TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS) and Subsidiary (TELCOSUR S.A.)
Reporting Period: Fiscal years ended December 31, 2002 and 2001.
Business Overview: TGS operates a natural gas transportation pipeline system connecting southern/western Argentina to the Buenos Aires area and produces/commercializes natural gas liquids (NGL). The company operates under a 35-year license granted following the privatization of Gas del Estado.
Economic Environment: The reporting period was defined by a severe Argentine economic crisis, including a sovereign debt default, the devaluation of the peso (approx. 237% in 2002), high inflation (CPI 40.7%), and the enactment of the "Public Emergency Law" which suspended tariff indexing to foreign currencies and mandated a 1:1 peso-dollar conversion rate for tariffs.

Key Financial Metrics (2002 vs. 2001)

Amounts in thousands of constant Argentine pesos, unless otherwise noted.

Segment Performance (2002):

• Gas Transportation: Revenues of 512,911; Operating Income of 269,145.
• NGL Production: Revenues of 335,966; Operating Income of 191,455.
• Other Services: Revenues of 57,703; Operating Income of 13,459.

Cash Flow: Cash paid for income tax was 21,871 (vs. 151,359 in 2001). Cash paid for interest (net of capitalized) was 285,467 (vs. 205,272 in 2001).

Material Changes vs. Prior Period

• Revenue Decline: Total net revenues decreased by approximately 23% (from 1.18 billion to 906 million pesos). This was driven by the suspension of tariff adjustments linked to the Producer Price Index (PPI) and the economic recession reducing demand.
• Financial Expense Surge: Net financial expense increased dramatically from 196,678 in 2001 to 1,055,454 in 2002. This was primarily due to a foreign exchange loss of 689,909 and inflation exposure losses resulting from the peso devaluation on dollar-denominated debt.
• Operating Income Drop: Operating income fell by 38% due to lower revenues and the inability to pass on cost increases via tariff adjustments.
• Capital Expenditure Reduction: Investments in property, plant, and equipment dropped significantly from 419,926 in 2001 to 104,609 in 2002, reflecting liquidity constraints and the economic crisis.
• Debt Covenant Breaches: Due to the devaluation of the peso, TGS failed to meet debt-to-equity and EBITDA-to-financial-expense covenants in its loan agreements, potentially making long-term debt callable.

Guidance, Outlook, Risks, and Contingencies

Management Commentary & Outlook: Management is implementing an action plan to mitigate the negative impact of the economic crisis but provides no assurance of success. The company is actively renegotiating its license and debt terms with the government and creditors. A 10% tariff increase was authorized by the government in January 2003, though it faces legal challenges.

Key Risks:

• Going Concern: The auditor's report expresses substantial doubt about the company's ability to continue as a going concern due to the economic crisis, covenant breaches, and uncertainty regarding asset recoverability.
• Debt Acceleration: Creditors may demand immediate repayment of approximately 1.8 billion pesos in long-term debt due to covenant violations. The company has classified this as non-current, but auditors suggest it should be current.
• Regulatory Uncertainty: The "Public Emergency Law" suspended tariff indexing. The outcome of license renegotiations is uncertain, impacting future revenue projections and asset valuation.
• Legal Contingencies: Significant disputes exist regarding provincial stamp taxes (claims totaling hundreds of millions of pesos) and easement payments owed by the former state entity (GdE). The company has obtained injunctions in several cases but faces potential liabilities.

Unusual Items:

• Capitalized Exchange Loss: The company capitalized an exchange loss of approximately 584,067 into property, plant, and equipment under specific accounting resolutions.
• Tax Loss Carryforward: Due to significant exchange losses, the company did not recognize income tax expense in 2002. A loss carryforward exists but is restricted to 20% utilization per year starting in 2002.

Investor Verification Checklist

• Debt Restructuring Status: Verify the outcome of negotiations with creditors regarding the covenant breaches and the potential acceleration of 1.8 billion pesos in debt.
• Tariff Renegotiation: Confirm the final status of the 10% tariff increase authorized in Jan 2003 and the broader license renegotiation process with the Argentine government.
• Asset Valuation: Review the assumptions used to determine the recoverable value of regulated assets, given the auditor's note on the uncertainty of future cash flows.
• Legal Resolutions: Monitor the status of provincial stamp tax lawsuits and the recovery of easement costs from GdE/ENARGAS.
• Liquidity Position: Assess the company's ability to service interest payments and meet working capital needs amidst restricted access to foreign currency and capital markets.