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The E.ON (EONGY) Uniper Spin Off

Summary

Uniper will list on Monday September 12th.

At least in the short-term, (EONGY) will retain a significant holding.

E.ON ADR holders will soon receive a cash distribution due to the spin off.

On Monday September 12 th, Uniper will debut on German Stock Exchanges. The company is the result of the break-up of E.ON and a consequence of the German energy transition (Energiewende). As a result of the spin off, E.ON will focus on renewable energy, energy networks and customer solutions while Uniper takes conventional energy (not German nuclear power though) and global energy trading. E.ON will maintain a significant holding in Uniper of just over 46%.

Local commentators including E.ONs own executives are expecting the newly listed Uniper stock to come under selling pressure. Aside from the relative attractiveness of Unipers business model, there are technical reasons why the stock may sell off; E.ON is part of the leading German blue chip index the DAX amongst others (for instance the Euro Stoxx 50). While E.ON will remain a part of the DAX, Uniper will not join the index. This will force some position holders to sell off. A smaller amount of selling may come from the need to make a cash distribution to E.ON ADR holders - as noted in the spin off documentation, the acting depository is also expected to sell it's Uniper stock as no ADR programme is planned for Uniper.

If the stock does sell off, will this represent a value opportunity and what does Uniper offer?

While renewable energy grows as the main source of electricity, coal and gas fired energy continue to be needed. As a well-run business focused on cost efficiency with a portfolio of varied strategic assets, the Uniper pitch is based on achieving consistent levels of free cash flow that will enable the company to pay consistent dividends while maintaining an investment grade rating. In the short term, they propose to pay EUR0.55 per share for the financial year 2016. The outlook for further dividends is less clear and is dependent on whether the free cash flow materializes.

A quick look at the published financials for Uniper shows that the outlook is cloudy. The IFRS compliant financials published for the six months ending June 30 th 2016 along with the previous three years all show negative earnings and EBIT, while CFO only comes back into the black with significant impairment charges being added back. Digging deeper into the financial statement notes reveals "adjusted EBIT" as the company's preferred indicator of operating earnings power which is positive but again after significant adjustments.

It's a leap of faith to anchor on the adjusted EBIT figures and try to extrapolate forward free cash flows so the question is how the company can achieve positive cash flows. What are the strategic assets that could drive positive free cash flow and how does the company plan to achieve this? There are three operational segments, European Generation (generation facilities), Global Commodities (energy trading) and International Power Generation (assets in Russia and Brazil). According to its recent capital markets day literature, the company expects to bring down capital expenditure levels to maintenance levels while optimizing working capital. It also expects to carry out at least EUR2bn in disposals by 2018.

Looking back at the previous financials, capex has been trending downwards and there has been progress on disposals. Other measures such as reducing the discount rate on pension plan liabilities and bringing down costs point in a positive direction for free cash flow.

The vagaries of the energy market, combined with tricky issues like reducing headcount and achieving acceptable prices on disposed assets may of course make the goals very challenging to achieve. Some commentators have even gone so far as to state that Uniper will be looking for investors who haven't read a newspaper since the Energiewende began while there is much comment that further write-offs are likely.

It will be interesting to see the market reaction to Uniper next week.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in UNIPER over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.