Starboard letter to Algonquin Power & Utilities Corp
$AQN
Dear Chris and Ken,
Starboard Value LP (together with its affiliates, “Starboard” or “we”) recently filed a Schedule 13D disclosing an economic ownership stake of approximately 7.5% in Algonquin Power & Utilities Corp. (“Algonquin” or the “Company”), making us the Company’s largest shareholder. We appreciate the time that members of the Board of Directors (the “Board”) and management have spent with us over the past several months.
As we have discussed, we believe Algonquin’s Regulated Services Group is a top tier regulated utility that is currently valued at a substantial implied discount to peers pro forma for a potential sale of all or a substantial majority of the Company’s unregulated renewables assets. Even without Algonquin’s unregulated renewables business (the “Renewable Energy Group”), Algonquin is significantly greener than peers, with approximately one-third of its electric generation capacity coming from renewables and no coal exposure, compared to an average of 26% for its regulated utility peers1 . Moreover, approximately 20% of Algonquin’s rate base comes from its extremely valuable Regulated Water Reclamation and Distribution business (the “Water Utility”), which generally trade at double the multiples of Electric and Gas utilities2 , compared to approximately zero water distribution exposure for Algonquin’s peers. It is also important to highlight that Algonquin has historically grown its rate base faster than peers3 , and we believe it has the opportunity to continue to grow faster than peers as a result of its unique global footprint of small-to-medium scale utilities. In other words, we believe the remaining regulated utility business, once the unregulated business is sold, should be highly attractive to public market investors.
Algonquin’s valuation has been hampered by a number of factors, most notably excessive leverage and a high dividend payout ratio. Algonquin’s high payout ratio, its recent dividend cut, its high proportion of unregulated assets, and scars from the recently-abandoned Kentucky Power deal have all combined to make Algonquin uninvestible for a large portion of traditional utility investors.
Fortunately, we believe these problems can be solved through a sale of all or a majority of the Renewable Energy Group. Pro forma for such a sale, we believe Algonquin would have lower leverage, a safer dividend, a greener asset base, and higher rate base growth than peers, and should be afforded a higher valuation.
As discussed, while there is tremendous upside to a sale of the Renewable Energy Group, it is critical that it be done in the right way and executed skillfully. Most importantly, the process should be driven by objectives for what Algonquin should look like following a divestiture of the Renewable Energy Group. In particular, we believe your key objectives should be:
1 Reduce leverage to industry-standard levels of approximately 5x gross leverage4 . Once target leverage levels have been achieved, excess proceeds should be used to repurchase shares of Algonquin to drive EPS accretion.
2 Improve EPS as much as possible, so that the dividend payout ratio is in-line with peers, with room for increases. As we have discussed, we believe a target of 75 cents in FY 2025 EPS5 is achievable.
In our view, the best path to achieving these objectives is through a sale of the substantial majority of Algonquin’s renewables assets, including the Company’s ~42% stake in Atlantica Sustainable Infrastructure PLC (“Atlantica”). This could entail a sale of the entire Renewable Energy Group as a whole, or multiple transactions for the majority of the unregulated renewables assets, while keeping certain assets that have strategic value and would allow the Company to achieve even higher pro forma EPS, with an even greener asset base and a higher growth profile. In either case, the Company would receive a substantial influx of cash with which to pay down debt and repurchase shares. Algonquin would become, what we view as, a best-in-class mid-sized utility with a highly attractive financial profile where the significant majority of earnings come from stable, regulated businesses.
While the immediate priority is untangling the Company’s unregulated renewables business in a manner that creates substantial value for shareholders, a close second is ensuring that shareholders can realize the potential of Algonquin’s extremely valuable Water Utility. Pro forma for a renewables sale, approximately 20% of Algonquin’s asset base will be from its Water Utility, making it one of the only companies in its peer group with any water reclamation and distribution exposure. Water utilities generally trade at massive premiums to Electric/Gas utilities. As such, we would expect Algonquin, with its Water Utility, to trade at a premium to other regulated utilities. If it does not, Algonquin has the opportunity to create substantial additional value through a separation of the Water Utility business. For example, if, following the sale of the Renewable Energy Group, Algonquin were to also sell its Water Utility and use the majority of the proceeds to repurchase shares, we believe that it could increase pro forma EPS to nearly 90 cents6 . Even after selling the Water Utility, Algonquin would still be greener than the majority of its peers, since its peers on average contain no water distribution exposure and get 26% of their electric power from coal. The Water Utility is a hidden gem within Algonquin’s portfolio, and its value should not be overlooked.
We look forward to continuing our discussions in order to ensure that maximum value is created for all Algonquin shareholders.
Sincerely,
Jeffrey C. Smith
Managing Member
Starboard Value LP
Source:
https://www.sec.gov/Archives/edgar/data/1174169/000119380523000957/exhibit991.pdf