Traps and Hurdles Loom on Poland's Path Toward Oil Champion

(Bloomberg) -- Shares in Poland's PKN Orlen SA and Grupa Lotos SA jumped on news that the state-controlled fuel companies signed a letter of intent to merge, moving closer to creating a national champion with $35 billion in annual sales.

But the plan to create a national oil champion to succeed after decades of aborted attempts faces a slew of hurdles. The deal driven by Prime Minister Mateusz Morawiecki's government must overcome obstacles including potential opposition from minority owners and European Union regulators.

Cash or Shares?

In a brief regulatory statement, Orlen said on Tuesday it wanted to buy the government's 53 percent stake in Lotos, and perhaps more. The companies didn't provide details as to how they would merge the two companies whose combined market value now stands at $15.6 billion.

• Orlen is likely to choose either a stock-for-stock transaction or pay with cash
• In the first scenario, 80 percent of Orlen's shareholders would need to back a possible share issue, which may be difficult unless it offers favorable conditions for minority owners
• The government directly controls about 33 percent of Orlen and possibly additional stakes below 5 percent that are owned by state-controlled pension funds; other large minority owners include pension funds of NN Group NV and Aviva Plc, with 8.3% and 7% respectively, according to data compiled by Bloomberg
• “For now, during the period of discussions between Orlen and the Treasury about how to proceed with the deal, share prices of both companies will stay elevated,” said Robert Maj, an analyst at Ipopema Securities SA in Warsaw. “The minorities would like to ramp up either the average share price in the tender offer or the parity in a share swap.”
• In case of a share swap, PKN would need to issue 107 million new shares for the existing shareholders of Lotos to gain a 100 percent stake, assuming current share prices, Adrian Kyrcz, an analyst at Bank Zachodni WBK SA in Warsaw, said in a research note. The company currently has 427.7 million shares issued, according to data compiled by Bloomberg

Public Bid

If Orlen opts for the cash route, it would not only have to buy the state's 53 percent stake, valued at 5.8 billion zloty ($1.69 billion), but would also be required to offer to buy as much as 66 percent in Lotos to comply with Polish law. This should keep Lotos shares bouyed.

• Orlen piled up 6.2 billion zloty of cash at end of 2017 against net debt of 761 million zloty, but spent 3.5 billion zloty to buy out other shareholders in its Czech unit, Unipetrol AS
• Orlen also plans to stick to its dividend policy, it said in emailed statement on Tuesday. The company pays as much as 5 percent of its average market capitalization from the previous year
• Paying with cash wouldn't require backing from a majority of shareholders but would limit the refiner's ability to finance future projects, including the potential construction of a nuclear power plant that Poland's government may want to develop
  • News of Orlen's possible move into nuclear power, non-core operations for the refiner, pushed its shares down as the plan may require about 70 billion zloty of financing
• A cash deal would be “more positive for Lotos minority shareholders as Orlen should come up with a public bid afterward,” said Tamas Pletser, an analyst at Erste Group Bank AG in Budapest
• “Details of the potential transactions have yet to be worked out, but we can gather from the announcement that PKN's intention is to pay for the shares in cash,” Kamil Kliszcz, the head of equity research at MBank SA in Warsaw, said in note on Wednesday

Track Record


History shows that Orlen has struggled with its M&A plans, although this deal may be different because the companies are so similar in their refining and retail operations, with most of their crude supplies coming from Russia. Both also have limited upstream operations, in the North Sea and in North America.

• In 2004, Orlen agreed to buy 63 percent stake in Unipetrol for $505 million. The company poured more money into the deal this year as it sought full control, upsetting the government, which lead to the chief executive being replaced
• The same year, the refiner and Hungary's Mol Nyrt. failed to agree on a merger -- falling out mainly over the state's ownership in Orlen -- that would have then created the region's biggest refiner
• Two years later, Orlen bought a Lithuanian refinery for about $2.8 billion. It later wrote down the investment almost entirely because of losses after learning about the limits of expanding in a part of Europe where Russian majors still dominate energy supplies; the unit kept posting profits for the past several years

Regulatory Approval

Orlen owns 1,776 of Poland's 6,624 fuel stations, while Lotos has about 500, with other major retailers including BP Plc, Royal Dutch Shell Plc and Alimentation Couche-Tard Inc.'s Circle K.

If combined, PKN and Lotos would together hold more than a third of the domestic fuel retail market, and part of this business may need to be sold to address regulatory concerns. Were this to happen, Total might be interested in an acquisition to expand its retail network in Poland, where the maturity of retail shops, particularly in city centers, makes it difficult to expand organically -- Salih Yilmaz, Bloomberg Intelligence

• Energy Minister Krzysztof Tchorzewski said the merged company wouldn't have to sell any fuel stations to get approval from antitrust regulators, as their joint share is below the 40 percent barrier seen as infringing competition
• While the two refiners control almost the entire wholesale fuel market in Poland, refining more than 25 million barrels of crude per year, they may be assessed by EU regulators regarding their ability to distort prices in the wider central and east European region, which would be smaller, according to MBank's Kamil Kliszcz
  • The merged company would have a 26 percent share in refining capacity when taking into consideration all the countries it operates in
• Marek Niechcial, head of the Polish antimonopoly agency UOKiK, said the the European Commission should look into the transaction.
• “In our opinion, the key risk factors to the potential deal completion are regulatory approval -- as a merger with Lotos would lift the merged entity's share of the retail market in Poland above the 40 percent threshold, so the merged entity might be required to sell part of its petrol stations network -- and shareholders' green light,” Zachodni's Kyrcz said

Local Politics

Premier Morawiecki told Bloomberg last week that he supports the idea of an Orlen-Lotos merger because the scale of operations is important to grow the industry and expand the country's corporate champions abroad. 

But on the regional level, politics may get more messy, especially in a year when Poles vote in local elections.

• Gdansk-based Lotos is the biggest company on Poland's Baltic Sea coast. It paid 526 million zloty of income tax in January-September last year, 23 percent of which goes to local authorities, and employs about 5,000 people in its refinery
• When asked about the potential merger earlier this month, a Gdansk municipal official from the ruling party, Grzegorz Strzelczyk, who also heads Lotos's Petrobaltic offshore oil production unit, said that the role of local politicians was to make sure that the city's budget is secure, indicating potential concerns about a merger impacting some of that revenue

To contact the reporters on this story: Maciej Martewicz in Warsaw at mmartewicz@bloomberg.net, Wojciech Moskwa in Warsaw at wmoskwa@bloomberg.net.

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net, Andras Gergely

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