It may be time for investors to kiss Petroleos de Venezuela (PDVSA) goodbye. For many, the farewell will be far from teary. The oil giant launched a tender offer early last week to retire roughly US$2.6 billion in export-backed notes issued via PDVA Finance, paper that plunged from investment grade to high yield over the last few years (see table, p. 20). The premium, most say, is juicy enough to entice buyside away from this state-owned company that has lost a lot of friends since the Chavez administration began squeezing the government harness.

"We view the deal positively; they're paying a significant premium," said Peter Marber, president of The Atlantic Funds, which has US$650 million in emerging-market debt in its portfolio, including PDVSA Finance. "For holders, it's a pretty fair offer."

That may hold doubly true for high-grade accounts who have not found the opportunity to bail since the company became one of Latin America's most notorious fallen angels.

Led by JPMorgan Securities and Deutsche Bank Securities, when announced, the offer was a premium of several points over secondary prices for most of the PDVSA curve, according to one trader. "I think a lot of people are going to use this to get out of the credit," he said. And while the sweetener appears to be tempting enough, the offer features covenant changes for those who decide to hang on. Depending on how successful the tender is and the resulting degree of deleveraging - the company set a 50% threshold to go ahead - remaining bondholders might be stuck with decidedly weaker covenants. That would be another incentive to take the money and run.

Among the proposed amendments is the dropping of key companies as designated obligors of the transaction, including PDVSA affiliates Citgo Petroleum Corp. and Hovensa, which in recent years have accounted for between 40% and 60% of total volumes sold to the structure's designated customers. Other changes include cutting the required export receivables sold through the PDVSA Finance structure to 4.5 billion barrels from 27 billion barrels of crude oil below 30 degrees American Petroleum Institute (API). This would come on top of slashing the mandatory percentage of total below-30-degree oil sales through the structure to 40% from 80%.

Finally, the company is seeking to reduce the scope of its financial disclosure, provided that PDVSA Finance is no longer required to file under the SEC.

The move towards opacity comes as no surprise to PDVSA watchers, as the company's finances appear to be growing ever more entwined with that of the sovereign. Repeated attempts to reach PDVSA officials went unanswered.

Rating agencies, for their part, have differing takes on the company and the potential impact of the tender offer. In the wake of the offer, Moody's Investors Service kept the bonds at Caa1', Standard & Poor's put their B+' rating on CreditWatch negative, and Fitch Ratings affirmed the structure at BB-'. One material difference among the agencies is how serious each views the government's intrusion into the affairs of the corporate, and, potentially, of the structure. "Our rating represents the high degree of political risk," said Maria Muller, senior credit officer at Moody's. This risk prompted the agency to collapse together the ratings of the corporate, structure and sovereign early last year. Fitch and S&P still believe the structure is somewhat shielded against sovereign interference, though government meddling has brought the ratings closer in line. "[The structured notes] offer some additional credit protection that the government and PDVSA itself do not have," said Kevin Kime, director at S&P. The agency has Venezuela at B-', a couple of notches below the sovereign.

Going forward, there is talk that PDVSA might issue in the local market, where dysfunction caused by government controls guarantees something of a captive audience for treasurys and quasi-sovereigns. While the payout for the bonds is substantial, retiring the paper would mean significantly freeing up cash flows. The company is pursuing a US$35 billion, five-year investment plan, but there is still the open question of how much the government will divert for social spending. Assuming the buyback is successful, "I don't think it will compromise capex going forward as much as social spending issues will," said Jason Todd, senior director at Fitch.

As for the EM market in general, if PDVSA hits its reported target of 100%, a good deal of cash will be flowing back into portfolios. But it's doubtful it will have much of an impact on demand in the structured market, sources said. A good number of PDVSA holders are non-EM dedicated accounts that will likely put their money to work elsewhere. In addition, non-structured paper will be vying for any bump-up in liquidity, while at least a few Latin American originators are expected to churn out fresh supply over the coming months.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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