Ezion Has Just got a “Thumbs-Up” From Its Bank: Here’s What Investors Need to Know

Ezion (SGX: 5ME), a services provider to the oil & gas industry, announced yesterday that it has successfully issued S$120 million worth of 5- year bonds that carry an annual interest rate of only 3.65%.

It’s an interesting bond issue exercise because comparable bonds are currently trading with a yield of roughly 6.5%. Given this, and the fact that the oil & gas industry which Ezion belongs to is, to say the least, not having the best of times, how has Ezion managed to borrow at such low rates?

The answer lies in the unique structure of the bonds in question. According to Ezion’s announcement, the bond is being “fully backed by a committed funding facility provided by DBS Bank Limited,” which is a part of Singapore’s largest bank DBS Group Holdings Ltd  (SGX: D05).

This does not mean that DBS is guaranteeing Ezion’s bond. Instead, the arrangement works like this: In the event that Ezion does default on the S$120 million bond, the debt instrument will be converted into a direct loan from DBS Bank.  In this way, holders of Ezion’s S$120 million notes should be protected from any default risks if DBS Bank does not remove the committed funding facility.

This is an interesting structure for a bond and it may also be taken to be an indication that DBS Bank is optimistic about Ezion’s ability to service and eventually repay the S$120 million worth of notes.

DBS Bank may have good reasons for this perceived-optimism. As of 31 March 2015, Ezion has a net-debt to equity ratio of 85%  Meanwhile, Ezion has an interest coverage ratio (EBIT / Interest Expense) of 8 for the whole of 2014. So while Ezion’s debt levels aren’t exactly low, it shouldn’t have any solvency issues with the margin of safety it has with its interest coverage ratio.

There are other risks to consider here too. Over the past five years, Ezion had generated negative free cash flow in each consecutive year; in 2014, Ezion’s free cash flow was a negative US$415 million.

Given that the company would likely only have slightly over US$400 million in cash after the bond’s issued, Ezion’s cash-burn might be a cause of concern. That’s especially so when raising more debt does not seem to be a palatable choice with the whole oil & gas sector being weak.

That said, Ezion could always dial back its capital spending. And with the weak business environment currently, the firm might no longer need to spend as much. As Ezion had managed to generate more than US$200 million in operating cash flow in 2014, the negative free cash flow may easily become positive in the future if the firm’s capital expenditures are reduced.

Foolish Summary

All told, the bond issuance is a success for Ezion as it allowed the company to raise capital and borrow at a low interest rate. DBS Bank’s involvement and willingness to back the bond through a committed loan facility is also a confidence booster for Ezion.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any shares in companies mentioned above.