Answers to Føljeton's questions about DONG Energy

14.09.2016 13:45

On 13 September 2016, journalists Anders Peter Mathiasen and Erik Valeur from the Danish digital news magazine Føljeton asked nine questions about the capital injection in DONG Energy in 2013-14.


All nine questions are questions which we have previously answered in debate pieces and in our response to the errors and misunderstandings publicised by Anders Peter Mathiasen in his book 'Det bedste bud' (in English 'The best bid'). See dongenergy.com. For the record, we are repeating our answers here.

 

Føljeton's nine questions – and our answers:

 

1. Why were the DONG shares sold so cheaply – and why wasn't Project RED used to encourage competition among potential investors as a way of obtaining a higher price?

 

At the time of the capital injection, the value of DONG Energy was on a par with the valuation of other European energy companies, corresponding to six to seven times the expected operating profit in 2013. This equated to a total value of the Group of approx DKK 81-95 billion. Less loans and borrowings, this resulted in a valuation of DKK 31.5 billion. In connection with the capital injection, two independent investment banks, Morgan Stanley and Danske Bank, carried out a valuation of DONG Energy and issued 'fairness opinions', which confirmed that the value was on a par with the market.


Project RED was a project developed by the Wind Power division in 2011, and which was considered four times by DONG Energy's Board of Directors in 2011 and 2012.


The project envisaged the demerger of DONG Energy's Wind Power division into a separate company and the injection of separate equity to support the future investment plans within offshore wind power. DONG Energy's Board of Directors concluded, however, that it would be more expedient to inject new equity into the DONG Energy Group as a whole, and therefore decided not to proceed with that part of the project.


The Board of Directors remained fully committed to the plans inherent in Project RED of expanding the DONG Energy Group's activities within offshore wind power, and this remains part of DONG Energy's strategy today. So the investment ideas behind Project RED have been fully realised, whereas the idea of divesting the wind division into a special company as part of Project RED was abandoned, and the capital was injected directly into DONG Energy instead. Financially, it thus does not make any difference.


Also, at the time of the preparation of Project RED, the plans for an expansion of the wind power business were not yet fully developed, nor had the necessary funding been allocated, and no final decision had been made. The value of the ideas had therefore not yet been realised, and consequently no investors were willing to pay the full price for the projects in connection with the capital injection.


As part of the process leading up to the capital injection, all interested investors were competing to offer the best price for the injection of new equity. All the bids received were submitted to the Finance Committee of the Danish Parliament, which confirmed that Goldman Sachs, ATP and PFA came up with the best bids, ie acquired the shares at the highest possible price for the Danish State.

 

2. Who was in possession of important knowledge about Project RED – without including it in the process?

 

Project RED was discussed both by DONG Energy's Board of Directors and in the Danish Ministry of Finance. It is therefore not as if the project was kept secret.


In connection with the preparation of the financial action plan which was presented to the public in February 2013, the expediency of injecting capital directly into Wind Power was examined. As the DONG Energy Group as a whole was in need of capital, this option was not pursued. Project RED was not an effective solution to the financial problems experienced by DONG Energy in the second half of 2012.

 

3. Was the sales process in 2013 organised in such a way that the Danish State was sure to obtain the best (the highest possible) price for the shares in its energy company?

 

The sales process was planned so as to ensure the best possible outcome for DONG Energy and for its shareholders, including the Danish State.


The need for a capital injection – and thereby the sale – was announced at a press conference in February 2013, and reported in several media.


The company's advisors then searched widely for investors both in Denmark and internationally. To ensure that no potential investors were overlooked in this process, an ad was inserted in the Financial Times. A number of bids were received, of which the Danish State selected the best, which came from Goldman Sachs, ATP and PFA. The bids have been presented to the Finance Committee of the Danish Parliament, which has confirmed that they were the best bids.

 

4. Why did the then Danish Minister of Finance Bjarne Corydon give the impression that the company was 'acutely in need' of capital – when in fact there was no imminent danger?

 

DONG Energy sustained significant financial losses in 2012 due to challenges in the gas market. From 2011 to 2012, DONG Energy's operating profit dropped by 37%, from DKK 13.8 billion to DKK 8.6 billion.At the same time, the Group's debt increased by 29%, from DKK 34.1 billion to DKK 43.8 billion, not least due to a large-scale investment programme within, in particular, offshore wind power and oil and gas. At the end of 2012, DONG Energy's key credit metric dropped to 8%, which must be seen in relation to the credit rating agencies' requirement of a credit metric of at least 30%.


Declining earnings and increasing debt meant that DONG Energy's creditworthiness came under pressure. The creditworthiness is assessed by the international credit rating agencies based on the ratio of cash flows from operating activities to net debt. If the net debt/cash flow ratio is too high, it increases the risk of a company not being able to meet its obligations. The credit rating agencies therefore set targets for how much debt a company may have in relation to its cash flows from operating activities. DONG Energy needs a solid rating to obtain the necessary financing to continue the expansion of its globally leading offshore wind power business and to trade in the international energy markets.


In October 2012, the credit rating agency S&P downgraded DONG Energy to BBB+ with a negative outlook, and in November 2012 DONG Energy was also given a negative outlook by the credit rating agency Fitch. The 'negative outlook' meant that if the DONG Energy management did not take significant steps to correct the situation, the rating would be downgraded further. For a company like DONG Energy, having to finance very large investment programmes in a market characterised by considerable risks, it would be untenable and irresponsible of its management to risk a non-investment grade rating. In such a scenario, DONG Energy would be the only large energy group in Europe without a solid investment-grade rating.


A financial action plan was therefore needed to restore the company's capital structure, ie the ratio of cash flows from operating activities to debt. A key element in the action plan was the injection of new equity. Without new equity, DONG Energy would have had to stall its investments in, for example, offshore wind power to redress the balance between its cash flows from operations and net debt.


It has been mentioned that DONG Energy had a solid cash reserve, ie enough money to pay its bills. That is correct, and this also appears from the company's financial statements. The challenge was that the debt had become too large in relation to earnings, and that was the problem which needed addressing to satisfy the international credit rating agencies.

 

5. Why did the Danish State circumvent – or give less priority to – the normal requirement for a broadly based and qualitative bidding process, which could attract the interest of many investors and thus possibly ensure a higher price?

 

That is not correct. The sales process was planned so as to ensure the best possible outcome for DONG Energy and for its shareholders, including the Danish State. The sales process was thus planned in view of the guidelines applying to the sale of government assets.


The need for a capital injection – and thereby the sale – was announced at a press conference in February 2013, and reported in several media.


The company's advisors then searched widely for investors both in Denmark and internationally. To ensure that no potential investors were overlooked in this process, an ad was inserted in the Financial Times. A number of bids were received, of which the Danish State selected the best – from Goldman Sachs, ATP and PFA. The bids have been presented to the Finance Committee of the Danish Parliament, which has confirmed that they were the best bids.

 

6. Were the Danish pension funds excluded from the process – and if so for which reason(s)?

 

The Danish pension funds were not excluded from the process, on the contrary. The Danish pension funds ATP and PFA were two of the three companies which acquired shares in the company at the time of the capital injection. Like all other investors, the Danish pension funds were invited to submit their bids.


In order to ensure full competition, the potential investors were not allowed to form consortia prior to the submission of their bids. This was done to prevent the formation of cartels and to ensure as much competition as possible.


PensionDanmark offered to lend money to DONG Energy, but did not offer to inject equity. The offer from PensionDanmark would thus not have resolved DONG Energy's need for capital. As the offer concerned a loan construction, the offer did not constitute a valuation as such, but stated only the size of the loan offered.

 

7. Why did the Danish State accept that the DONG Energy management – represented by CEO Henrik Poulsen – handled the sales process in that situation?

 

That is not correct. The sales process was handled by the Danish Ministry of Finance, on behalf of the company's shareholders. The Danish Ministry of Finance sat at the head of the table at all the negotiations.

 

8. Why did the Danish Ministry of Finance not commission an independent, impartial valuation of DONG Energy – potentially including Project RED?

 

That is not correct. Two independent valuations of DONG Energy were made. Two investment banks (Morgan Stanley for DONG Energy's Board of Directors and Danske Bank for the Danish State) carried out the valuations. The price of the shares was the highest price offered in the bids received following an extensive search in Denmark and abroad for potential investors.


DONG Energy has realised an ambitious expansion of its offshore wind power activities, which was also at the core of Project RED. The focus on offshore wind power was part of the business plan and thus also included in the valuation in connection with the injection of equity.


Over the past few years, the successful expansion has turned DONG Energy into the globally leading player in the field of offshore wind power and led to very significant job creation and growth for Danish society.

 

9. Where was former Chairman of DONG Fritz Schur in the process?

 

Fritz Schur was Chairman of the Board of Directors of DONG Energy, and he was actively involved in the entire process. The capital injection – and thereby the offering of the shares – was decided by the shareholders at the time, with the Danish State leading the way.