Ellies has a problem

Ellies finds itself in a curious position — its share price plummeted to below its planned rights offer price, which means shareholders are better off not exercising their rights.

In February, Ellies announced its plan to acquire a 100% interest in the alternative energy company Bundu Power.

Ellies announced that it would pay R202.6 million in total for the company — over four times its current market cap.

The acquisition forms part of Ellies’ plans to move the company into the smart infrastructure space, focusing on alternative energy solutions.

Acquiring Bundu Power will be a significant step for Ellies to grow its presence in the alternative energy market and bolster its finances.

Ellies has been struggling in recent years. Ellies reported a profit in 2019 and traded at a price-to-earnings (P/E) multiple of 1.14 times at the time.

However, since then, the company has raked in losses. Ellies reported a net loss of R85 million in its latest financial results — almost twice its market cap of R48 million.

Bundu Power, in comparison, is profitable and has grown its revenue and profit amidst South Africa’s electricity problems.

Buying Bundu Power does not come cheap. Ellies is set to acquire the company at a P/E multiple of 18 times.

Ellies plans to finance its Bundu Power acquisition with a rights offer. It would allow shareholders to purchase 2.13 additional Ellies shares at 7 cents per share for each share held.

At the time of the rights offer announcement, Ellies’ share price was trading at 11 cents, translating to a rights offer discount of 36%.

At this discount, shareholders not exercising their rights would be diluted and lose 25% of their initial share value if it traded at the breakeven post-rights share price.

However, since the rights offer was announced, Ellies’ share price has seen a dramatic fall to its lowest level of 5 cents per share.

This created a very rare case where the share price was lower than the discounted rights offer price.

Therefore, instead of being diluted for not exercising their rights offers, shareholders’ share price would be concentrated.

At a share price of 6 cents per share, where it has been trading in recent weeks, shareholders who do not exercise their rights would make a guaranteed return of 17% at the post-rights price of 7 cents per share.

As the rights offer is fully underwritten, Ellies shareholders are guaranteed to gain a return from the rights offer by not exercising their rights.

The rights offer has, therefore, completely lost its appeal. Instead of incentivising investors to contribute more capital, it incentivises them to withhold capital.

This article was first published by Daily Investor and is republished with permission.

Now read: Competition Commission approves Ellies acquisition of Bundu Power

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Ellies has a problem