It’s a company I have followed closely, having initiated coverage at the current share price in mid-April ('Pointing towards a profitable income', 19 Apr 2016), and last recommended holding the shares at the same price in early May (‘Latest twist for Leaf Clean Energy’, 4 May 2016).
It’s a complicated situation, and one that takes some explaining, but rest assured it’s worth following. That’s because the vast majority of the value in the company's $117m (£88m) investment portfolio is tied up in one holding alone, 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. The stake had a value of $101m (£76m) at the end of December 2015 when Leaf Clean Energy reported a net asset value of $109m (£82m) since when the company has received a capital return of $3.9m.
Invenergy then exercised its right to buy the shares owned by Leaf Clean Energy, and Leaf Clean Energy has exercised its right to sell the units to Invenergy. Both companies are entitled to initiate these put/call processes under the terms an Operating Agreement governing the original investment. In light of these moves, third-party appraisers have been retained and placed a value of $76m and $36.4m, respectively, on the Invenergy stake. Because of the disparity a third appraiser has been jointly appointed and the average of the three valuations will be used. If the average valuation is used then Leaf Energy's net asset value is around 48p a share at current exchange rates, or 31 per cent less than the last reported figure of 69.5p based on a sterling:US dollar cross rate of £1:US$1.33 and using an issued share capital of 118m shares.
However, it's worth noting that the valuers have to take into consideration a number of factors when making their assessment and the key one is a legal action instigated against Invenergy by Leaf Clean Energy in the Delaware Court of Chancery in Delaware, US. The complaint concerns the sale of 930 megawatts of wind power capacity by Invenergy to New York Stock Exchange-listed TerraForm Power (US:TERM) for $2bn (£1.5bn) at the end of last year.
The Operating Agreement is key
That disposal was significant because Leaf Clean Energy's board contends that its 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 £94.7m. That sum is double Leaf Clean Energy's own market capitalisation of £46m.
And here is the rub. The Delaware Court of Chancery has just granted Leaf Clean Energy’s motion for partial judgement on the pleadings that Inveregy breached the Operating agreement. I have seen a copy of the ruling from Vice Chancellor Laster which was granted last Thursday. Although the court’s ruling does not determine the amount of damages to which Leaf Clean Energy is entitled to as that will take further proceedings to determine, it is clearly highly supportive of the company achieving a positive outcome for shareholders in this matter. The company is now working with its advisers to determine damages and to pursue its claim. Importantly, the put/call process and the $126m complaint are not mutually exclusive events, a point that the investment advisers to Leaf Clean Energy have made. And by my calculations the upside from the court action is in the price for free.
That’s because I estimate that Leaf Clean Energy has net funds north of $8m, or 5.1p a share, to which we can add the proceeds from the forthconing sale of the Invernergy stake. Using the average of the two aforementioned valuations the holding would be worth around 35.8p a share. This means that shareholders will have a free ride on any upside from the $126m complaint against Invernegy.
My advice here is to hold onto your Leaf Clean Energy's shares if you followed my earlier advice and await news of the third valuation of the Invernegy stake, and news on how the company intends to pursue its legal claim. Frankly, you have nothing to lose as even if it’s a lowball valuation, you still have potential for a huge windfall if Leaf Clean Energy successfully pursues Invenergy for damages as per the terms of the Operating Agreement. Hold.
