Drilling Down Into Genie Energy’s Exchange Offer

Some companies just can’t stop maneuvering. Less than a year after being spun out of IDT (IDT), Genie Energy (GNE) announced that it is launching an exchange offer for up to 8.75m of its common shares. Before digging into the offer, it is worth familiarizing oneself with some background information on the operations. For a fuller description check out our earlier articles (and here) on the company, but in short, the company has two business lines:

1) IDT Energy – a retail energy provider supplying electricity and natural gas to residential and small business customers in the Northeastern United States. This is currently the only revenue, profit and cash flow generating part of the business

2) Shale Assets – the company has highly speculative shale plays in Colorado and Israel which could potentially be huge…or amount to nothing. The Colorado asset, American Shale Oil, is a JV with Total SA and is currently preparing a pilot test for later in the year.

The company believes that some shareholders are mostly interested in business #1’s stable cash flow and potential yield. One option would have been to pursue another spinoff, but management believes there are synergies between the divisions so it devised this exchange offer (here is the full filing) instead. Now investors will have a choice regarding their exposure.

The way it works is that shareholders of Class B common units can swap shares on a 1 for 1 basis for newly created preferred shares which would trade under the ticker GNE.PR. The new preferreds will have a liquidation value of $8.50, pay an annual dividend of $0.6375 (~7.5% yield) plus a potential additional dividend of 7.5% * ((IDT Energy EBITDA >$32M)/8.75m). The preferred shares would be redeemable by the company after five years or after four years at 101% of the liquidation value. Obviously, the preferred holders would also move up the capital structure and in the event of bankruptcy would be owed their $8.50 before the common unit holders received anything.

As part of the transaction, the company is cancelling the current $0.05 common dividend on the Class B shares. Interestingly, it did not mention canceling the dividend for the Class A shares which are entirely controlled by company chairman Mr. Howard Jonas. Here is where it starts to get interesting. Mr. Jonas, who is also chairman and CEO of IDT, is really the key behind everything IDT (and IDT spin) related as he is the controlling shareholder of both companies. Mr. Jonas has said that he will NOT participate in this exchange offer and will hold onto his Class B shares.

Keeping that little, but important fact in mind, lets examine the share count and base. As of August 2, Genie had about 21.4m Class B shares and the 1.57m Class A shares owned by Howard Jonas which can be converted into Class B Shares. While those Class A shares are often lumped with the Class B shares on an accounting basis (rightfully so), I do not think Mr. Jonas will convert his Class A shares as they control most of the voting power (3 votes per share vs. 1/10th vote per B unit) and it seems like dividends were not suspended for that share class. Looking at just the Class Bs, Mr. Jonas owns 3.9m Class B shares and various Jonas foundations and trusts (of which he has no ‘direct’ control) own an additional 1.92m shares. I am going to assume that his foundations and trusts will follow his lead and not participate in the offer, although it is very possible that they might desire yield to fund investments. Adding those together puts Mr. Jonas’ stake at ~5.82m Class B shares or ~27% of the outstanding shares. Removing those shares leaves 15.58m shares outstanding. The minimum amount of shares required to participate in the exchange is 4.375m and the exchange is capped at a maximum of 8.75m shares (it is worth noting that the minimum condition can be waived though). If all 8.75m shares were to be exchanged, Mr. Jonas would then effectively control close to 46% of the Class B units without even taking his Class A units into account. Adding those in would bring his stake to over 50%.

That seems like the real motivation behind this exchange offering to me. Mr. Jonas ends up more leveraged to his bet on the shale assets (the huge ‘call option’) without him having to shell out another dime. The company essentially foots the bill of buying people out through the preferred dividend. The end result is that Mr. Jonas controls more of the company and is left much more exposed to shale and any potential upside of the company. The preferred upside is essentially capped and would not benefit from shale taking off and only slightly benefit from the IDT Energy business growing. As a result, I would bet that the company would waive the minimum threshold if there was a reasonable amount of interest in the deal and redeem the preferreds if the company takes off.

So what to do? Convert? A 7.5% yield is extremely enticing, especially in this zero interest rate environment. However, I am more tempted to follow the chairman’s lead as he knows the most about the business and is certainly motivated for it to succeed. It is obviously the riskier play, but I imagine if you bought shares of Genie you probably weren’t looking for a stable income generator. The common units might face some pressure in the near term though as I expect earnings will turn negative in the next few quarters as the preferred dividends soak up all of the income. In fact, the company currently doesn’t even generate enough net income to pay off the preferreds and might decide to tap into its cash pile. Analyst coverage on the name is weak and the poor numbers will likely turn people off of the name. Additionally, there is a real possibility that liquidity dries up as few shares will be trading hands. I would also bet that liquidity will also be challenged in the preferred shares as well which might open up some post-exchange opportunity as well.

The exchange offer expires on September 5th, although depending on your brokerage you may be required to respond earlier. We will keep you updated on the situation, but in the meantime…what do you think?

Disclosure: Author currently holds shares of GNE.