Wolf of NGX

Aradel Holdings Plc Q3 2026 Results There were too many moving parts in Aradel's Q3 2026 performance. The company is still digesting its recent acquisitions, and the ownership structure makes its financial numbers quite complex to understand. The ownership structure is something like this. Aradel owns a company, which owns another company, which in turn owns a stake in another business. So, Aradel indirectly owns these businesses, but the percentage ownership at each level makes things complicated. And because Aradel does not own 100% of these businesses, some of the profits reported in its accounts actually belong to other shareholders. One of the biggest surprises in Q3 was the sharp decline in gross margin. On the surface, Aradel's gross margin declined from 67% in Q2 to just 15% in Q3. That is a massive deterioration, but a closer look at the numbers provides some context. Aradel recorded a stock adjustment expense of about ₦482bn under cost of sales. However, a related positive overlift movement of approximately ₦368bn was recorded separately under other income. The accounting treatment makes the reported gross margin somewhat misleading. The large stock adjustment reduces gross profit, while the income that partly offsets it is recorded elsewhere in the financial statements. In my extract below, I normalised this by moving the stock adjustment from cost of sales to other income and expenses, so that it sits alongside the overlift gain. This does not change the company's total profit, but it provides a better picture of its underlying gross margin. I have explained overlift and underlift before, but let me explain again. Imagine Aradel and another oil company jointly own an oilfield that produces 100,000 barrels of crude oil. Both companies own 50% each, meaning they are each entitled to 50,000 barrels. Now, suppose Aradel takes 70,000 barrels instead of 50,000 barrels. It has taken 20,000 barrels more than its entitlement and must eventually compensate the other company, either through future production or a financial settlement. That is overlift. Underlift is simply the opposite. It happens when a company takes less crude oil than it is entitled to. That's by the way. Another major issue in Aradel's results was the earnout relating to the acquisition of Shell's former Nigerian assets. Aradel's enlarged group paid over ₦500bn in earnout payments during the first nine months of 2026, which significantly affected its reported profit. For those unfamiliar with the term, an earnout is an arrangement where the buyer of a business agrees to pay the seller additional money after the acquisition, depending on certain agreed conditions. You know that thing in football transfers when Chelsea sells a player to Arsenal, and they agree that if the player scores 15 goals in a season or wins the Champions League, Arsenal will pay Chelsea an additional amount? That is an earnout arrangement. A better illustration for Aradel's situation would be buying a 100-acre farm from someone for ₦100m. The seller agrees to transfer the farm to you, but includes a condition that, for an agreed period, he will continue to receive 20% of the net revenue generated from 30 acres of the farm. That is broadly similar to the arrangement between Renaissance and Shell. Aradel has disclosed that certain developments since the acquisition agreement was signed have created an imbalance in the earnout arrangement. The company and other Renaissance shareholders are now negotiating with Shell to address the situation. However, management has not explained exactly what developments caused the imbalance. Economically, the concern is that Renaissance could invest heavily in production infrastructure, absorb operating costs, take substantial commercial risks and still be required to make sizeable payments to Shell. For context, the over ₦500bn earnout payment represents more than 20% of Aradel's operating cash flow for the first nine months of 2026. That is a significant amount of money. And it raises questions about the quality of the acquisition agreement. Did the buyers underestimate the economic consequences of some of the contractual terms? Or were they so eager to acquire Shell's assets that they accepted certain obligations without fully appreciating how expensive those obligations could become? I mean, the acquisition was strategically transformative. For the indigenous consortium, taking over Shell's former assets offered an opportunity to achieve a scale that would ordinarily have taken many years to build. When an acquisition offers that kind of transformation, buyers can become so focused on securing the opportunity that they may not sufficiently consider all the things that could go wrong. Of course, we do not have enough information to conclude that this happened. It is also possible that the arrangement made economic sense when it was signed, but subsequent developments changed the economics. We need more clarity from management. In my analysis, I treated the earnout charge as an unusual expense and excluded it from my estimate of normal business profits. This assumption is "shaky", however, because the earnout obligation has not disappeared. The company could continue making payments for some time, and those payments would affect how much cash the business ultimately retains. Another important consideration is that not all the reported profits belong to Aradel's shareholders. Remember the ownership structure I explained earlier. Aradel now reports production of about 144,700 barrels of oil equivalent per day. However, that production figure covers the enlarged group, including businesses that Aradel does not own entirely. Only a portion of the economic value generated by those assets ultimately belongs to Aradel's shareholders. This is particularly important when valuing the company. If you take the entire group's profits and assume everything belongs to Aradel's shareholders, you could significantly overestimate what the company is worth. In my extract below, I adjusted for the stock movements, overlift and underlift, earnout expenses, taxes and the portion of profits belonging to other shareholders. I also adjusted the net assets to reflect the portion attributable to Aradel's shareholders, while accounting for other shareholders' interests in the balance sheet. Based on these adjustments, I estimate Aradel's annualised 2026 profit at over ₦650bn. This is my estimate of the company's normalised earnings, based on the assumptions and adjustments explained above. The major concern remains the earnout arrangement and how much it could continue to cost the business. Aradel has become a significantly larger oil and gas company, with much greater production capacity and earnings potential. However, the obligations attached to the acquisition could continue to affect how much of that value ultimately flows to shareholders. Management needs to provide more clarity on the outstanding obligations, expected future payments and the progress of negotiations with Shell.