Activist Starboard prepares the groundwork to reduce leverage and build value at Algonquin Power
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Company: Algonquin Power & Utilities (AQN)
Business: Algonquin Power is a renewable energy and utility company that provides energy and water solutions and services in North America and internationally. The company operates through two segments – (i) the regulated services group, which provides a portfolio of rate-regulated water, electricity and gas utility services, and (ii) the renewable energy group, which generates and sells electrical energy produced by its portfolio of renewable power generation facilities.
Stock Market Value: ~$5.7B ($7.87 per share)
Activist: Starboard Value
Percentage Ownership: 7.5%
Average Cost: $8.38
Activist Commentary: Starboard is a very successful activist investor and has extensive experience helping companies focus on operational efficiency and margin improvement. Starboard has made 111 prior 13D filings and has an average return of 27.52% versus 12.10% for the S&P 500 over the same period. This is Starboard’s first 13D filing in the utilities sector.
On June 30, Starboard reported a 7.5% interest in Algonquin Power. The firm sent a letter to the company on July 6, saying that a sale of Algonquin Power’s renewables business can help it reduce leverage and provide “a safer dividend.”
Behind the scenes
Algonquin Power is a utility company based in Canada with most of its assets in the United States. The regulated services segment accounts for 87% of the company’s revenue and its business is comprised of the following: 60% electricity, 20% gas, and 20% water. Sixty-five percent of the electricity the company provides is generated by gas and 35% by renewables. The core utilities business is operated efficiently with a rate base growth rate of 8% versus 6% to 7% for peers. Despite this, Algonquin currently trades at 13 times to 14 times price-earnings with a 5% dividend yield, versus 17.5 times P/E and a 3.5% dividend yield for peers. Moreover, the water business is better than electric and gas, and Algonquin Power has more water exposure than peers, so it should trade at an even higher P/E ratio.
Arun Banskota was named Algonquin Power’s CEO in 2020 and has prioritized strategic transactions over operations. Accordingly, the company announced an agreement in October 2021 to buy Kentucky Power for nearly $3 billion. In December 2022, the Federal Energy Regulatory Commission denied approval of the transaction. In April 2023, the company terminated the agreement to acquire Kentucky Power. Amid these developments, Algonquin Power’s stock fell from over $15 per share to roughly $6.52 per share as shareholders lost confidence in management. And for good reason: A large acquisition was the last thing the company needed. Investors were looking for a stable, predictable company with a strong balance sheet and a good dividend ratio – things you generally expect from utilities. Instead, the acquisition would have added to an already over-leveraged balance sheet, putting Algonquin Power in an even less stable financial position.
The activist campaign here is relatively simple: Sell the renewables business and focus on the core, stable regulated utility business. Selling the renewables business will not only provide the company with a large capital infusion to stabilize its balance sheet and secure its dividend, but it would also provide the type of investors who like utilities businesses with more certainty, predictability and stability. In other words, it would do the exact opposite of what the Kentucky Power acquisition would have done. While the renewables business only accounts for about $300 million in revenue and roughly $200 million in earnings before interest, taxes, depreciation and amortization, there is a lot more value in this business than may appear for several reasons. That includes the fact that Algonquin Power has several joint ventures in which income has not started coming in yet, plus there are significant tax benefits that are not included in EBITDA. Based on the per megawatt basis of comps, the renewables business could yield over $5 billion in a sale to one or more larger companies.
Moreover, this may be similar to pushing an open door. In May, the company announced that it retained JPMorgan to conduct a strategic review of the renewables business. So, unlike many activist campaigns, persuading management is no longer an obstacle: It now just depends on execution. We have no doubt that Starboard will be keeping a close eye on the company to see how it executes this strategic review. If the firm feels the company needs some guidance in the process, we expect Starboard to seek board representation, given its history. Finally, if this happens it will likely lead to a more operationally focused CEO as opposed to a strategic visionary.
There is also an Activist ESG (AESG) thesis here. Algonquin Power’s energy generation is currently divided into natural gas and renewables. However, as equipment and facilities depreciate, they can no longer be included in the rate base, and the company cannot get paid on them. So, companies like Algonquin Power will close facilities and retire equipment and build new facilities and buy new equipment that can be added back into the rate base. The trend in the industry is toward more environmentally friendly assets. So, while the company presently is approximately 65% natural gas and 35% renewables, there is an opportunity to increase the percentage of renewables in the future.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Algonquin Power is a holding in the fund. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.