Emerging Markets

04 September 2009

Naftogaz
Breach of covenant & debt restructuring?

The debt-restructuring terms are still in question, but an indication has

been given. According to the IFRS report, the company is in negotiations to
restructure c. $1.6bn debt to foreign banks and is aiming to complete it
successfully by the end of 2009. The precise details of restructuring are still
unknown but the majority of sources are referring to possible exchange of the
Eurobonds into an issue of 3-5 years longer maturity with a state guarantee.
That said, investors have the following options:

Selling the bond as soon as possible. For any investors who bought the
issue at 40% of par last autumn profit taking looks very reasonable.

Holding the bond and most likely receiving 3-5 years state guaranteed paper
with 10%-13% coupon in exchange for Naftogaz 2009 eurobonds quoted
78.5/86 of par. This option seems quite attractive assuming that the
exchange will be done at par and most likely this is the main reason for the
quite high resistance of the Eurobond to negative news flow. However, we
note there is high execution risk in the deal, as some investors are clearly
thinking of suing the company for default. In addition, so far we have no
clear information that the bonds will be converted at par. On the other side
we still do not rule out the option that Ukrainian government and Naftogaz
are just shaking the boat for political purposes or trying to reduce the market
price of the Eurobond for repurchase. In this case risk-tolerant investors can
benefit.

Buying the bond at some 86% of par. Given the described risks and high
bid-offer spreads we would not recommend increasing positions. We believe
in the current situation the compensation for risk is not sufficient.

Suing the company for default. So far we have not found any clear evidence
of the event of default. One of the possibilities would be to refer to the
material adverse effect clause which exists in certain loan agreements of
Naftogaz, but we assume that this event would be very hard to prove.
Should the bankruptcy procedure be initiated this would be in the interest of
neither the company nor creditors given the weak financial situation in
Naftogaz. This could also cause a potential risk for Naftogaz payments for
Russian gas. We consider this scenario quite unlikely. Acting Minister of
Finance of Ukraine announced that the company is accumulating cash
($667m) to pay for August gas supplies before 7 September.

Naftogaz
Moodys

Caa2 (Negative)

S&P

NR

Fitch

CC (Negative)

Naftogaz 2009 eurobond Performance

100
90
80
70
60
50
40
30
20

PX_ASK

PX_BID

10
0
Se
p08
O
ct
-0
8
N
ov
-0
8
D
ec
-0
8
Ja
n09
Fe
b09
M
ar
-0
9
Ap
r09
M
ay
-0
9
Ju
n09
Ju
l-0
9
Au
g09
Se
p09

Naftogaz of Ukraine has actively been on the news recently after the
company unveiled FY 2008 financials and announced the restructuring of
its external debt. The company hired Credit Suisse as a consultant for
the restructuring and Credit Suisse was in charge of restructuring
Ukraines sovereign debt in 2000. Corlblow, representing the interests of
a group of Russian investors, is trying to escalate the Eurobond
repayment referring to a breach of the financial covenant in the
companys FY 2008 IFRS report. The group states that it would block any
action on the Eurobonds besides a full and timely repayment no later
than 30 September 2009. In July we had already warned that the situation
around the company is worsening. Investors still had a chance to get rid
of the bond at some 78.5% of par when we were writing this report. The
other option would be to wait for restructuring terms, but this would
incur certain risks especially given the currently unstable economic and
political situation in Ukraine.

Source: Bloomberg, Commerzbank Corporates&Markets

Analyst
Marina Vlasenko
+7 495 651 6033
marina.vlasenko@commerzbank.com

For important disclosure information please see pages 3 and 4

cbcm.commerzbank.com

CIS Credit Monitor

The company is not

planning to repurchase or
repay the eurobond

The companys statements have recently been controversial. On 3 September 2009 in the
Ukrainian edition of Kommersant newspaper deputy CEO Igor Didenko stated that the company
has no plan for full or partial repayment or repurchase of the Eurobond and does not have any
cash reserved for the repayment. We recall that previously Naftogaz always insisted that full
repayment of Eurobonds is part of the companys financial plan and therefore $500m is reserved
for the repayment.

Only restructuring is
expected to improve the
financial situation

Naftogaz financial situation was poor in FY2008 and in 2009, however certain efforts have
been made. The company largely suffered from the devaluation of the national currency with FX
losses recorded at UAH 8.7bn. As a result Naftogaz posted a UAH 2bn net loss. The companys
debt almost doubled in the year as it had to attract massive debt resources to cover a UAH
9.9bn operational cash outflow and UAH 3.6bn investment costs. Therefore the debt almost
doubled and Net debt/EBITDA ratio according to our calculations reached 5x. In 2009 the debt
remained high and was reported at UAH 35bn ($4.5bn) in total according to the May audit
commission. In 2009 the cash-flow situation in the company is known to be very tight due to the
lack of demand for gas from local consumers and limited ability to increase prices. The foreign
currency liquidity situation has also been under pressure with payments for gas executed with
regular scandals in the press. However, we have to note that the company managed to secure
UAH 7.3bn in loss compensation from the state budget (UAH 3.7bn already received) and it
received a considerable UAH 18.6bn injection of capital which it is planning to monetise by the
year end. It will also be able to increase prices by 20% as early as this autumn. On top, the
company extended its loan agreements with state banks for UAH 12.6bn from 2009 to 2010 and
is in talks to attract another UAH 11bn. The company believes that only in combination with debt
restructuring will it be able to continue its operations.
We believe that the case of Naftogaz is more a question of willingness than the ability to
pay as $3.3bn IMF tranche was supposed to cover the debt repayment by gas monopoly (See
CIS Notes: Ukraine, the sovereigns ability to pay published on 28 July by Barbara Nestor). Fitch
noted that Naftogaz debt restructuring will not be treated as sovereign default, but will threaten
the countrys perception on the credit market.

Corlblow wants to block

the restructuring and
insists on early repayment

The Action Group of Russian bondholders has recently announced in its blog
(http://www.ukrnaftogaz-default.com) that it will be trying to escalate the repayment of
$500m Naftogaz eurobond due on 30 September 2009. Corlblow company (Belize)
representing the interests of the group holds $112m of the companys $500m Eurobond. The
group states that its analysis of FY 2008 IFRS results points in the direction that Naftogaz was in
breach of the financial covenant under the underlying Standard Bank - Naftogaz loan agreement
as of 31 December 2008. The group refers to paragraph 14.11. "Naftogaz shall not, at any time,
permit Consolidated Net Indebtedness to exceed 75% of Consolidated Net Worth and shall
procure that, of such permitted Consolidated Net Indebtedness, the aggregate Indebtedness of
all Consolidated Subsidiaries shall not be, at any time, be greater than an amount equal to 30%
of Consolidated Net Worth. The group sees the critical ratio at 88.8% and believes that as
Naftogaz has exceeded the critical ratio it is in irreparable default and therefore owes immediate
repayment of the principal and accrued interest. On 2 September the Group asked the Trustee
to initiate the enforcement of early repayment.

We have not identified a

breach of covenant so far

However, we are not sure that the breach of financial covenant has actually taken place.
According to our calculation with respect to definitions given in the Prospectus, we have not
identified a breach of covenant (see Table 1). We see the critical ratio at 63% FYE 2008. In the
IFRS report of Naftogaz for FY 2008 the auditor (Ernst&Young) does not mention any breach of
financial covenant. The auditors refer only to a technical default which occurred due to the failure
of Naftogaz to publish its annual IFRS report within seven months after the reporting period (no
later than 31 July 2009). However, the report was finally submitted to trustee (BNY Mellon) by 1
September, right after the banking holiday, and therefore the technical default case was
resolved. We recall that it is quite typical for Naftogaz to delay IFRS publication and bondholders
have always provided waivers.

04 September 2009

CIS Credit Monitor

TABLE 1: Naftogaz financials

IFRS, UAHm
Sales
EBITDA*
Net Income

2007

2008

Change %, y-o-y

30,424

53,143

75%

6,020

6,807

13%
2942%

-66

-2,008

Interest Expense

-1,375

-1,383

1%

Total Debt

12,870

36,347

182%

of which: Short term

3,459

19,628

467%

Long-term

9,411

16,719

78%

587

2,604

344%
175%

Cash&Cash Equivalents
Net Debt

12,283

33,743

Equity

56,957

53,200

-7%

108,641

123,617

14%

Total Assets
Operation CF

5,885

-9,885

-268%

-5,803

-3,667

-37%

20%

13%

0%

-4%

Net debt/Equity (Covenant, )***

22%

63%

Debt/EBITDA ()**

2.14

5.34

Net debt/EBITDA (x)

2.04

4.96

CAPEX
Profitability ratios
EBITDA Margin (%)
Net Margin (%)
Debt ratios

EBITDA/Interest expense ()
Debt/Assets ()

4.4

4.9

0.12

0.29

* Adjusted for FX losses and impairment of property, plant and equipment

** Ratios based on EBITDA for the last 12 months
*** Commerzbank estimates
Source: Company Data, Commerzbank Corporates & Markets

04 September 2009

CIS Credit Monitor

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