Deal focus: PEP reaches its Zenith

The deal

Elemental Infrastructure, a consortium led by Australian private equity firm Pacific Equity Partners (PEP), last month completed a A$259 million ($180 million) acquisition of Zenith Energy, paying A$1.05 per share for the listed Australian power generator. It signaled the end of a remarkable five-month pursuit shaped by COVID-19 and shareholder opposition.

PEP made its initial bid of A$1.01 per share just as the pandemic was ramping up in Australia. Even though the offer represented a 45.3% premium to the previous closing price – and broader market circumstances being highly unfavorable for shareholder leverage over bidders – it was twice effectively "blocked" by different sets of shareholders, forcing terms to be recut.

Elemental, initially solely controlled by PEP, was joined by Apex Opportunities, a vehicle comprising Canadian pension fund OPTrust and Australian partner Infrastructure Capital Group (ICG). PEP has a 33.35% stake in Zenith while OPTrust and ICG own 23.16% each. The remainder is held by company management.  

The asset

Zenith Energy, based in Perth, was founded in 2006 and went public in 2017, raising A$25 million after pricing its shares at A$0.50 apiece.

The company specializes in cost-effective power generation systems for installation in remote, off-grid areas of Australia and Southeast Asia. Fuel sources include diesel, gas, solar, and hydro technologies, with some projects being hybrids. Contact options include a build-own-operate model whereby Zenith takes full responsibility for an operation, and a manage-operate-maintain model, whereby clients maintain ownership.

Income is generated primarily from sales of electricity and contracts for engineering, procurement and construction work. Clients include Chevron and Northern Star Resources.

The player

PEP made the acquisition through its debut secure assets fund, which targets Australasian companies generating annuity income with potential for private equity-style operational improvements. The vehicle launched in 2018 with a target of A$750 million. It closed earlier this year on A$660 million, including a A$300 million co-investment pool.

Zenith is the fund's fourth investment, following intelliHUB and Metrix, smart meter businesses in Australia and New Zealand, respectively, and last-mile utility service provider WinConnect, according to Andrew Charlier, a managing director at PEP who led the investment.

While traditional infrastructure investors usually buy a single asset and collect cash flow under a long-dated service agreement with a single counterparty, PEP takes an active management approach. Its typical target is a business platform where "you can sell it for more than you bought [it for]," says Charlier. This strategy requires very different skillsets to drive value appreciation over the course of the investment period.

The strategy

Remote power is a capital-intensive business and, as the industry moves to displace some generation capacity with renewables, it becomes even more so, says Charlier. "We like the fact that Zenith's contract terms are longer, its growth rate is higher, and it has a history of some quite good engineering solutions that deliver low cost outcomes for the clients," he adds. "There is a good meeting of minds, and a good meeting of strategy."

Zenith has a strong position in the market and is well regarded by customers. Along with OPTrust and ICG, PEP has significant capital to deploy into the business to support the next leg of growth. "We are targeting doubling or tripling the business under our ownership," Charlier notes.

Future growth will come in three parts: organic expansion; the displacement of gas and diesel generation capacity by renewables; and the provision of additional services to mining industry and other customers in remote sites. These services include air conditioning, water, and utility management.

While there is talk of renewables achieving 20% penetration on Australia's east coast, Zenith is pushing beyond 50% in remote sites, Charlier says. Renewables are desirable in remote sites because the alternative is to transport the fuel for 1,000-2,000 kilometers.

According to Zenith's 2017 IPO prospectus, the company's key rivals in Australia are Pacific Energy, EDL, UON Energy, Contract Power and Cummins Power. Charlier identifies EDL and Pacific Energy as the key competition. However, while EDL focuses on large sites, Zenith is nimbler.

The process

PEP started discussions with Zenith's founder and management 18 months ago and began formal due diligence in December 2019. Its proposed scheme of arrangement was recommended by the company's board.

The agreement was the first involving a listed Australian company to feature a material adverse change (MAC) clause that specifically excluded a "pandemic." MAC was defined as any event that diminishes EBITDA by A$3 million or reduces net assets or net indebtedness by 15%.

Charlier explains that it came down to whether the business would be impacted by the pandemic, and whether structural change would hurt the valuation. With Zenith, PEP did not see any such impact because the business has a long-term contracted position. One source familiar with the situation notes that PEP never asked for COVID-19 protection because it would not have been granted and the PE firm was comfortable with the underlying business risk.

Meanwhile, OPTrust entered the fray on April 6 and bought up 23.1 million shares, or a 15.45% stake in the company. Two weeks later, the pension fund increased its position to 17.61%, triggering speculation that it could table a rival bid. One month later, PEP and Apex agreed to jointly bid for Zenith at AUD 1.01 per share.

"As we explored with OPTrust and ICG, we had the same business plan, the same approach, the same view of what this business could become," Charlier says, reflecting on the negotiations with Apex. "It is in the best interest of the company and in the best interest of us to collectively enable that vision, rather than to leave the business in a stalemate."

OPTrust and ICG are "good parties to have on the register," he concludes, noting that the bidding partners may end up buying PEP's stake when it exits.

At the end of June, Westoz Funds Management publicly expressed "disappointment" that Zenith had not negotiated an improved offer. Its listed fund Ozgrowth held 12.9% of Zenith, by far the largest holding in its portfolio. It lodged proxies representing 22.25% of the shares eligible to vote against the resolution. With other shareholders supporting Westoz, the bidders were forced to increase their offer to A$1.05 in July.

A second source observes that a potential counterbidder for a listed company acquiring a lot of stock well below the announced bid price due to market dislocation represents a unique set of circumstances. "It also showed how positive mining and mining services have been in Western Australia in this COVID-19 environment," the source adds.

This is part of a series of deal focus stories produced by AVCJ and sister title Mergermarket.

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• Topics
• Australasia
• Buyouts
• Infrastructure
• Cleantech
• Australia
• energy
• Pacific Equity Partners