the Consolidation.

The new Ordinary Shares consolidated will rank pari passu with the existing Ordinary Shares but owing to the Share Split and subsequent Consolidation, they will be of a nominal value of KES 1.00 each and will be credited as fully-paid up.

Until they are cancelled, the Deferred Shares will be of a nominal value of KES 0.25, will have no voting rights or economic rights and will rank behind all other shares on the winding up of the Company and will, upon issue, be credited as fully paid. This solves the hurdle where KQ could not allot and issue new shares below their nominal value.

HURDLE 2: After debt conversion, the lenders will have acquired a shareholding of 35% in KQ. This is above 25%, which is the threshold for effective control and they will thus be deemed to have made a takeover over.

To solve this, the Government and KQ Lenders Co. Ltd have committed to expressly state that neither of them have an intention to make a general offer to acquire the shares of all other Shareholders through a take-over offer. Such an exemption can be sought from the Capital Markets Authority under Regulation 5 of the Take-Over Regulations. Such an exemption would allow the levels of the holdings of KQ Lenders Co. Ltd and the Government of the Ordinary Shares to be above the threshold, without them being deemed to make a takeover over.

In addition, KQ will make an application to the CMA to issue the new Ordinary Shares and to the NSE to list the new Ordinary Shares on the NSE.

HURDLE 3: The Pre-emption right requirement for the new issue

The Companies Act Under Section 338(1) provide for pre-emption rights, that is, new shares in a company cannot be offered to other potential investors without first being offered to the current shareholders. This means that for the KQ board to allot new shares, they in first instance must offer them to existing Shareholders in the proportion to their holdings.

To ensure the new shares are offered to the lenders in debt equity conversion, the main shareholders, the government and KLM, had to be urged to agree to waive their pre-emptive rights to allow allotment of equity securities.

CONCLUSION 

Deleveraging KQ is the first step in ensuring recovery of the airline. Probably, having lenders as shareholders will ensure the airline is more ambitious. Terrible strategic decisions like those made by Titus Naikuni in his project Mawingu, will be curtailed.

However, it is vital to note after restructuring, the top 3 shareholders, the Kenyan Government, the Kenyan banks, and KLM, will cumulatively have a shareholding of 95%. It is therefore not rational to have such a company with such a low market float to continue being listed. It should be listed and re-list at a later date. Probably, the Kenyan banks would exit through an Initial Public Offering to recoup their investment.

 

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