S&P: EMP assigned 'B' rating with positive outlook; proposed notes rated 'B'

(Singapore, Oct. 18, 2012) -- Standard & Poor's Ratings Services said today that it had assigned its 'B' long-term corporate credit rating to Indonesian exploration and production (E&P) company PT Energi Mega Persada Tbk. (EMP). The outlook is positive. At the same time, we assigned our 'B' issue rating to a proposed issue of senior secured notes that EMP and its subsidiaries guarantee. EMP's subsidiary, EMP International Holdings Pte. Ltd., will issue the notes. Our rating on the proposed notes is subject to our review of the final issuance documentation. EMP is a holding company that has interests in production sharing contracts in various oil and gas blocks.

"The rating on EMP reflects the company's large capital expenditure requirements relative to its free cash flow generation," said Standard & Poor's credit analyst Vishal Kulkarni. "The rating also reflects the limited track record of EMP's development blocks, and the company's exposure to volatile oil prices and asset concentration in Indonesia. EMP's good growth potential in its blocks, long-term fixed-price gas sales contracts, and the favorable outlook for energy demand in Indonesia, particularly for gas, temper the above weaknesses. The rating is based on the assumption that the company will refinance its debt with the proposed notes."

The rating considers PT Bakrie & Bro. Tbk.'s 15% stake in EMP. EMP, an affiliate of Bakrie & Bro., and an unrelated third party jointly own 36% stake in Offshore North West Jawa (ONWJ) oil block. The shareholder agreement among these entities gives the unrelated third party control over business and cash flow related decisions at ONWJ. We believe the agreement mitigates potential related-party transaction risks at ONWJ at the current rating level.

EMP has limited cash flows at the holding company level, after accounting for debt servicing and capital expenditure at the operating subsidiary level, in our opinion. All of the company's major blocks are undergoing sizable capital expenditure programs that EMP can fund internally, but only with a small cushion. However, the company has some flexibility in its capital expenditure plans.

We believe that EMP has limited operating diversity. In addition, the company's cash flow generation from the oil segment is exposed to volatile oil prices. Moreover, all of EMP's assets are concentrated in Indonesia. This exposes it to Indonesia's country and macroeconomic risk and geological risks. EMP's blocks have a favorable reserve life and the company sells to counter parties with good credit profiles.

Debt servicing on the proposed notes will be subordinated to the payment of interest on, and amortizing principal payments for, a US$300 million debt at the Kangean block, which is non-recourse to EMP. Dividends paid from ONWJ's cash flows to its other shareholders will also cause some cash leakage, even though such payments are optional.

"We view the bullet maturity of the notes in 2017 as causing refinancing risk, particularly because there will be no sweep of excess cash or dividend restrictions in the years when the notes are outstanding," said Mr. Kulkarni.

The positive outlook reflects our expectation that the increase in EMP's gas production will boost its cash flows.

We could upgrade EMP if: (1) the company is on track to produce about 7.5 million barrels of oil and 115 billion cubic feet of gas in 2013; and (2) the company generates free cash flow of more than US$250 million annually (after dividends at ONWJ, and debt servicing and amortization at Kangean but before capital expenditure). We assume that EMP will not increase its already sizable capital spending and that it won't make any debt-funded acquisitions.

We could revise the outlook to stable if production slips or oil prices fall such that EMP's free cash flow (after dividends at ONWJ, and debt servicing and amortization at Kangean but before capital expenditure) is less than US$200 million in 2013. Such a scenario will reduce the company's financial flexibility and lower its capital expenditure, thus jeopardizing future growth in production and cash flow generation. Negative rating action is also likely if: (1) EMP fails to refinance its debt through the proposed notes; or (2) the company engages in any new or additional related-party transactions related to ONWJ or any other asset that could hurt its cash flow or weaken its financial profile. (ends)