TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS)
Reporting Period: Year ended December 31, 2004
Business Overview: TGS is Argentina's leading natural gas transporter, operating a 7,419 km pipeline system delivering approximately 60% of the country's gas consumption. The company operates three segments: regulated gas transportation, non-regulated Natural Gas Liquids (NGL) production and commercialization, and other services (midstream and telecommunications).
Macro Environment: Operations occurred within an improved Argentine macroeconomic environment (8% GDP growth) and high commodity prices. However, the company faced significant regulatory uncertainty due to the Public Emergency Law, which froze tariffs and suspended standard adjustment mechanisms.

Key Financial Metrics (2004)

Note: Figures are in constant Argentine pesos as of February 28, 2003, per the filing's accounting basis.

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased by 48% (from Ps. 286.2M to Ps. 147.9M). This was primarily due to the absence of a Ps. 137M deferred tax liability reduction and a Ps. 30.7M foreign exchange gain recorded in 2003. Conversely, 2004 included a Ps. 26.0M foreign exchange loss.
• Revenue Growth: Total revenues increased by 11.3% (Ps. 101.3M). The NGL segment drove this growth with a Ps. 77.9M increase due to higher international prices and volumes. Gas transportation revenue grew modestly by 2.9%.
• Segment Shift: The NGL segment's share of total revenue rose to 51% (from 48% in 2003), while the regulated gas transportation segment's share fell to 44% (from 47%).
• Cash Flow Contraction: Operating cash flow dropped significantly to Ps. 116.3M from Ps. 527.6M. This was largely due to the payment of Ps. 370.3M in accrued interest that had been postponed since May 2003.
• Debt Restructuring: TGS successfully restructured its indebtedness in December 2004, obtaining 99.76% creditor consent. This resulted in a Ps. 33.1M gain from the forgiveness of default interest and lower interest rates, reducing total debt by Ps. 531.5M.

Guidance, Outlook, and Risks

Management Commentary and Outlook

Management views 2004 as a year of transition. The primary focus for 2005 is the renegotiation of the regulatory framework with the Argentine Government to restore the economic value of the regulated gas transportation business. Key priorities include:

• Regulatory Renegotiation: Securing tariff adjustments and a mechanism for periodic reviews to ensure long-term investment viability.
• Expansion Projects: Proceeding with the San Martín pipeline expansion (2.9 MMm³/d capacity increase) financed via a government-backed Trust Fund.
• Non-Regulated Growth: Consolidating the NGL segment and exploring synergies in midstream and telecommunications.

Risks and Contingencies

• Regulatory Uncertainty: The Public Emergency Law has prevented tariff adjustments for three years. The lack of a settled regulatory framework hinders investment and profitability in the core transportation business.
• Legal Proceedings:
  • Gas del Estado (GdE) Lawsuit: A Supreme Court ruling ordered TGS to pay the market value of compressor plants plus interest. TGS has recorded a Ps. 60M provision but is appealing, considering the amount excessive.
  • Tax Claims: Significant stamp tax claims from provinces (totaling Ps. 506M) and a Ps. 13M provision for Buenos Aires Province turnover tax on NGL sales.
• Market Risks: The creation of the Gas Electronic Market (MEG) may impact interruptible transportation revenues by forcing the sale of non-allocated capacity.

Investor Verification Checklist

• Debt Covenant Compliance: Verify TGS's ability to meet the new debt covenants, specifically the consolidated debt-to-EBITDA ratio (cap of 3.50 decreasing to 3.00) and liquidity requirements.
• Regulatory Progress: Monitor the status of the license renegotiation with UNIREN and the Argentine Government, as tariff adjustments are critical for the regulated segment's profitability.
• Legal Provisions: Review the final outcome of the GdE lawsuit and provincial tax disputes, as current provisions (Ps. 60M and Ps. 13M) may be adjusted.
• Trust Fund Financing: Confirm the execution of the San Martín pipeline expansion project and the successful funding of the Trust Fund by the government and producers.
• Exchange Rate Exposure: Assess the impact of Argentine peso volatility on the company's dollar-denominated debt and revenues, given the recent history of exchange losses.