Irenic Capital Management, L.P. (together with its affiliates, "Irenic" or "we") today announced that it has sent the below letter to the Board of Directors of Capricorn Energy plc (LSE: CNE.L).
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October 19, 2022
Capricorn Energy plc
50 Lothian Road
Edinburgh EH3 9BY
United Kingdom
Attn: The Board of Directors
Dear Members of the Board:
Re: Proposed All-Share Combination of Capricorn Energy plc with NewMed Energy Limited Partnership
Irenic Capital Management, L.P. (together with its affiliates, "Irenic" or "we") is a meaningful shareholder of Capricorn Energy plc (the "Company" or "Capricorn"), with an approximately 1.5% stake in the Company. We write to you today to share our views on the Company's recently announced merger (the "Proposed Merger") with NewMed Energy Limited Partnership ("NewMed"). We welcome the Board's decision to embrace the overwhelming logic of shareholder demands to withdraw from the previously considered combination with Tullow Oil plc ("Tullow"). However, its simultaneous pivot to pursue the Proposed Merger instead is equally unwise and disappointing.
We believe that the terms of the Proposed Merger remain profoundly unfavorable to Capricorn shareholders. Like the Tullow transaction, the Proposed Merger materially undervalues Capricorn's collection of liquid or otherwise easily monetizable assets. Based on readily available markers of value for the majority of the Company's assets?including its large net cash position, several near-term contractual earn-outs that will mostly turn to cash within the next year, and its sole production asset in Egypt?we believe the Company could realize almost 40% of incremental value through a straight liquidation relative to the Proposed Merger.
The plain numerical logic of the argument is clear: at current market prices, through the Proposed Merger, Capricorn shareholders are set to receive total consideration of GBp 254 in the form of (i) a pre-closing dividend of GBp 165 and (ii) a stake in the newly combined entity worth just GBp 88. By contrast, a straightforward liquidation would generate GBp 350 to Capricorn shareholders.
While the Proposed Merger represents a relative improvement to the terms contemplated in the now abandoned Tullow Scheme and the envisaged pre-close cash dividend is a step in the right direction, it will still result in Capricorn shareholders receiving grossly inadequate and riskier value for the assets they contribute. Moreover, the Company has yet to present shareholders with any proposal that represents superior value relative to the straightforward liquidation value we have assessed. This is despite months of efforts to effect one. For these reasons, we urge the Board to abandon the Proposed Merger and proceed with a liquidation of the Company's assets in orderly fashion.
We have been involved in many similar situations across various industries and appreciate that an orderly wind-down must be done thoughtfully. Maximizing firm value against the backdrop of an imminent ceasing of operations requires considerable discipline. We are writing this letter in hopes of fostering a constructive dialogue with Capricorn's management and Board where we can work together to adopt a thoughtful liquidation strategy.
About Irenic
Irenic is a research-intensive firm that engages in substantial due diligence. We make only a small number of investments such that when we do, we have high conviction in our conclusions. Our work on Capricorn has been extensive and exhaustive. In assessing the opportunities available to the Company, we utilized a full spectrum of internal resources and enlisted investment bankers, lawyers, and industry executives to further inform our views.
Irenic is named deliberately. The word irenic is an adjective that describes conduct "favoring, conducive to, or operating toward peace, moderation, or conciliation." We will do our utmost to embody those tenets and be good partners to you as we work together to safeguard and realize value at Capricorn.
The Proposed Merger does not Maximize Value for Capricorn Shareholders
We estimate Capricorn's Net Asset Value (NAV) to be GBp 350 per share. Most of this NAV is currently cash (roughly GBp 216?representing ~90% of the Company's current share price) and is, therefore, subject to limited risk. Capricorn's UK earn-out is deeply "in-the-money" and its Egyptian assets were acquired only recently in a competitive process at market-clearing prices. Moreover, Brent prices have climbed by close to 20% since the acquisition closed in September 2021 (and significantly more since the acquisition price was agreed in March 2021) implying material value should have accreted to the assets since the acquisition. These two components?earn-outs and Egypt?represent an incremental GBp 122 of per-share NAV in present value terms.1
Capricorn's NAV is not only well in excess of its current share price, but also highly certain and reasonably realizable?the cash is in the bank, the earn-outs are contractual, and its Egypt asset was only recently acquired. In contrast, the Proposed Merger effectively asks that Capricorn shareholders give up a meaningful chunk of its cash (~GBp 50?GBp 216 less the GBp 165 proposed dividend), ~75% of its earn-outs, and ~75% of the Egypt asset in exchange for just ~10% of the newly combined company. While we regard NewMed's assets as more attractive than Tullow's, their value remains highly uncertain and subject to a number of binary outcomes related to several key development stage expansions. Moreover, even after the combination, the combined equity will be significantly geared and investment research analysts believe NewMed to be currently trading at a significant premium to its NAV2, underscoring the risk embedded in the share consideration of the offer?a risk that shareholders will not need to bear in a straightforward liquidation process.
Beyond the uneconomical exchange ratio implied by the reverse merger and risky nature of NewMed's assets, the Proposed Merger appears to have limited strategic rationale; except, of course, to effectively provide NewMed?a tightly-held, Israel-listed partnership?with a premium listing on the LSE. The combination is set to produce minimal financial synergies of which Capricorn shareholders would only receive a diminished pro-rata share of ~10%. In fact, the companies did not once include reference to any synergies in their recommendation document published on September 28, 2022. While the Proposed Merger is touted as "creating a MENA Gas and Energy Champion," we do not see strategic merit in combining gas-rich onshore assets in Egypt with offshore gas assets in Israel. These are different production technologies, regulatory regimes, and geopolitical risk profiles; and unlike the prior transaction, there are no meaningful financial synergies from G&A savings. By contrast, the liquidation process we propose effectively creates full G&A reduction ("synergies") which fully accretes to Capricorn shareholders and provides meaningful upside.
Below we outline our more detailed considerations on Capricorn's value buckets:
Conclusion
The Proposed Merger?much like the previously contemplated Scheme?seeks to compel Capricorn shareholders to contribute their high-quality assets at a bargain valuation to a combined company, this time using an upfront cash payment as a carrot and a lower acceptance threshold as a stick. The alternative is handing to shareholders the straightforward value of the assets they are due.
We are yet to find a single shareholder that believes Capricorn has a mandate to grow. What shareholders seek is a course of action that maximizes value?whether that course entails growth or entails shrinking is of no consequence. Given shareholders' reaction to the Tullow deal, the Board should know this. While the Proposed Merger looks improved relative to the Tullow transaction, it is still not the value maximizing path and we have little doubt Capricorn shareholders remain opposed.
At this point further efforts to identify yet another proposed merger do not make sense. The fact that no superior proposal beyond the Proposed Merger has emerged after months of searching speaks a plain and simple language: the Board must act in the fiduciary duty of its shareholders and liquidate the assets.
We appreciate your consideration and look forward to engaging with the Board on our proposal over the coming weeks.
Sincerely,
Adam Katz |
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Andy Dodge |
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Justus Goettemann |
Co-Founder, Chief Investment Officer |
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Co-Founder, Director of Research |
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Senior Analyst |
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About Irenic
Irenic Capital Management, L.P. is an investment management firm founded by Adam Katz and Andy Dodge. Based in New York City, Irenic works collaboratively with publicly traded companies to ensure operating activities, capital deployment and management incentives are all aligned to create value for the company and its owners. For more information about Irenic, please visit www.irenicmgmt.com.
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1 In addition, Irenic is of the view that there is material incremental upside potential in the Egypt asset based on the ability to renegotiate cost-sharing terms with the Egyptian government. The local authorities have recently improved several operators' terms to incent incremental capital investment into the country's hydrocarbon production. If Capricorn were to realize similar improvements, it could result in GBp 100 of upside. However, given uncertainty around such renegotiations we do not ascribe any immediate value to a renegotiation now. It is likely that a different owner?one with experience in operating Egypt and other assets on the ground?would be willing to ascribe some value to this renegotiation when looking at a potential purchase of the Egypt assets.
2 Barclays, the sole NewMed broker, most recently attributed ILs 770 of NAV per share to NewMed's assets versus its current share price of ILs 825.
3 We commend the company's decision to already return a significant portion of its $1,056 million Indian tax refund to shareholders by means of its April 2022 tender offer representing more than $500 million.
4 APA Corporation Announces Egyptian Parliament's Approval of Modernized Production Sharing Contract, November 30, 2021, https://www.globenewswire.com/en/news-release/2021/11/30/2343505/0/en/APA-Corporation-Announces-Egyptian-Parliament-s-Approval-of-Modernized-Production-Sharing-Contract.html.
5 In addition to our asset-level NAV that is based on the value at year-end 2022, we believe Capricorn will generate well-level free cash flow of at least $160 million in 2022. From this well-level free cash flow, we deduct $130 million for management's guided capital expenditures in 2022.