Background:
The guys from Paladin AM have outlined the Innogy case very nicely on their blog (in German): Intro & Update
Q1 hedge fund letters, conference, scoops etc
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 Dividend | 1.40 |
| E.On multiplier | 4.3710 |
| E.On share price | 9.83 |
| E.on DIvidend | 0.43 |
| E.On shareprice Ex Dividend | 9.40 |
| Total payout | 42.49 |
| Potential Return on Innogy shareprice | 9.36% |
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:
- 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
- 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
- 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:
| Scenario | Probability | Return | Weighted |
| Doesn’t close | 10% | -20% | -2.00% |
| Closes, but no top aup | 25% | -1.83% | -0.37% |
| Top up happens | 65% | 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.
Article by Value And Opportunity
