7.3. SETTLEMENT OF THE ACQUISITION OF ENERGA SHARES IN ACCORDANCE WITH IFRS 3 BUSINESS COMBINATIONS

On 5 December 2019 PKN ORLEN announced tender offer (‘Tender Offer”) to subscribe for the sale of all shares of ENERGA at the price amounting to 7 PLN per share. On 15 April 2020, as a result of negotiations with the Ministry of State Assets, PKN ORLEN increased the price in a Tender Offer to PLN 8,35 per one Share.
The Tender Offer has been announced under the following conditions:

• legal condition that the PKN ORLEN obtains an unconditional decision of the European Commission (or another competent anti-monopoly authority) approving the merger involving the takeover of control of the ENERGA that was fulfilled on 31 March 2020,
• condition precedent that the number of ENERGA shares subscribed for sale under the Tender Offer corresponds at least to 66% of the aggregate number of votes at the General Meeting, that was fulfilled on 20 April 2020,
• other conditions, i.e. adopting by the General Meeting a resolution amending the Articles of Association of ENERGA, adopting by the Supervisory Board of ENERGA a resolution adopting a consolidated text of the Articles of Association and entering into an agreement between PKN ORLEN and ENERGA concerning a due diligence audit of ENERGA, that were fulfilled on 22 April 2020.

The subject of transaction concluded under the Tender Offer were:
a) 33,533,320 ordinary bearer shares of ENERGA, corresponding to 33,533,320 votes,
b) 152,851,762 ordinary bearer shares of ENERGA, corresponding to 152,851,762 votes,
c) 144,928,000 certificated registered shares of ENERGA, corresponding to 289,856,000 votes.

The significant shareholder selling ENERGA shares under the Tender Offer was the State Treasury, which at the time of the transaction held a package of 213.33 million shares in the company representing 51.52% of its capital and entitling to approximately 64% of votes at the company's General Meeting.

Settlement of the transaction mentioned in point a) above has been completed on 24 April 2020. The transaction mentioned in points b) and c) above has been completed on 30 April 2020.

As a result of the above, on 30 April 2020 PKN ORLEN completed the process of acquisition of 331,313,082 shares of ENERGA representing approximately 80% of the share capital of ENERGA and corresponding to approximately 85% of the total number of votes at the General Meeting of the company and thus took control over ENERGA. The price amounted to PLN 8.35 per one Share and the total price for the Shares purchased by the Company amounted to approximately PLN 2,766 million and was covered by PKN ORLEN by cash from own resources and consortium credit line.

ENERGA together with entities comprising ENERGA Capital Group (‘ENERGA Group’) is one of the leading energy groups and a supplier of electricity and services for ¼ of country. Almost 40% of energy produced by the group comes from renewable energy sources (“RES”) in own production. ENERGA is a company listed on the Warsaw Stock Exchange.

The core business lines of ENERGA Group involve ENERGA Operator (responsible for the distribution of electricity and of key importance to the company’s operating profitability), ENERGA OZE (responsible for generation) and ENERGA Obrót (responsible for sales). Main assets of ENERGA Group, located in the northern and central part of Poland, are, among others, heating networks, combined heat and power plants, wind farms, hydropower plants and photovoltaic farms.

As part of takeover of capital control over ENERGA Group, the Company signed an agreement with the State Treasury, in which the Company declared to continue strategic projects of ENERGA Group with simultaneous verification the conditions for their continuation as well as maintaining of employment policy assuring proper operating of the companies of ENERGA Group. Additionally PKN ORLEN undertook to perform the obligations of companies from ENERGA Group resulting from the development plans accepted by the President of Energy Regulatory Office (“ERO”) including, among others, maintaining total installed capacity from renewable energy sources, providing production services and assuring the continuity of heat deliveries, supplying power from a generating unit located in the Ostrołęka county and proper operating of the distribution network. As of the date of this consolidated financial statements in the Group’s opinion there is no risk that the conditions included in the agreement with the State Treasury might not be met.

PKN ORLEN plans to further develop the areas in which PKN ORLEN and ENERGA are already active such as electromobility or project connected with renewable sources of energy, but also to take on new projects, such as offshore wind farms.

PKN ORLEN started to integrate activities within the enlarged Group, which will allow, among others, synergies in terms of reducing operating costs, including those related to energy trading on the Commodity Power Exchange (Towarowa Giełda Energii in Polish) by using the production surpluses in ENERGA Group and increasing the sales of products and services, in particular in the segment of retail customers by combining the customer base of both groups.

Full settlement of the transaction

The transaction of acquisition of ENERGA shares is subject to settlement applying the acquisition method in accordance with IFRS 3 Business Combinations. The date on which PKN ORLEN obtained control of ENERGA was 30 April 2020. In the consolidated half-year report for the first half of 2020 and in the consolidated quarterly report for the 3rd quarter of 2020, the Group presented a provisional settlement of transactions due to the uncompleted process of valuation of fixed assets and contingent liabilities. In 4th quarter 2020 the Group finalized the process of valuation to fair value of individual items of property plant and equipment and intangible assets, as well as the right-of-use assets related to right of way and perpetual usufruct right. Moreover, the Group finalized the valuation of provision with respect to the assumed contingent liabilities to the general contractor resulting from the suspension of construction works at the power plant Ostrołęka C, in connection with the plans to continue the construction project in the variant of the Combined Cycle Gas Turbines (CCGT) unit as well as contingent liabilities concerning legal disputes against ENERGA Group related to energy infrastructure of Energa-Operator S.A. located on private land. Therefore, in the consolidated quarterly report for 4th quarter of 2020 and in these consolidated financial statements, the Group presents the final fair values of the acquired assets and liabilities and finally settles the transaction related to acquisition of ENERGA.

The final value of net assets amounted to PLN 8,443 million, which is an increase by PLN 457 million compared to provisional settlement of the transaction presented in the consolidated half-year report for the 1st half of 2020 and in the consolidated quarterly report for the 3rd quarter 2020. The following items has changed significantly:

• property, plant and equipment, whose fair value on final settlement amounted to PLN 14,281 million (the provisional value amounted to PLN 13,715 million),
• intangible assets, which fair value on final settlement amounted to PLN 882 million (the provisional value amounted to PLN 942 million),
• right of use asset, which fair value on final settlement amounted to PLN 814 million (the provisional value amounted to PLN 843 million),
• short term provisions, which fair value on final settlement was reduced to the amount of PLN 754 million (the provisional value amounted to PLN 835 million) due to the change in the estimate of the fair value of the acquired contingent liabilities, relating to legal disputes against companies from ENERGA Group, from the value of PLN 154 million to PLN 74 million.

As a result of the above changes, related to the fair value measurement, the amounts of the deferred tax asset and deferred tax liability also changed significantly and their value as part of the final settlement were set at the level of PLN 388 million and PLN 861 million respectively (the provisional values amounted to PLN 421 million and PLN 794 million respectively). The fair value of other net assets did not change significantly from their provisional values.

The total value of non-controlling interest presented in the above table, valued at PLN 1,659 million and measured on a pro-rata basis of net assets includes the non-controlling interest within the ENERGA Group of PLN (37) million (the provisional value amounted to PLN (30) million), existing as at the date of taking control, related to net assets of subsidiaries, in which ENERGA S.A. does not hold 100% in share capital, as well as non-controlling interest of PLN 1,696 million assigned to minority shareholders holding 20% of the share capital of ENERGA (the provisional value amounted to PLN 1,603 million).

As part of the acquisition transaction, the pre-existing relationships were settled which related to the dispute between PKN ORLEN and ENERGA at estimated fair value of PLN 43 million, which corresponded to the value of the provision previously recognised in the standalone financial statements of PKN ORLEN and the consolidated financial statements of ORLEN GROUP in position of current provisions.

According to specific requirements of IFRS 3 Business Combinations, the Group estimated fair value of additional provisions with respect to Ostrołęka C project due to the decision of ENERGA and Enea to suspend the construction of a coal-fired unit and plans of implementation of the project using natural gas. Such change is in line with the strategy of ORLEN Group which assumes the development of zero and low-emission investments, including the use of gas technology. As part of the settlement of the acquisition, the Group with the support of independent experts analysed process in relation to the legitimacy of the amount of claims regarding settlement of work in progress and suspension costs resulting from the proposals presented by the general contractor. The total fair value of provisions recognised by the Group related to the Ostrołęka C project resulting from investment liabilities towards the general contractor in connection with the suspension of construction work at the Ostrołęka C power plant, as well as the contingent liability for the risk of non-performance of the capacity obligation under the concluded capacity agreements, amounted to PLN 259 million. In the Group’s opinion, in case the above risk materialize, main outflow of economic benefits in this respect will take place till the end of 2021.

The Group also recognised provisions related to fair value of assumed contingent liabilities related to legal disputes against companies from ENERGA Group including claims related to energy infrastructure of ENERGA Operator S.A. located on private land in the final amount of PLN 74 million, which was determined taking into consideration probability of meeting clients' claims based on the estimation of law firms. The Group estimates, that the outflow of economic benefits in this respect, in the event of an obligation, may occur in 2021.

Fair value of acquired trade and other receivables as at the acquisition date recognised as part of full purchase price allocation amounted to PLN 2,057 million, wherein the gross contractual amounts of those receivables amounted to PLN 2,558 million as at that date. In accordance with the best estimate, the Group considers the repayment of the presented trade and other receivables in the amount of PLN 2,057 million as probable.

As a part of settlement the Group made also an adjustment with respect to the gross value of the loans granted to SPV implementing Ostrołęka C project in the amount of PLN 364 million to their fair value determined at the level of PLN 180 million, which represents the value of loan being liability of Enea toward ENERGA in accordance with the terms of the agreement concluded between them on 30 April 2019.

At the date of acquisition, the share of PKN ORLEN in the net of the fair value amounts of the identifiable assets, liabilities and contingent liabilities exceeded the consideration transferred by PLN 4,062 million, which was recognised as a gain on a bargain purchase within other operating income in the consolidated statement of profit and loss and other comprehensive income for the 12-month period of 2020. As a result of changes in the fair value of net assets and the value of non-controlling interests described above, as part of the final settlement of the transaction the gain on a bargain purchase increased by the amount of PLN 372 million in comparison to previously presented provisional value of PLN 3,690 million.

Taking into account the requirements of IFRS 3 Business Combinations with respect to the possibility of recognizing a possible gain on a bargain purchase, the Group has reviewed and reassessed the procedures used to identify and measure all amounts affecting the calculation of the result on the transaction and considered the recognition of the gain on the bargain purchase justified.

The price in a Tender Offer of PLN 8.35 per one Share of ENERGA was determined based on strategic plans of ORLEN Group with respect to further development of the energy area, and taking into consideration also declaration on the implementation by ORLEN Group of the energy policy of Poland through, among others, continuation of strategic investments, including project Ostrołęka C. The proposed price of the Tender Offer exceeded the market valuation of ENERGA by approx. 20% as at that time and in the opinion of ORLEN Group it corresponded to the fair value of the share price of ENERGA.

Despite offering a 20% premium to the share price from the date of the Tender Offer the Group recognised gain on a bargain purchase resulting from the excess of net asset value of ENERGA Group over the price paid by the ORLEN Group. According to the Group, the bargain purchase gains resulted from a series of facts and circumstances, the key of which were related to the significant decline in market value of energy companies listed on the Warsaw Stock Exchange in the last 5 years, including also underpricing of ENERGA shares. This is largely due to their significant coal assets and their continued material investments in the mining sector. Taking into consideration increasing cost of CO2 emission and climate policy of the EU, which continues to put more and more emphasis on decarbonisation and requires Member States to increase the share of RES generation capacity, domestic companies from the energy sector have been struggling with low valuations for a long time. Moreover, the required changes towards increasing the share of low-emission sources and the related planned significant CAPEX expenditures together with a high level of indebtedness of those companies negatively affected their dividend policies, which additionally impacted their valuations.

PKN ORLEN views the acquisition of the ENERGA shares and taking control of the company as a strategic and long-term investment that will enable the implementation of plans to create an integrated multi-utility concern, capable of operating more effectively on the increasingly competitive fuel and energy market. Building a multi-energy concern and diversifying sources of income make the Group more resistant to market fluctuations and macroeconomic volatility and strengthen the competitive and financial position of combined companies. Additionally, it is a response of PKN ORLEN to global trends and challenges related to, among others, growing regulatory pressure in the field of pro-climate policy, development of alternative fuels and renewable energy sources, digitalization of production, as well as growing expectations and awareness of customers and related necessity to search for the most effective directions of development.

Net cash outflow related to the acquisition of ENERGA, being the difference between acquired net cash (recognised as cash flows from investing activities) and cash transferred as a consideration amounted to PLN 1,609 million.

In the period from the acquisition date, the share of ENERGA Group in the net profit generated by the ORLEN Group amounted to PLN 382 million, and in sales revenues PLN 7,838 million. If the acquisition of the ENERGA shares took place at the beginning of the annual reporting period, the Group's net profit would be PLN 2,876 million, and sales revenues would be PLN 90,374 million.

In connection with the transaction, the Group incurred in the current period acquisition-related costs to the takeover of ENERGA shares of PLN 1 million which were presented as administrative expenses in consolidated statement of profit or loss and other comprehensive income and as element of cash flows from operating activities in consolidated statement of cash flow.

Purchase of additional 10.91% of ENERGA shares

On 21 September 2020, PKN ORLEN announced the second Tender Offer to all other ENERGA shareholders to subscribe for the sale of shares issued by ENERGA. The subject of transactions concluded under the second Tender Offer was 45,175,558 dematerialised shares in ENERGA, representing approximately 10.91% of the share capital of ENERGA and approximately 8.08% of the total number of votes at the General Meeting of ENERGA S.A. The transaction was settled on 30 November 2020. The price per ENERGA share under this Tender Offer was PLN 8.35, and the value of the additional shares acquired amounted to approximately PLN 377 million and was covered from own funds and the available syndicated loan.