TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Year ended December 31, 2010
Business Overview: TGS operates a natural gas transportation pipeline system in Argentina and produces/commercializes natural gas liquids (NGLs). The company also provides midstream and telecommunications services. A major milestone in 2010 was the inauguration of the second submarine pipeline crossing the Strait of Magellan, adding 600 MMcf/d capacity.

Key Financial Metrics (Year Ended Dec 31, 2010)

Note: All figures in Argentine Pesos (Ps.) unless otherwise stated. Financial indebtedness is in US Dollars.

Segment Performance

• Gas Transportation: Revenues decreased to Ps. 551.0 million (from Ps. 669.4 million) due to the derecognition of a previously recorded tariff increase. Operating income dropped significantly to Ps. 63.5 million.
• Liquids Production & Commercialization: Revenues increased to Ps. 1,010.4 million (from Ps. 800.5 million), driven by a >30% rise in international prices. This segment accounted for 61% of total revenues.
• Other Services: Revenues declined to Ps. 91.6 million (from Ps. 130.7 million) due to lower construction and midstream service volumes.

Material Changes vs. Prior Period

• Revenue Recognition Reversal: The most significant financial change was the reversal of Ps. 122.1 million in revenue related to a 20% tariff increase granted in 2009. TGS discontinued recognizing this revenue in 2010 because the regulator (ENARGAS) had not approved the billing methodology, and an appeal was pending. This resulted in a Ps. 122.1 million charge under "Other operating expenses."
• Net Income Decline: Net income fell by Ps. 76.2 million (43%) primarily due to the tariff revenue reversal, partially offset by higher margins in the liquids segment.
• Debt Reduction: TGS continued its debt reduction policy, purchasing debt notes under par (US$ 21 million face value), generating a profit of Ps. 5 million. Total financial indebtedness reached a low of US$ 374 million with no principal maturities for three years.
• Operational Reliability: The pipeline system maintained 97.3% equipment availability and 99.1% reliability. Liquids production remained stable at ~986,000 short tons.

Guidance, Outlook, and Risks

Management Commentary & Outlook

For 2011, management prioritizes:

• Tariff Renegotiation: Continuing negotiations with UNIREN to re-compose gas transportation tariffs to restore profitability.
• Liquids Optimization: Developing methods to optimize production and negotiating new supply agreements to mitigate lower gas volumes arriving at the processing plant.
• Telecommunications: Commercializing the extensive capacity of the Telcosur subsidiary.
• Safety: Reducing work accident rates through training and new tools.

Risks and Contingencies

• Regulatory Uncertainty: The outcome of the tariff renegotiation and the pending appeal regarding the 20% tariff increase remains uncertain. The Public Emergency Law, which impacts tariff adjustments, is set to expire on December 31, 2011.
• Legal Proceedings:
  • Tax Disputes: Ongoing disputes regarding turnover tax exemptions for liquids sales (Provision of Ps. 29.1 million) and fuel tax assessments (Provision of Ps. 57.4 million).
  • GdE Lawsuit: A remaining balance of Ps. 5.2 million related to a Supreme Court ruling on compressor plant costs.
  • Central Bank Proceedings: Summary proceedings regarding late foreign currency settlements (US$ 14.7 million); no provision recorded as management believes it has strong legal grounds.
• Customer Credit Risk: A Ps. 27.2 million allowance for doubtful accounts was recorded for receivables from MetroGAS S.A. following its bankruptcy filing.

Investor Verification Checklist

• Tariff Resolution Status: Verify the current status of the appeal regarding the 20% tariff increase and the timeline for the integral license renegotiation with UNIREN.
• Liquids Price Sensitivity: Assess the sustainability of the >30% increase in international NGL prices that drove 2010 revenue growth.
• Regulatory Expiry: Monitor the implications of the Public Emergency Law expiring on December 31, 2011, on future tariff structures.
• Debt Covenants: Confirm compliance with debt covenants (Coverage ratio > 2.0:1; Debt ratio < 3.75:1) given the volatility in operating income.
• Tax Provision Adequacy: Review the potential impact of the Ps. 86.5 million total tax provisions (turnover and fuel taxes) if legal outcomes turn unfavorable.