Financial markets can play a part in combatting the effects of climate change by directing funding to new solutions. In the search for uncorrelated return sources—that is, returns that are separate and distinct to those available through broad market exposure—perhaps this theme of providing capital to these renewable energy providers has much to offer for both issuers and investors. Certainly for investors, providing capital in the form of a bond that offers downside protection, but also receiving an option to convert that can become more valuable if the issuer itself is the subject of a takeover offer, there is a more tangible outcome to investment compared with a simplistic approach of denying capital to issuers that are already known to be carbon-intensive.
We saw a recent example where an Italian provider of renewable energy—Falck Renewables—received a takeover offer on 20 October 2021 from the Infrastructure Investment Fund, known as the IIF, which is a +$10 billion vehicle advised by JP Morgan for institutional investors. This offer came at a premium of about 30% to where its stock price had been trading. To help finance its own growth, Falck Renewables had issued a green convertible bond in September 2020, which we held in the RWC Sustainable Convertibles Fund. Thanks to a mechanism known as a ratchet that compensates for the remaining time value in embedded options, convertible bondholders received an enhancement above the takeover offer for Falck’s shares. In this example, we felt that it was significant that not only is there more value ascribed to Falck’s business by a buyer, but also additional value for providers of capital to that company.
Falck Renewables is a relatively new entrant into power production, but its founders have a long track record. The Falck Group was founded in 1906 and became of one of Italy’s longest-standing steel producers. However, the firm decided to end steel production, closing the first plant it had built in the Sesto San Giovanni area of Milan in the mid-1990s. The Falck family, who remained majority owners of the firm, decided in the late 1990s to diversify by investing directly in renewable energy production assets. Falck Renewables launched in 2002 as a separate subsidiary with its own stock market listing, and subsequently expanded its operations from Italy into Europe and the USA. The Falck family retained 60% of the shares of Falck Renewables and had turned to the convertible bond market in late 2020 with a green convertible bond that was raising finance for further expansion and development of renewable energy production assets.
When we invested in the Falck Renewables green convertible bond at its launch, we looked first at the potential of the business and its longer-term value. We believed that Falck Renewables could be a valuable source of clean energy and that its shares could be more valuable as a result of a necessary transition to low-carbon power sources. Given the size of the convertible bond at EUR 200 million, we felt that we might struggle to hold a larger position across all our portfolios. That said, we did believe that Falck’s green convertible bond warranted a large position within the RWC Sustainable Convertibles Fund. Our strategy for this fund is to identify issuers that have fewer risks from an ESG perspective, but also those that have return-seeking potential, perhaps from investment themes related to sustainability, or from improvements that can be made to their own operations. We continued to add to this stake, particularly after a meeting with the issuer where we reviewed their ESG policy and targets and held a position of approximately 1.5% of the portfolio in the Falck Renewables bond at the time of the takeover offer.
That said, we knew that if a takeover of the company was a possibility, with a convertible bond, such an offer can produce an additional, uncorrelated gain for holders. Convertible bonds, particularly those from European issuers, often contain a mechanism that calculates the value of remaining time value of an embedded option. These mechanisms are often referred to as ratchets and are more proportionately valuable to holders earlier in the life of the convertible bond, when remaining time value is highest. As it transpired, Falck’s assets did attract new buyers, and with the Falck family agreeing to the sale of its shares, the resulting mandatory bid should give convertible holders roughly 10% extra on top of the premium to be paid. We used the announcement of the offer to sell our position at a price far greater than what we had paid at issue for the bonds.
Falck Renewables is not the only European renewable power supplier that has issued green-labelled convertible bonds within the past 12 months. And as it transpires, the other two issuers (French companies Voltalia and Neoen) have backing from similar family ownership groups. In the case of Voltalia, the investment office of the Mulliez family—who own sporting goods retailer Decathlon and the Auchan grocery store chain–holds more than 2/3 of the company’s shares, while Neoen is just under 50% owned by an investment vehicle launched by the former CEO of the Louis Dreyfus commodity trading group. Could it be the case that both of these ownership groups might contemplate a sale of the stakes they hold in these businesses? They have put up capital to get these power producers up and running, but their longer-term interests may not necessarily be as operators of power assets.
In any case, while we can’t predict future M&A activity, we do see that providing renewable power should provide value as a necessary tool to help the world decarbonize. Should these smaller-sized power producers help fill a need for a larger operator or other end investors to demonstrate a solution for decarbonization, any interest in these firms could translate into an enhancement for convertible holders.
Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
The information shown above is for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.
Unless otherwise stated, all opinions within this document are those of the RWC Convertible Bonds team as at 11th November 2021.