The situation in Egypt

TransGlobe Energy (TGL.TO, TGA) and Centamin PLC (CEY.L, CEE.TO) are two publicly-traded companies that have not been able to get their profits out of Egypt.  The end game may be awful for shareholders if they cannot get any profits out of the country ever.  While I am interested in shorting companies with Egyptian assets, the obvious danger is if the Egyptian government begins to respect foreign capital.

*Disclosure:  No position in either TransGlobe or Centamin.

I’ve written about TransGlobe in the past (writeup).

Centamin is a mining company with a fully-built mine in Egypt.  It has been putting money into expanding the mine.  Like TransGlobe, it too seems to be having problems in getting money out of the country.  According to its 2013 annual report:

With a view to demonstrating goodwill toward the Egyptian government, PGM has made advance payments to EMRA of US$18,950,000 (2012: nil) which will be netted off against any future profit share that becomes payable to EMRA.

centamin-annual-report-excerpt

It is possible that Centamin won’t ever see any profits from its mine.

Why I’m not trying to short Egypt

The thesis is largely driven by politics.

  1. I know very little about Egyptian politics.
  2. Even political experts may not be very good at predicting the future political climate.

The political situation in Egypt

In February 2011, Mubarak resigned and fled Egypt.
In June 2012, Mohammed Morsi became the new president.
In July 2013, the military staged a coup and removed Morsi.
In June 2014, Abdel Fattah el-Sisi was sworn in as president.  He previously resigned as the head of the Egyptian armed forces.

Politically, the situation continues to be tense.  Egypt’s current rulers (the military) continues to crack down against its opponents.  Egyptian Minya Criminal Court sentenced 529 people to death in a single hearing on 25 March 2014.  Many of the supporters of the Muslim Brotherhood have been jailed.

Saudi Arabia and the UAE are also currently supporting the Sisi government with loans and aid.  Egypt receives military (and other) aid from the US.  I’m guessing that the US wants a military ally in the region and is willing to overlook Egypt’s human rights abuses.  Many people say that US foreign policy is driven by oil.  However, I have no idea how true that is.  I believe that Egypt continues to withhold profits from foreign oil companies.

Egypt has a large debt burden but it continues to be able to obtain more debt.  I believe that various other countries are willing to keep the current regime in power and are willing to keep Egypt afloat financially.  Economists have criticized the country for continuing to subsidize domestic energy costs as a populist measure.  Its economy is not very productive due to corruption and a lack of respect for foreign capital.  Egypt would be producing a lot more oil if it allowed foreign companies to take some of their profits out of the country.  I suspect that the current regime is interested in looting the country for personal enrichment.  There is no long-term vision in place.  It is a terrible environment for capitalism.

On the other hand, there are plans for the country to expand the Suez canal.  The canal will be financed by bonds sold mostly to individual Egyptians.  The government is looking to tap into a sense of nationalism.  Some of the bonds carry an interest rate of 12 percent.  I believe these bonds are denominated in Egyptian pounds.  The Egyptian government will have the power to inflate its way out of trouble.

Currency

Given the country’s political woes, the currency hasn’t fallen that much.

At the beginning of 2011, the official exchange rate was roughly 5.8 EGP : 1 USD.  The current exchange rate is roughly 7.15 EGP : 1 USD.  The black market rate has widened significantly in the past and has dropped down to around 7.45:1 according to this Reuters article.  Currency controls continue to create an artificial exchange rate.  A cato.org blog article has an interesting graphic showing the historical black market rate to the middle of 2013:

egyptian-pound-black-market

My take

Given that the government still isn’t allowing foreign companies to take their profits out of the country, it seems less and less likely that they will see any profits from their investments.  The current regime is not thinking long-term and isn’t creating an environment that is capitalism-friendly.  Thanks to aid from foreign countries, the current regime seems like it will be well-armed and difficult to topple.  There could be a coup from within.  However, it is unlikely that the succeeding regime will also be capitalism-friendly.  Of course, there is the risk that somebody like Augusto Pinochet takes power and implements free market reforms.  That might be the worst-case scenario for short sellers.

I’m going to sit on this idea and think about it for a bit.  In the future, I may or may not short companies like TransGlobe, Centamin, and Petroceltic International.  I don’t want to short the Egypt ETF EGPT because weird things can happen.  The ETF arbitrage mechanism could be suspended, causing a short squeeze in the ETF.

Links

Why one foreign investor left Egypt – Very interesting blog post on a foreign investor that left the country and was able to take money out.

EDIT (10/19/2014): I think I’ve misread the situation.  TransGlobe has been getting some of its money back.  El-Sisi has been implementing some sensible economic reforms such as greatly reducing Egypt’s fuel subsidies.  The shrinking spread between the black market and official rates suggests that the currency will not collapse.

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5 thoughts on “The situation in Egypt

  1. Does Egypt withhold profits? It’s true that Egypt owes TGA a great deal of money, so TGA is in effect providing short term funding to the gov’t. But the receivables do get paid down at the end of the year. If we assume that Egypt is good for its gov’t debt – and investors apparently do – then it should be good for the TGA money. Otherwise it would make sense for TGA to get paid in Egyptian debt, and I’m sure the Egyptians would agree to that. The real problem that TGA has is that so much capital is tied up in short-term loans to Eyptian gov’t. That puts a big dent in the ROE.

  2. TGA is taking cash out. There is free cash flow. Yield on working capital is well into double digits. Egypt is not Argentina or Venezuela – Egypt is in no position to nationalize oil and/or stiff foreign creditors. It relies on foreign creditors to fund food imports, so no foreign credit, no food. The cash on the balance sheet is sufficient to cover the 2017 debentures, so that’s a safe 9% yield.

    • Thanks for the comment. I guess I haven’t been following TransGlobe lately. They have been getting some of their cash back. And Egypt has taken some positive steps such as reducing the fuel subsidies to get the economy back on track.

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