Tullow Fails Corporate Governance 101


(Bloomberg Opinion) -- The $1.7 billion hit to Tullow Oil Plc’s market value on Monday — a 65% drop — provides a stark reminder of why bosses shouldn’t stay too long at the top. The hydrocarbon producer has been stubbornly overoptimistic about its prospects. Reality has now dawned, and it turns out the London-based group is in an extremely tight position.

Oil and gas production in 2020 and beyond will be much lower than previously forecast, Tullow says. Estimated reserves in one of its major fields have been cut by 30%. Free cash flow will be around $150 million annually, against previous expectations of $500 million. The loss of market capitalization becomes explicable when you estimate the shortfall over the next few years, discount it back to the present day and add some shock value.

This isn’t Tullow’s first disappointment. The company had already conceded that production would be off-target this year. It also had to admit that a recent discovery was going to produce heavy oil, not the more profitable light kind that investors had wrongly anticipated.

Tullow Fails Corporate Governance 101

The company’s chair, Dorothy Thompson, will now run things temporarily. Chief Executive Officer Paul McDade and Exploration Director Angus McCoss have left abruptly. Two questions loom.

One is whether Tullow needs to raise equity. Net debt had been forecast to end the year at $2.8 billion — twice earnings before interest, taxes, depreciation and amortization. Going into next year, that leverage multiple is going to shoot up as the forecast for Ebitda will inevitably come down. Tullow also faces awkward refinancing obligations: A $300 million convertible bond matures in 2021, which is unlikely to be repayable in stock. In 2022, $650 million falls due. Tullow stresses its reduced free cash flow estimate was struck after the cost of debt servicing, and its dividend has also been suspended, which should allow for some debt reduction. Still, there’s no room for another disappointment on production and financing significant capital expenditure will be a serious challenge.

The second question is whether the problems that led to the inflated forecasts have been addressed. Did Tullow’s culture prevent bad news travelling upward? Or did management just take a glass-half-full approach instead of being appropriately skeptical? Thompson says staff were transparent with her as she conducted a review, which would point to the latter.

But either way, this company needs a reboot — and it’s hard to see how that can happen without an external CEO coming in. McDade and McCoss had been on the board for more than a decade. Before that, founder Aidan Heavey was the chairman for more than three decades. There’s a reason that corporate-governance box-tickers get anxious about long-serving bosses. Objectivity and perspective are diminished as the years pass by. Add Tullow to the list of case studies.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2019 Bloomberg L.P.

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