Germans are known to create strict regulations and long words. E.g., there was actually a "law for the delegation of monitoring beef labeling,” which in official legal lingo was the "Rindfleischetikettierungsüberwachungsaufgabenübertragungsgesetz". That’s 63 characters for you!
This particular law was repealed in 1999. However, to this day Germany remains a country where both ordinary people and experts regularly get caught up in the complexities of rules, laws, and regulations set by Deutschland’s powerful class of bureaucrats and legislators.
Even the CEO of one of the country’s largest energy companies recently fell into the trap of not checking the Ins and Outs of the country’s arcane, quirky corporate law before making a public statement about his company’s plans. What was a misstep for this particular CEO, turned out to be an opportunity for shrewd investors to turn a virtually risk-free profit on the German stock market.
The following anecdote from the German market wrecks the claim that if something sounds too good to be true, it usually isn’t.
Germany’s energy executives struggling outside of their comfort zone
The energy market of Europe’s largest economy is in a state of upheaval and restructuring.
For many years, Germany’s large energy producers enjoyed a relatively stable and reliable framework to operate in. Growth was low but margins were good, and managing the country’s energy behemoths wasn’t too much of a managerial challenge. Shareholders benefited from reliable dividends and stable share prices.
Much has changed since then.
The country was among the pioneers when it came to legislating a gradual shift to renewable energies – until it made the far-reaching decision of wanting to switch off ALL of its nuclear power plants by 2022. For a country that up to this point had relied on nuclear energy to provide nearly 30% of its power, this was as ambitious a change as its energy industry had ever experienced. Add changing regulations for grid use and energy pricing, and you have an industry thrown into the cold water at the deep end.
No wonder there's been a flurry of deals aimed at reshuffling assets and preparing energy providers for a very different future.
The resulting take-over bids and strategic deals involve several layers of thick regulations provided by German corporate law. It’s here that one of the industry’s top executives, E.ON’s CEO Dr. Johannes Theyssen, exposed that he doesn’t yet understand the finer details of some of the challenges he is now facing. Which, if you are the boss of an EUR 20bn energy company like E.ON, just shouldn’t happen.
E.ON’s CEO threatening something that he can’t legally threaten with
E.ON launched a bid aimed at taking over Innogy, a renewable energy company founded by E.ON’s competitor, RWE. Innogy had been spun off by RWE two years ago and was already separately listed on the German market when the intention to take over the company was made public.
Spelling out all the details of this multi-layered, phased bid to take control of Innogy would easily fill several blog posts. To keep it short and to the point, here is – in slightly simplified terms – what you need to know about take-overs of public companies in Germany:
- Germany’s take-over code for public companies requires the bid price for the acquired company's shares to be calculated in different ways. Just how the legally required bid price is calculated depends on how many shares an acquirer already owns or attempts to acquire; the structural changes that are planned for the acquired company and over what time they are intended to be carried out, as well as a gamut of other factors.
- If a bidder wants to acquire 100% of a publicly listed company, this usually can’t be done in a single transaction and instead requires a process to launch several subsequent bids based on several separate but intertwined legal processes. Not all of these steps can be planned and calculated down to the last penny before the previous step hasn’t been completed. In other words, executives of the bidder do not have a perfect vision for planning the transaction down to the final step and the total price tag. Along the way, factors can emerge that change what bid price is legally required for the next step.
- For reasons that relate to the country’s past and its legal system and culture, the rights of minority shareholders to this day enjoy a relatively significant level of legal protection. This is the case even after recent changes in legislation that were aimed at making the system less convoluted and less biased towards minority rights.
If you are still with me after this mind-boggling explanation, here is what Dr. Theyssen did.
When announcing the first of what would be at least two bids for Innogy, he offered EUR 36.76 per Innogy share AND publicly stated that for the next bid(s), he was sure that there wouldn't be a bid any higher than the EUR 36.76 per share he offered in the first round. Obviously, his statement was aimed at preventing speculators from driving the price up beyond EUR 36.76 in anticipation of a higher bid at a later stage.
Problem is, there is NO legal basis for such a statement. The spirit of the law is actually aimed at preventing such “threats” from being issued. Even worse, based on everything that was known up to this stage and taking into consideration the legalities and practicalities of how these multi-layered bid processes usually unfold, it was virtually certain even right after the initial announcement that for a second (or third) bid aimed at further increasing its stake in Innogy, E.ON would have to pay more than EUR 36.76 for each Innogy share.
Needless to say, in the highly competitive world of financial markets, a bunch of cunning investors were immediately onto Dr. Theyssen’s case.
Buy below a guaranteed future bid price
When all this news emerged, Innogy shares were trading at around EUR 36, i.e., slightly below the initial cash offer price of EUR 36.76. Because of the complexities of this deal, the cash price was only going to be paid out in mid-2019, however, until then there was also going to be a dividend of EUR 1.64 per Innogy share. Investors with detailed knowledge of the German take-over code could at that stage buy for EUR 36 and be certain that by mid-2019, they’d receive no less than EUR 38.40 per share (EUR 36.76 + EUR 1.64 dividend); a gain of 4.6% in a year if you leave commissions and taxes aside.
But it gets better than that…
E.ON is likely going to make a second bid for the remaining shares, sometime during the remainder of 2019. There is a possibility that this second bid, for both legal and practical reasons, needs to be higher than the first bid. Also, Innogy shareholders are likely to receive another dividend payment in 2019, probably to the tune of EUR 1.64.
Because of that, Innogy shareholders are virtually guaranteed to receive at least EUR 40.06 per share before the end of 2019; and they could receive an even higher pricer if they are a bit lucky and the second bid price is increased. There are some credible reasons to hope for a price that takes the overall pay-off closer to EUR 42/43.
This is the deal that presented itself to those who were in the know and quick to act:
- Buy Innogy shares at EUR 36.
- Hold for one year and get at least EUR 38.40, which is your guaranteed profit.
- There is a possibility of receiving an even higher price during the second half of 2019 as well as another dividend payment; the latter alone will take investors to > EUR 40 per share. With a bit of luck, this will be increased to EUR 42/43 because of a higher bid in the 2nd round.
An investment with no downside risk, a guaranteed yield and the possibility to be surprised by additional upside? Much as I simplified this description somewhat to make sure the complicated subject matter remains reasonably understandable, that’s what it actually boiled down to in this case.
If something sounds too good to be true, it may yet be true.
Look beyond your own country's borders
To the best of my knowledge, only Germany’s stock market offers the possibility to pull off such a feat. Such opportunities actually appear quite regularly in Germany. I have been involved in them, on and off, since the mid-1990s.
To take advantage of them, you either need to
- research them yourself (which is difficult, not the least because it involves lengthy German words!), or
- read a blog where such opportunities are occasionally presented in more detail and in a timely fashion (ready for you to make use of them - as will be the case for this blog), or
- have someone else take care of it for you (there is a cottage industry of specialized funds that has sprung up to take advantage of these opportunities).
Whether this is immediately relevant for you or not, there is another general point that is even more important than this specific opportunity:
- Markets aren’t efficient, no matter what anyone else says. Armed with the right information, you can take advantage of these inefficiencies!
- Looking beyond the borders of your home country can lead you to fairly extraordinary opportunities that you just wouldn’t find at home.
- Complexity often hides opportunities; which is another way of saying that if you put in more research work than others, chances are it’ll pay off.
The previous incarnation of my blog occasionally discussed such opportunities, and with good success. Also, I do like complexity and the opportunities that complexity regularly offers. Hence, for understanding the approach I’ll take in the more extensive research reports that I will launch on this website, I wanted you to get a clearer understanding of the rationale.
This all may sound terrifically boring, and one is left to wonder why Germany doesn’t simply adopt the kind of take-over legislation that is applied in most other parts of the world.
But if there is money to be made without taking undue risks, who would we be to complain?