Good Energy (GOOD.L) – Hostile Takeover – 30%+ Upside

Current Price: £3.10

Offer Price: £4.00 (could be increased)

Upside: 30%+

Expiration Date: Oct’21

 

UK renewable energy supplier Good Energy received a hostile takeover offer by its peer and largest long-term shareholder Ecotricity. The buyer owns 25% stake and has already made 4 bids with the latest one at £4.00/share in cash. Good Energy management with the support from certain shareholders (combined 15% stake) has rejected all the bids but hinted they would be willing to sell at around £4.50/share. Buyer’s intentions are firm and there are chances the offer will be increased to meet board’s requests.

GOOD shares used to trade at only a few percentage points spread to buyout offer prices, but have recently declined to pre-announcement levels after the fallout of UK energy crisis that has forced some of Good’s peers to file for bankruptcy. I think the market has overreacted and investors dumped shares across the board – Good Energy is not in the same bucket as the failed peers due to hedged energy supplies and price cap exceptions. This is evidenced by continued interest from Ecotricity, which has recently accelerated the offer instead of canceling it, as well as management’s intentions to payout a large £0.75/share (24% of current market cap) special dividend if shareholders reject Ecotricity hostile offer – clearly proving strong financial footing of the company.

The latest Ecotricity offer expires on the 8th of October. In case the offer fails, the downside is a bit uncertain – the company already trades at the pre-announcement levels and at around 9x pre-tax earnings based on H1’21 underlying run-rate. However, due to energy market turmoil, the stock will likely trade down further in no merger scenario.

The situation is under the radar for most investors due to the London AIM listing, small size (£50m market cap), and rather limited liquidity with £40k-£50k daily trading volume.

 

UK’s Energy Crisis

UK gas and electricity prices have been gradually increasing since the beginning of this year due to a number of factors including an uptick in demand following post-COVID recovery, the alleged gas price manipulation from Gazprom, higher gas demand in Asia, lower wind energy output, 22% of the entire UK electricity supply being offline due to maintenance, etc. Energy prices passed the £100 per MWh mark in August (first time since 1990). Then at the beginning of September, prices exploded as Ireland, major UK energy supplier, warned of possible blackouts during the upcoming winter due to supply shortages. Subsequently, UK’s electricity price went bonkers reaching £2700 per MWh on the 9th of September. Over the next ten days, 7 UK’s energy suppliers went bankrupt with media reporting significant concerns of more to come.

UK energy suppliers are in a tight spot. They act as middlemen by buying energy at wholesale prices and then reselling it to end-customers at retail prices, while keeping the margin for admin costs and profits. However, the problem in UK is that the retail energy prices are capped by regulators whereas wholesale prices fluctuate – this exposes energy suppliers to energy price volatility risk. And that is exactly what has brought some of these companies that did not hedge to their knees. Here is a good overview of the situation and some more sources here: Good Energy, The Guardian, Sky.com, spglobal.com, Bloomberg, inews.co.uk. The tight market is expected to continue into Q1 2022.

Importantly, Good Energy is exempt from the price cap and in theory should be able to pass higher energy costs onto end-consumers (at least on its variable plans). From Good Energy annual report:

In 2018, the government introduced a market-wide Standard Variable Tariff (SVT) price cap, which sets the maximum price suppliers can charge for omestic electricity and gas. The cap is intended to protect consumers that have not proactively chosen a tariff and are therefore on an SVT or other default tariff. On 1 August 2019, Ofgem awarded us a permanent derogation from the price cap for our SVT in recognition of how we support renewable energy; the costs associated with providing green energy; and because our customers actively chose to switch to our SVT to support our purpose. Successfully proving all these factors means our SVT is exempt from the price cap until its removal in 2023.

The company is still likely to be exposed to energy price fluctuations on their fixed contracts (not clear what % of Good Energy customers are variable vs fixed). According to the company, this exposure has been hedged.

Importantly, both Ecotricity and Good Energy clarified that the companies will not succumb as have their peers. Ecotricity’s CEO issued a statement saying that the companies, which went bankrupt had not hedged, whereas Ecotricity is protected at the “maximum possible” level. GOOD CEO also issued a statement saying that the business is in solid shape and they should not run into any issues.

 

Good Energy and Ecotricity

Good Energy has two business divisions – energy supply and electricity generation. The company owns 6 solar (30.1MW) and 2 wind (17.4MW) sites. Proprietory generators produce 15% of the supplied energy. The rest is sourced from c. 1600 smaller third-party renewable energy generators through direct power purchase agreements. Like other energy supply middlemen, the company mostly earns from the spread between retail and wholesale energy costs. In the financial reports, Good Energy proclaims to be hedged where necessary and not exposed to energy price fluctuations, however, it is not exactly clear to what extent.

Ecotricity is one of the oldest UK green energy companies owned by green energy enterpreneur Dale Vince. Ecotricity has 88MW capacity. Similarly to Good Energy, the company generates around 20% of its supply in own facilities and the rest is sourced from third parties.

 

Hostile Offer

Ecotricity is a knowledgeable buyer that has a good understanding and insight both into the target company and industry dynamics. It has a 25% stake in Good Energy since 2016. The strategic rationale for the merger seems solid. Ecotricity states that the combination has strong strategic merit from a geographical standpoint and complementary capabilities perspective. Renewable energy market is getting increasingly competitive and the merger would result in increased scale allowing the combined company to compete with UK’s “big six” energy suppliers and new entrants. Ecotricity is a private company focused on aggressive growth – all of the profits are put to new project development. They call it ‘bills to mills’. Good Energy’s 175k customers would certainly add some ‘bills’ to Ecotricity’s basket. Cost synergies are estimated at around 10%.

The buyer is criticizing target’s financial performance stating that over the last 3 years GOOD’s revenues grew at only 6% CAGR while gross and profit margins contracted. Allegedly, the root cause for this is the loss of domestic customers and their replacement with lower margin business contracts – Ecotricity plans to address after the merger.

Good Energy’s management seems to be willing to sell and appears to mainly object the offered valuation of £4.00/share (more details in the timeline at the end of the write-up). This has been highlighted numerous times in the rejection statements with the key argument being that UK’s average takeover premium stands at 50% to pre-announcement price, whereas the last Ecotricity offer comes only at 30% premium. This seems to suggest that the board might agree to a £4.50/share bid. Given buyer’s willingness to push upwards the offer so far (fourth iteration with the initial one £3.10/share) the remaining valuation gap does not seem that large. Also, with the ongoing UK energy crisis might motivate Good Energy management to accept a lower offer.

Ecotricity has left the doors open for the price increase – the latest offer hasn’t been declared as final even after the energy crisis outbreak over the last weeks. On the contrary, the recent acceleration statement says that Ecotricity wants to complete the offer “as soon as possible”. The expiration date has been moved forward by two days – from the 10th of October to the 8th of October, however, the statement included a provision of letting the buyer to “put aside” the acceleration in case of certain events. The first two of them are “agreement or consent of the board of Good Energy” and “an increased or improved offer by Ecotricity being recommended by the board of Good Energy”.

It’s likely that this ‘acceleration’ announcement was made just to seek additional attention from Good Energy management and shareholders amidst the UK energy crisis. The buyer clearly has firm intentions to close the transaction and I think they are likely to raise the price one more time. If the price bump materializes, Good Energy share price should immediately jump up reflecting renewed market’s confidence in the offer going through.

Importantly, if the offer fails, Good Energy has promised its shareholders a major £0.75/share special dividend (24% of the current market cap), which should provide strong share price support if the merger thesis doesn’t play out as expected. The dividend was announced (14th Sep) after the energy crisis had already started (~9th Sep), so the risk of management walking back on this is low.

An interim dividend of 0.75p will become payable conditional upon the hostile offer by Ecotricity Group Limited lapsing or being withdrawn.

 

Risks

The stock currently trades at pre-announcement levels, however, given energy market turmoil in UK, Good Energy shares are likely to fall further down if the hostile offer fails. So the downside is a bit uncertain in this case. However, the continued interest by Ecotricity at a premium to current prices as well as management’s intentions to pay a large dividend, suggest that Good Energy is navigating the energy crisis well.

 

Timeline

• 15th June – Ecotricity made the first offer for GOOD at £3.10/share in cash. 3 days later target’s board rejected the proposal.
• 24th June – Ecotricity made the 2nd bid at £3.30/share (6.5% increase). GOOD rejected the second offer on the 29th of June.
• 12th July – GOOD publicly announced a possible non-binding takeover offer from Ecotricity at £3.40/share in cash (3% increase). Pre-announcement price (9th July) stood at £3.075/share.
• 12th July – target’s board rejected the 3rd bid calling it inadequate, fundamentally undervaluing, and not offering full takeover premium.
• 14th July – another statement of unanimous rejection from Good Energy board. The offer is again called to be a highly opportunistic bid from a direct competitor.
• 22nd July – Ecotricity launched cash offer at £3.40/share. Acceptance condition stood at 50%. Other conditions included regulatory and competition watchdog approvals and other third party consents.
• 22nd July – Good Energy firmly rejected this highly opportunistic and hostile offer by a direct competitor of the company.
• 18th August – Good Energy released a 40-page length response circular again rebuking the offer. Amongst other things, the board stated that Ecotricity is an unfit buyer because there is low visibility into the business and the latest audited reports state a “going concern” issue. Worth noting that, it’s quite unlikely that Ecotricity’s financial position was/is really that poor as it intends to pay the consideration in cash on hand. The board also stated that business compatibility is low was Ecotricity is aiming to be a renewable energy farms developer, whereas GOOD had moved from this model years ago and now aims to be a digitized supplier instead.
• 7th September – Good Energy CEO released offer rejection video. No new arguments were presented.
• 14th September – Good Energy announced H1’21 results.
• 16th September – Good Energy reiterated rejection of the offer stating that interim results prove that this is a stable business in contrast to Ecotricity assertions.
• 16th September – Ecotricity increased the offer to £4.00/share in cash (18% increase).
• 17th September – another rejection statement. The board stated that it recognized that the offer is substantially higher than the previous one, but it was still opportunistic and undervalued the company. “The offer is too low to recommend on financial grounds” as it only comes at a 30% premium.
• 23rd September – Good Energy released second response circular (only 8 pages this time). The main highlight is that despite the ongoing UK energy crisis, the company is in a good shape, the business is stable and there is no risk of running into any trouble.
• 24th September – Ecotricity released acceleration statement – “due to continuing uncertainty in the energy market with soaring prices and supplier failures, Ecotricity wishes to bring the offer process to a conclusion as soon as possible.” The expiration date was changed from the 10th of October to the 8th of October. The acceptance level was 2.6% on the date. All of the regulatory and third-party consent conditions were announced to be either satisfied or waived. Acceleration statement could be set aside in case of certain events (the first two – either GOOD’s board accepts the offer or Ecotricity makes an increased bid and the board accepts the improved offer).