8.8. Business combinations

On April 28th 2016, PGNiG TERMIKA S.A. (“PGNiG TERMIKA”) purchased from Spółka Energetyczna Jastrzębie S.A. (“SEJ”) 100% of shares in Przedsiębiorstwo Energetyki Cieplnej S.A. of Jastrzębie-Zdrój (“PEC”), together with all rights attached thereto, including the right to exercise 100% of the voting rights at the General Meeting of PEC. The fair value of the payment made (representing the purchase price for the shares) was PLN 190.4m and was paid with cash.

In the share purchase agreement, PGNiG TERMIKA undertook not to dispose of or otherwise convey the title to PEC shares (in whole or in part) from the date of the agreement to the date on which the banks are provided with the technical advisor’s closure report on the construction of an FBC unit, to be prepared following project completion. The undertaking was reflected in the sale price. However, the restricted right to dispose of or otherwise convey the title to PEC shares does not the affect right to exercise control of PEC, and thus to determine the acquisition date. Accordingly, the date of acquisition of PEC by PGNiG TERMIKA was set as April 28th 2016. For the purposes of accounting for the transaction, April 30th 2016 was adopted as the transaction accounting date.

PEC is involved in the distribution and generation of heat in the municipalities of Jastrzębie-Zdrój, Czerwionka-Leszczyny, Knurów, Racibórz, Kuźnia Raciborska, Pawłowice, Rybnik, Wodzisław-Śląski and Żory. The company operates 288 km of heating networks and 14 local heating plants, which produce 40% of all heat sold by PEC. In 2015, the total sales of heat generated by the company were 2.6 PJ.

The key reasons for the PEC acquisition were:

• to enter new markets and expand the PGNiG Group’s geographical reach;
• to strengthen the PGNiG Group’s market position;

• to increase the PGNiG Group’s value growth on the back of higher total revenue and EBITDA generated by PGNiG TERMIKA and its subsidiaries;
• to increase PEC’s value through employment restructuring and operational integration.

As at the date of the transaction, the goodwill on acquisition of PEC shares as disclosed in the interim condensed consolidated financial statements of the PGNiG Group for the six months ended June 30th 2016 and in the interim condensed consolidated financial statements of the PGNiG Group for three months ended September 30th 2016, recognised at fair value of the payment made (PLN 190.4m), less the then initially determined fair value of the identifiable assets and liabilities assumed (PLN 150.9m), was PLN 39.5m.

Measurement of the fair value of net assets for the purposes of the Group’s interim consolidated financial statements was provisional as measurement of the fair value of identifiable assets and liabilities for the purposes of these consolidated financial statements was not completed until December 2016.

As a result of the final accounting for the transaction, which included in particular reassessment of completeness and correctness of all the identifiable assets and liabilities assumed in the transaction and their fair value measurement, the fair value of net assets as at the acquisition date was determined at PLN 174.5m, i.e. PLN 23.6m more than the provisional valuation. In consequence, goodwill recognised in the PGNiG Group’s consolidated statement of financial position as at December 31st 2016 was PLN 16m.

The goodwill was entirely allocated to the cash-generating unit identified at PEC within to the Generation Segment.

On August 11th 2016 (acquisition date) PGNiG TERMIKA purchased from Jastrzębska Spółka Węglowa S.A. (“JSW”) 100% of shares in Spółka Energetyczna Jastrzębie S.A. of Jastrzębie-Zdrój (“SEJ”), together with all rights attached thereto, including the right to exercise 100% of the voting rights at the General Meeting of SEJ. The shares were purchased for a total of PLN 371.8m, including the amount received by SEJ for sale of PEC shares on April 28th 2016. As at the date of these consolidated financial statements the shares had been paid for in cash. For the purposes of accounting for the transaction, July 31 2016 was adopted as the transaction accounting date, with SEJ data adjusted to account for material events which occurred between July 31st 2016 and August 11th 2016.

SEJ’s business consists in generation of electricity and heat for JSW mines and other industrial customers, and generation of heat for households, which is then distributed by PEC. The amount of heat delivered by SEJ to PEC is about 0.9 PJ per year, which represents approximately 60% of SEJ’s total heat output. SEJ is also produces compressed air and cold for JSW mines.

As part of the transaction, the parties agreed on long-term conditions of purchases of coal and methane by SEJ from JSW, and sales of heat, electricity, cold and compressed air to JSW.

By acquiring SEJ shares, PGNiG TERMIKA indirectly acquired also 55% of the shares in SEJ-SERWIS Sp. z o.o., and thus the PGNIG Group’s overall indirect interest in that company increased to 100% of the share capital (45% of SEJ-SERWIS shares were purchased as part of the acquisition of PEC).

The key reasons for the SEJ acquisition were:

• to enter new markets and expand the PGNiG Group’s geographical reach;
• to strengthen the PGNiG Group’s market position;
• to increase the PGNiG Group’s value growth on the back of higher total revenue and EBITDA generated by PGNiG TERMIKA and its subsidiaries;
• to increase SEJ’s value through employment restructuring and operational integration.

The transaction was initially accounted for as at September 30th 2016, and a PLN 72.8m gain from bargain purchase was disclosed under ‘Other income and expenses’ in the quarterly consolidated statement of profit or loss of the PGNiG Group. This amount was calculated as the excess of fair value, initially determined on that date, of the company’s identifiable assets and assumed liabilities (PLN 444.6m) over the fair value of the paid consideration (PLN 371.8m).

Measurement of the fair value of net assets for the purposes of the Group’s interim consolidated financial statements was provisional as measurement of the fair value of identifiable assets and liabilities for the purposes of these consolidated financial statements was not completed until December 2016.

As a result of the final accounting for the transaction, which included in particular reassessment of completeness and correctness of all the identifiable assets and liabilities assumed in the transaction and their fair value measurement, the fair value of net assets as at the acquisition date was determined at PLN 368.3m, i.e. PLN 76.4m less than the provisional valuation. In consequence, goodwill recognised in the Group’s consolidated statement of financial position as at December 31st 2016 was PLN 3.6m.

Goodwill arose both on the acquisition of PEC and SEJ, and includes mainly the fair value of expected synergies arising from the acquisition, which cannot be separately disclosed in the statement of financial position. Goodwill comprises the expected synergies arising from the combination of the acquirer’s and acquiree’s businesses, driven by future economic benefits derived from anticipated increase in revenue and employment by PEC and SEJ of highly-qualified staff. Goodwill also comprises future economic benefits derived from the market position of PEC and SEJ, their relationship with Jastrzębska Spółka Węglowa, agreements executed by JSW with heat users, and the possibility to optimise coal procurement for larger groups of customers in order to create added value for the entire PGNiG Group.

The goodwill was entirely allocated to the cash-generating unit identified at SEJ within to the Generation Segment.