The company first came to my attention while I was running my slide rule over another Aim-traded investment firm Crystal Amber (CRS: 154p), one of the constituents of my 2015 Bargain shares portfolio. Crystal Amber is an activist fund and owns 29.9 per cent of Leaf Clean Energy’s issued share capital, so has a major interest in this special situation and with good reason.
Cash rich, and undervalued
The key point to note is that Leaf Clean Energy’s investment strategy is to undertake an orderly realisation of its unlisted assets and then return the capital to shareholders in a tax efficient manner. Last autumn the company returned $9.8m (£6.4m) through a compulsory redemption of shares at net asset value, a sum equivalent to 5p a share at the time. Following that capital return, the company’s book value was $107m (£75m) at the end of 2015 which at a current exchange rate of £1:US$1.42 equates to around 65p a share. The shares trade on a bid-offer spread of 37p to 38p which values the equity at £45m, or 41 per cent below book value.
One reason for the hefty share price discount is that some of the four remaining investments are illiquid and will take some time to be sold off. However, the vast majority of the value tied up in the $117m investment portfolio is in one holding, a 2.3 per cent shareholding in Invenergy Wind LLC, North America's largest independently owned wind power generation company.
Leaf Clean Energy originally invested $40m in Invenergy convertible loan notes in 2008 and 2009, and subsequently converted these into equity last year. That investment has more than doubled in value to $95m, equating to 56p per Leaf Clean Energy share, so has performed well. It looks warranted too as Invenergy sold 930 mega watts of wind power capacity for $2bn (£1.4bn) to New York Stock Exchange-listed TerraForm Power (US:TERM) at the end of last year. That deal was significant because Leaf Clean Energy's board believe that the company's equity investment in Invenergy is governed by the Operating Agreement it entered into when it acquired the convertible loan notes and that Invenergy was required to either obtain its consent to the TerraForm Sale prior to its consummation or, absent such consent, make a payment to Leaf Clean Energy upon the closing of the sale. The amount of such payment is determined by a formula in the Operating Agreement which Leaf Clean Energy’s board has calculated to be $126m, or £88m. That's almost double Leaf Clean Energy's own market capitalisation of £45m.
But Leaf Clean Energy has not attributed any value to this disputed payment on its last balance sheet, mainly because Invenergy has informed the company that it does not believe that Leaf Clean Energy is entitled to it. That said, Leaf Clean Energy’s board has filed a complaint against its investee, Invenergy, in the Delaware Court of Chancery in Delaware, USA, so is clearly confident enough to believe that its claim is valid.
In another twist, and one that I have just become aware of, Invenergy has now exercised its right to buy the shares owned by Leaf Clean Energy, and Leaf Clean Energy has exercised its right to sell the units back to Invenergy. Both companies are entitled to initiate these put/call processes under the terms of the aforementioned Operating Agreement governing the original investment. In light of these moves, third party appraisers have been retained and the report from them is due out later this month. The appraisal process could result in a purchase price for Leaf Clean Energy’s interest, or a third independent appraisal being required to settle the price if the initial appraisals are too far apart. It’s worth noting though that Leaf Clean Energy’s board does not believe the put/call process and the litigation are mutually exclusive, so depending upon the ultimate result in the put/call process, it may seek to pursue the litigation even after this process is completed.
That’s worth considering because it increases the likelihood of a compromise being reached and one that will be to the benefit of Leaf Clean Energy’s shareholders. I must point out though that there is no certainty on the outcome or the timing, nor any assurance that Leaf Clean Energy will prevail in its legal action, but the fact that it has initiated an action suggests there is a strong case to be made.
Potential for a sharp re-rating
Moreover, with the investment in Invernegy accounting for $95m of Leaf Clean Energy’s investment portfolio worth $117m, and the company in a strong cash rich position – net funds are now north of $8m, or 5p a share, by my reckoning – then the company is in a strong bargaining position. Indeed, even if we ignore any upside from the litigation, the simple fact remains that the holding in Invenergy is worth 50 per cent more than Leaf Clean Energy’s current share price. There are deferred tax liabilities of $20m on the company’s balance sheet which largely explains why net asset value of $107m is below the combined valuation of the investment portfolio and net funds.
The bottom line is that I feel that it’s worth buying Leaf Clean Energy’s now around the 38p level in advance of the third party appraisers releasing their report later this month. If their valuation comes anywhere close to the $95m valuation placed on the company’s 2.3 per cent stake in Invenergy, valuing the equity of that group at $4.1bn, then Lead Clean Energy’s shares could easily soar to 50p, or beyond. From my lens at least, the investment risk looks skewed to the upside.
I would also point out that the investment advisers of Crystal Amber are “confident that the value of Invenergy will be released this year” and believe Leaf Clean Energy’s shares “remain deeply undervalued.” They have a point. Buy.
Please note that I have published three columns today, and four so far this week, all of which are available on my IC home page...
