TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS), also known as Gas Transporter of the South Inc.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2007
Accounting Basis: Argentine GAAP (with US GAAP reconciliations provided)
Primary Operations: TGS is the largest natural gas transporter in Argentina, operating the southern gas transportation system. It also engages in the production and commercialization of Natural Gas Liquids (NGL) and provides midstream and telecommunications services.

Key Financial Metrics (Year Ended Dec 31, 2007)

Note: Financial statements are presented in thousands of Argentine pesos. US GAAP figures differ primarily due to the treatment of deferred taxes, capitalized foreign exchange differences, and troubled debt restructuring.

Material Changes vs. Prior Period (2006)

• Revenue Decline: Net revenues decreased by 4.0% (Ps. 52.2 million) to Ps. 1,257.3 million. This was driven by an 8.1% drop in NGL production revenues due to lower volumes, partially offset by a 3.6% increase in gas transportation revenues.
• Profitability Drop: Net income under Argentine GAAP fell 58.8% to Ps. 147.5 million. This sharp decline was primarily caused by a Ps. 125.1 million increase in income tax expense (due to the reversal of a tax loss carryforward allowance in 2006) and lower NGL volumes.
• Debt Refinancing: In May and June 2007, TGS successfully refinanced its outstanding debt. It issued US$ 500 million in new notes (7.875% fixed rate, due 2017) and used proceeds to redeem restructured notes and prepay Inter-American Development Bank loans. Total USD-denominated debt was reduced to US$ 500 million.
• Operating Costs: Costs of sales increased by 2.4% (Ps. 14.8 million), mainly due to higher maintenance and labor costs.

Guidance, Outlook, Risks, and Contingencies

Outlook and Management Commentary

• Tariff Renegotiation: TGS is engaged in ongoing renegotiations with UNIREN (Unit for Renegotiation and Assessment of Utilities Contracts) regarding its public service contracts. The Public Emergency Law, which suspended tariff indexing and fixed the peso-dollar conversion rate at 1:1, remains in effect until December 31, 2008. No agreement has been reached as of the filing date.
• Capital Expenditures: Projected capital expenditures for 2008-2010 total approximately US$ 205.6 million, primarily for gas transportation expansions and reliability improvements. These are expected to be financed by cash from operations and customer advances.
• Dividends: A dividend of Ps. 32.0 million was approved on April 10, 2008, and paid on May 7, 2008. Future dividends are subject to debt covenants requiring a consolidated coverage ratio of at least 2.0:1 and a debt ratio of no more than 3.75:1.

Key Risks

• Regulatory and Political Risk: Significant exposure to Argentine government actions, including potential changes to the Public Emergency Law, tariff freezes, and the outcome of the UNIREN renegotiation process.
• Currency Risk: Substantially all debt is USD-denominated, while over 40% of revenues are peso-denominated. A devaluation of the peso would increase the peso cost of debt service while revenues may not adjust proportionally.
• Energy Crisis and Supply Constraints: High domestic demand and low production have led to government-mandated interruptions of firm transportation contracts to prioritize residential and power plant users. This disrupted NGL production at the Cerri Complex in 2007.
• Export Taxes: NGL exports are subject to a variable export tax regime. If international prices exceed certain thresholds, the marginal tax rate can reach 100%, capping post-tax revenues.

Contingencies and Legal Proceedings

• CNV Tax Withholding: The Argentine Securities Commission (CNV) challenged the tax-exempt status of US$ 178 million in notes issued in 2004. TGS faces a potential withholding tax contingency of US$ 6 million to US$ 17 million. No provision has been recorded as TGS believes it has sufficient legal grounds to defend its position.
• BCRA Foreign Exchange: The Central Bank of Argentina (BCRA) initiated summary proceedings regarding late settlement of foreign currencies (approx. US$ 14.7 million) between 2002-2003. TGS estimates a potential fine not exceeding US$ 7.3 million and has filed a motion to dismiss.
• Tax Claims: TGS has recorded provisions of Ps. 15.9 million and Ps. 20.1 million for potential losses related to turnover tax claims by the provinces of Buenos Aires, Santa Cruz, and Río Negro.

Important Facts for Investor Verification

• Debt Covenants: Verify compliance with the restrictive covenants of the new US$ 500 million notes, specifically the coverage and debt ratios that limit dividend payments and additional borrowing.
• Tariff Renegotiation Status: Monitor the progress of negotiations with UNIREN, as the current tariff structure (pesified at 1:1) significantly impacts the USD value of regulated transportation revenues.
• NGL Production Volumes: Assess the impact of government-mandated gas supply interruptions on NGL production volumes, which constitute over 50% of total revenues.
• Exchange Rate Sensitivity: Evaluate the company's net liability position in USD (approx. US$ 367.6 million as of Dec 31, 2007) and the potential impact of peso devaluation on financial results.
• Legal Contingencies: Review the status of the CNV tax withholding dispute and BCRA foreign exchange proceedings, as adverse outcomes could result in significant cash outflows.