Essar Energy: minority squeeze-out with a 10% spread

Introduction
The most recent deadline for acceptances for Essar Energy (ESSR:LON) moved from 23 May to 6
June, triggering a sell-off and presenting an opportunity. It is possible that the market and
arbitrageurs in particular are fearful that the transaction may not go through, therefore triggering a
selloff. At the time of writing the share price stood at 0.635. With the offer price standing at 0.70,
this implies a 10% gross spread. Evidence points to the deal going through and the offerees receiving
the payments due.
Background
The Essar Energy takeover is a controversial topic in London. When the Ruia family made a bid of
0.70 per share through their buyout company Essar Global Fund Ltld (Bidco), the shares were
clearly undervalued and the operations at the company were steadily improving. For example, the bid
effectively values the equity in the company at 900m, whereas as of 30 July 2013 the company had a
tangible book value of 3,000m. Insurers and asset managers were critical of the bid, after all many of
them invested during the IPO in 2010 when the company was priced at 4.20 . In November 2013
BidCo which is also Ruias holding company stated that ESSR was worth 0.97 a share.
Two months ago at a small investors conference, where 4 commodity micro-caps gave presentations
on the prospects of their business, a 70-year old investor started his question to the CFO of a small
Indian electricity supplier with a long introduction: For 20 years foreign companies have been taking
advantage of minority shareholders Although he was exaggerating slightly about the length of the
abuse, everyone in the room knew what the aged investor was talking about. This man obviously
wanted to know if the electricity suppliers majority shareholder, the founding family, would not go
ahead with a takeover such as the one witnesses at ESSR. The CFO of the electricity company
admitted: I cannot guarantee that we will not. Low valuations of emerging market stocks and cheap
credit have presented good buy-out opportunities for those familiar with the relevant companies. A
week after the conference this author noticed that in fact Standard Life, a British insurer, and a vocal
critic of the bid, had in fact sold some of their shares.
The ESSR situation is underpinned by a motivated buyer. The intention to make an offer was
confirmed on 14 March and on 25 April the Independent Committee confirmed that the bid
undervalues the company. On 9 May Bidco stated that the offer is no longer conditional. The offer
becoming unconditional increased the probability of the deal going through: previously the offer was
conditional upon the acceptances from all the shareholders. A stubborn shareholder may have
therefore tried to wrestle Bidco under the terms of the previous offer. Now, that shareholder may be
left with owning shares in a private company with low liquidity, low publicity and no insight into the
operations of his investment. The shares are materially undervalued and represent a bargain for the
bidder who plan on selling off parts of the ESSR and continuing their turnaround efforts, which
judging from ESSRs Q4 results here
(http://www.essarenergy.com/media/51065/Press%20release_Essar%20Oil%20Q4FY14%20results_2
005.pdf ) have been fairly successful.
The law: the acquisition is almost definite
New Financial Conduct Authority rules effective from 16th May partially as a result of the ESSR
takeover - require the controlling shareholder to have the majority of the minority shareholders to
approve the take-private bid. Ruias have it: the BidCo controls 98.51% of the total share capital
including 20.52% of the total holding it did not previously own and therefore 93.24% of the minority.
English corporate law allows a 75% shareholder to delist the company and re-register it as a private
entity.
However sufficient protection is afforded to minorities in a squeeze-out. Section 979 Companies
Act 2006 states that a bidder who has already acquired 90% of a companys shares must buy-out the
remaining shareholders; equally section 983 allows such minority shareholders to require the offeror
who already owns 90% of the shares to buy their holdings in the target company.
With regards to payment, on 9 May the company applied to the UK Listing Authority and the London
Stock Exchange for a delisting scheduled for 10 June. According to Rule 31.7 of the UK Takeover
Code Settlement of Consideration:
Except with the consent of the Panel, the consideration must be sent to
accepting shareholders within 14 days of the later of: the first closing
date of the offer, the date the offer becomes or is declared wholly
unconditional or the date of receipt of an acceptance complete in all
respects.
6
th
June is the latest possible date from which the 14 days will be counted down since it is the last
possible day when one could accept the offer. Therefore you should be able to receive your 70p per
share by 21
st
June.

Understanding the sell-off
It is worth asking why this opportunity has presented itself. There are several explanations.
1. SC Lowy Primary Investments and other funds
First, it is possible that the disclosure of a partial disposal by SC Lowy at 15:10 on 21 May a
successful fund resulted in many doubting that the transaction will go through. The sell off began on
22
nd
May. However SC Lowy disposed of 5,000,000 convertible bonds (out of the total 33,900,000 it
purchased), not common shares. This bet was also made by the likes of Citadel and Farallon on 2016
4.25% convertible bonds, hoping that Essar would eventually bid higher on the bonds/and or shares.
The bonds were priced well below par and the main reason for buying the 2016 bonds was due to the
fact that bondholders would get the full face value if the offer to shareholders would go
unconditional; and not the initial 80% of face value that was offered by BidCo in April.
A better explanation may be found through the various complex trades employed by financial
institution after rumours of the offer circulated and the subsequent offer was made. These can be
followed through Form 8.3 filings. Entities such as Bank of America Merrill Lynch, Barclays,
Blackrock and Citadel may have attempted to profit from the volatility of the stock movements or the
convergence between the prices of ESSR shares and convertible bonds. For example, a 8.3 Form on
6
th
May shows Blackrock taking a long position in 9,319,316 shares (0.71% of the total), backed by a
position in 13,700,000 bonds (2.49% of the total), whilst shorting 1,715,486 shares (0.13% of the
total). It is possible that with the Essar story now coming to a close, the traders have slowly started to
unwind their large positions consequently leading to the sell-off.
2. Extension
The extension of the offer on 23
rd
June from that date to 6
th
June may have resulted in further share
selling. This is the second time the bidder has extended the deadline, but previously that extension
was moved from 9
th
to 23
rd
May. This is as a result of certain shareholders not accepting the offer.
However, even if one or more shareholders do not accept, this should not impact the payments due to
tendering shareholders.
3. Financing
Previously the share price experienced a relatively significant drop after it was rumoured that
Barclays withdrew from providing the acquisition finance. The main bank providing financing and
advice on the deal is VTB Capital a Russian state-owned bank and investors, upon hearing that
Barclays withdrew, decided that sanctions would be imposed on VTB that would not let it finance the
acquisition of Essar. As of today the BidCo have posted a facility agreement between them and VTB,
an accounts pledge agreement (Bidco being the pledgor) and a security agreement between the parties
with a share offer cash account at Royal Bank of Scotland. The documents indicate a substantial
commitment to the deal.
4. Reputation and history
Although more qualitative and historical factors, the following should be borne in mind when
assessing the present situation. First the Ruia brothers have a poor business reputation: apart from the
current transaction, they have previously defaulted on loans and have been in unsuccessful in previous
partnerships with Western corporations. Luckily if you are currently holding ESSR shares you will
find out sooner rather than later just how unimportant their reputation is to them and VTB. If the
payment does not go through VTBs reputation and ability to work on other deals in London will be
materially impaired. Secondly, the Ruias have attempted to delist Essar Oil and Essar Shipping before
and failed. None of the attempts however have gone this far and they have in fact completed one
delisting Essar Steel.
Conclusion
I look forward to feedback and insights from others. This idea really does not require a whole article
however I felt that it is worth writing this one down given the amount of great ideas I have come
across through people sharing their thoughts on the internet. Also, I have been following the story for
at least 3 months and felt happy when the price dropped to 0.63. This is not so much an idea as an
opportunity. There are far more intellectually superior ideas. The share price has previously touched
0.64, and even 0.64, for a variety of reasons, the incentives of the acquiror, on the other hand, have
always remained the same.
Note: I have a position in ESSR. Please do your own research before spending money on ESSR
shares. If youre not doing your diligence youre gonna have a bad time. Thanks.
IM