Activist Starboard prepares the groundwork to reduce leverage at Algonquin Power

Enterprise: Algonquin Energy is a renewable vitality and utility firm that gives vitality and water options and providers in North America and internationally. The corporate operates via two segments – (i) the regulated providers group, which offers a portfolio of rate-regulated water, electrical energy and gasoline utility providers, and (ii) the renewable vitality group, which generates and sells electrical vitality produced by its portfolio of renewable energy technology amenities.

Inventory Market Worth: ~$5.7B ($7.87 per share)

Proportion Possession:  7.5%

Common Value: $8.38

Activist Commentary: Starboard is a really profitable activist investor and has in depth expertise serving to corporations concentrate on operational effectivity and margin enchancment. Starboard has made 111 prior 13D filings and has a mean return of 27.52% versus 12.10% for the S&P 500 over the identical interval. That is Starboard’s first 13D submitting within the utilities sector.

On June 30, Starboard reported a 7.5% curiosity in Algonquin Energy. The agency despatched a letter to the corporate on July 6, saying {that a} sale of Algonquin Energy’s renewables enterprise will help it scale back leverage and supply “a safer dividend.”

Algonquin Energy is a utility firm based mostly in Canada with most of its property in the USA. The regulated providers phase accounts for 87% of the corporate’s income and its enterprise is comprised of the next: 60% electrical energy, 20% gasoline, and 20% water. Sixty-five p.c of the electrical energy the corporate offers is generated by gasoline and 35% by renewables. The core utilities enterprise is operated effectively with a fee base development fee of 8% versus 6% to 7% for friends. Regardless of this, Algonquin at the moment trades at 13 instances to 14 instances price-earnings with a 5% dividend yield, versus 17.5 instances P/E and a 3.5% dividend yield for friends. Furthermore, the water enterprise is best than electrical and gasoline, and Algonquin Energy has extra water publicity than friends, so it ought to commerce at a fair larger P/E ratio.

Arun Banskota was named Algonquin Energy’s CEO in 2020 and has prioritized strategic transactions over operations. Accordingly, the corporate introduced an settlement in October 2021 to purchase Kentucky Energy for practically $3 billion. In December 2022, the Federal Power Regulatory Fee denied approval of the transaction. In April 2023, the corporate terminated the settlement to amass Kentucky Energy. Amid these developments, Algonquin Energy’s inventory fell from over $15 per share to roughly $6.52 per share as shareholders misplaced confidence in administration. And for good cause: A big acquisition was the very last thing the corporate wanted. Buyers have been in search of a secure, predictable firm with a robust steadiness sheet and a superb dividend ratio – belongings you typically count on from utilities. As an alternative, the acquisition would have added to an already over-leveraged steadiness sheet, placing Algonquin Energy in a fair much less secure monetary place.

The activist marketing campaign right here is comparatively easy: Promote the renewables enterprise and concentrate on the core, secure regulated utility enterprise. Promoting the renewables enterprise won’t solely present the corporate with a big capital infusion to stabilize its steadiness sheet and safe its dividend, however it might additionally present the kind of buyers who like utilities companies with extra certainty, predictability and stability. In different phrases, it might do the precise reverse of what the Kentucky Energy acquisition would have executed. Whereas the renewables enterprise solely accounts for about $300 million in income and roughly $200 million in earnings earlier than curiosity, taxes, depreciation and amortization, there’s much more worth on this enterprise than could seem for a number of causes. That features the truth that Algonquin Energy has a number of joint ventures during which revenue has not began coming in but, plus there are vital tax advantages that aren’t included in EBITDA. Based mostly on the per megawatt foundation of comps, the renewables enterprise may yield over $5 billion in a sale to a number of bigger corporations.

Furthermore, this can be much like pushing an open door. In Could, the corporate introduced that it retained JPMorgan to conduct a strategic overview of the renewables enterprise. So, in contrast to many activist campaigns, persuading administration is now not an impediment: It now simply relies on execution. We’ve got little question that Starboard might be maintaining an in depth eye on the corporate to see the way it executes this strategic overview. If the agency feels the corporate wants some steering within the course of, we count on Starboard to hunt board illustration, given its historical past. Lastly, if this occurs it can seemingly result in a extra operationally targeted CEO versus a strategic visionary.

There’s additionally an Activist ESG (AESG) thesis right here. Algonquin Energy’s vitality technology is at the moment divided into pure gasoline and renewables. Nevertheless, as tools and amenities depreciate, they will now not be included within the fee base, and the corporate can’t receives a commission on them. So, corporations like Algonquin Energy will shut amenities and retire tools and construct new amenities and purchase new tools that may be added again into the speed base. The development within the business is towards extra environmentally pleasant property. So, whereas the corporate presently is roughly 65% pure gasoline and 35% renewables, there is a chance to extend the share of renewables sooner or later.

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and he’s the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Algonquin Energy is a holding within the fund. Squire can be the creator of the AESG™ funding class, an activist funding fashion targeted on enhancing ESG practices of portfolio corporations.