Special situation: Innogy Tendered Shares (IGYB) -(very) Cheap Optionality ?

Background:
The guys from Paladin AM have outlined the Innogy case very nicely on their blog (in German): Intro & Update

I’ll try to summarize it in my own words:

Innogy, the renewable energy spin-off of RWE is in the process of being taken over by competitor E.ON. E.ON in 2018 had announced to purchase the 77% stake of RWE and has offered on a voluntary basis 36.74 EUR per share which, plus the upcoming dividend adds up to a total consideration of 38,14 EUR per share before tax. The closing of the transaction is subject to a relatively complex regulatory approval process which is already facing some delays. Most experts however think that the transaction will be ultimately approved.

Currently two types of Innogy shares are traded on the stock Exchanges:

The un-tendered shares (Ticker IGY) trading at 41.31 EUR and the tendered ones (ticker IGYB) trading at 38.75 EUR. The first question is clearly: Why are the un-tendered shares trading higher than the tendered ones ? I guess this has to do with German regulation. If E.On wants to de-list Innogy, they will need to first pass the threshold of 90% and then initiate a Squeeze out process. These cases always end up in court and investors seem to think that the initial price will be surpassed.

However also the tendered shares, which will not benefit from that potential payment after a Squeeze out are trading above the offer value. Why is that the case ?

This is where the Paladin case comes in: E.On agreed to pay RWE with its own shares once the transaction closes which at the time of signing represented ~4.37 E.on hsares per Innogy share. The trick now is the following: Under German securities law, the relevent point in time to determine if the offer for minorities is fair is however the closing date and not the signing date.

According to Paladin, RWE receives exactly 4,37098692 shares of E.On for each Innogy share. RWE will not receive the 0.43 EUR dividend for the E.On shares so this then has to be deducted. If we assume that in the end, E.on wil acknowledge German security law, the pay off for the tendered shares could look as follows:

Current share price Innogy:38.85
Innogy Dividend1.40
E.On multiplier4.3710
E.On share price9.83
E.on DIvidend0.43
E.On shareprice Ex Dividend9.40
Total payout42.49
Potential Return on Innogy shareprice9.36%

This would mean a 9,4 % return with maybe 4-6 months (closing is expected in Q3/Q4). This looks attractive but there are also quite a few risks:

Risks:

  1. The obvious risk is that the deal doesn’t close. The lowest price of Innogy before the announcement was somewhere around 31-32 EUR. So there is a -20% risk in this case
  2. E.On will not pay the adjustment. In this case, an Innogy “tendered” shareholder will only receive 36,74 EUR plus the dividend, resulting in a -2% loss
  3. Finally, the E.On price will fluctuate and could be lower, however this also could work to the benefit

I would assume that the risk of a non-closing is fairly low, maybe 10%. The risk that a lawsuit will not be successful is maybe higher, let’s put it at 25%. So the expected return from this Special Situation a priori looks as follows:

ScenarioProbabilityReturnWeighted
Doesn’t close10%-20%-2.00%
Closes, but no top aup25%-1.83%-0.37%
Top up happens65%9.36%6.55%

In total this adds up to around +4.2%. Not spectacular but still ok from a risk adjusted perspective. However there is one other risk: Timing

I am not completely sure how the top up scenario will play out in practice. Most likely, E.on will only pay the 36.74 EUR, then there will be a law suit and at some point in time E.On will compensate investors. This means that the time to realizing the whole profit will be longer. On the other hand, one will get back the 36.74 plus the 1.4 dividende pretty soon and the ultimate pay-out will not require any capital to back it despite the ~ -1,8% “Loss investment” one has to make for this to play out.

Option perspective
Another perspective of looking at the tendered Innogy stock would be to look at it as a “contingent” E.On Option. Leaving out the probability of the deal not closing, as an Innogy shareholder I either get 38.14 EUR or, in case German law will be applied the pay-off of 4.37 E.on shares (minus the dividend). So the “strike price” of this option would be (38.14/4.47) = 8,72 EUR. Looking at the Eurex Quotes, a December 8,60 E.On Call Option trades at EUR 1.27, a 8.80 EUR strike Option at 1.10, SO lets’ assume the fair price would be 1.17 EUR. Multiplied by the 4.37 I would get an “unconditional option value” of around 5.11 EUR per Innogy share. Again I have to make adjustments for the other scenarios mentioned above, but paying around 0,65 EUR for that conditional option still looks like a decent deal.

Why does the opportunity exist ?
Even the tendered Innogy shares are relatively liquid, so the quwstion is: Why does this opportunity exist ? My guess is that firstly, the opportunity is quite complex. Secondly, due to the legal aspect, it is not easy to leverage and hedge for professional “hedgies”. For traditional funds at this stage it is also difficult as technically it is quite likely that the position will first end as a loss and then only after the law suit the top up comes in.

Summary:
First of all a big thank you to the Paladin guys who have dug out this interesting special situation. I was a little bit slow to see it in the beginning. Although it is no “slam dunk” anymore, I think there is still a decent upside and I find the situation also “Intellectuallly stimulating”.
For the portfolio, I have bought a 2% position at around 38.75 EUR per share. I will potentially add a little more depending on the relative pricing.

 

 

 

11 comments

  • Dividends have now been paid on both ends. (at Innogy as well as at E.on). E.on rallied like crazy, the upside is now >16%.

  • I thought the tender offer is 36,76 not 36,74? The total value should be 1,64+36,76=38,4, a bit higher than 38,14 that you state as total consideration?

    Regards

    Arne

  • Innogy explicitly states the transfer of the RWE shares as a seperate transaction, from the tender offer. That will make it tough and lengthy to get more than the offer price for the tendered line, specially if you take into account the very complicated transaction, where Innogy will argue that a purported 42 euro is way to simplified. Furthermore be advised that the offer is topped up to 38,40 cum div. whatever 2018 dividend is paid, which makes the final offer 37 euro.

    • And where I said Innogy I meant Eon…

    • Well, not sure what you mean in the last sentence. As mentioned in the post the cash tender offer is 36,74 EUR plus 1,40 EUR dividend. And yes, the “top up” might be tough and lengthy to obtain but the capital is only invested for a relatively short time.

      • From the transaction website:

        If the takeover offer completes prior to the date on which innogy’s Annual General Meeting resolves on the dividend for the fiscal year 2018 or if the dividend for the fiscal year 2018 is less than €1.64 per innogy share, E.ON will increase the offer price such that the total value of €38.40 per share remains unchanged for the shareholders of innogy.
        RWE will not take part in the offer, but will transfer its innogy shares to E.ON as part of a separate transaction. RWE will receive substantially all of E.ON’s renewables activities, innogy’s renewables business, a minority stake of 16.67% in the enlarged E.ON and certain other assets. E.ON will receive a cash payment of €1.5bn from RWE.

        You’re right about the capital invested.

        • That is simply a provision that you will receive the dividend for 2018 either through a higher compensation payment by E.on (if completed early which is no longer possible) or via the regular way (div+ compensation).

  • The big question I have, what are the legal requirements to be able to participate in the possible upside? Do you need to participate in the lawsuit itself? are there deadlines associated with starting/joining a case? Are there potential technical requirements/formalities? Would be a bit sad to buy this and then find out that in order to get the top-up you needed to do something that you didn’t. I don’t know anything about German law, but I do know that in plenty of countries participating in something like this isn’t trivial.

    • My assumption would be that each shareholder Who holds the share when the Tender is settled, is a potential beneficiary. It would be very unusual if only suing shareholders would be eligible.

  • Thanx 4 sharing !

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