Hedge fund calls for sale of Algonquin's unregulated renewables business

Activist hedge fund Starboard Value LP is calling on Algonquin Power & Utilities Corp. to offload its unregulated renewables business and its stake in Atlantica Sustainable Infrastructure PLC to improve its valuation and "restore investor confidence."

Starboard Value released a July 6 letter sent to Kenneth Moore, chair of Algonquin's board of directors, and Christopher Huskilson, chair of the company's strategic review committee. The letter follows a Schedule 13D filing with the SEC through which Starboard disclosed an "economic ownership stake" of about 7.5% in Oakville, Ontario-headquartered Algonquin, which the firm said makes it the company's largest shareholder.

Starboard had disclosed a 5% ownership stake in its June 20 Schedule 13D filing but also noted that it has "economic exposure to an aggregate of 51,413,000 shares (representing approximately 7.5% of the outstanding shares) due to certain cash-settled total return swap agreements."

The activist hedge fund said in its letter that it has held talks with Algonquin's board and management "over the past several months" about how the company's core regulated utilities business is undervalued and how a "properly executed sale of all or a substantial majority" of its unregulated renewables business could "accelerate efforts to delever, lower the dividend payout ratio and restore investor confidence."

The talks reportedly began after Algonquin's US-based subsidiary Liberty Utilities Co. and American Electric Power Co. Inc. announced a mutual decision to terminate their $2.65 billion deal for American Electric Power's Kentucky Power Co. and AEP Kentucky Transmission Co Inc. businesses.

"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," Starboard founder and CEO Jeffrey Smith wrote. "Fortunately, we believe these problems can be solved through a sale of all or a majority of the Renewable Energy Group."

The hedge fund said the key objectives from the potential sale should be to reduce leverage to industry-standard levels and improve earnings per share to ensure the dividend payout ratio is in line with peers.

Algonquin launched a strategic review May 11 to consider divesting its unregulated renewables portfolio, which caught many investors and analysts off guard. The company's stock has since declined about 6% and was trading down about 1.7% as of 12:30 p.m. ET on July 6.

"Algonquin maintains open communications with its shareholders and values constructive input that advances our goal of enhancing shareholder value," Algonquin spokesperson Stephanie Bose wrote in a July 6 email. "While the strategic review process includes assessing a potential sale or spin-off of the Renewable Energy Group, the Board is reviewing alternatives with a view to positioning each business for continued growth and determining the best path forward to drive meaningful, long-term value for all shareholders."

The renewable energy group consists of a fleet of hydroelectric, wind, solar and thermal generation assets with a net generating capacity of about 2.4 GW, with 82% of the output sold through long-term contractual agreements, according to Algonquin.

In addition to numerous solar, wind and hydro projects throughout the US and Canada, S&P Global Market Intelligence data shows Algonquin's unregulated portfolio includes combined-cycle natural gas and oil-fired power plants in the US and Bermuda. It is unclear if these units would be part of a potential sale.

Additionally, the renewables unit has a 51% interest in the Stella, Cranell, East Raymond and West Raymond wind farms in Texas.

Algonquin is also the largest shareholder of UK-headquartered Atlantica Sustainable Infrastructure, which is undergoing its own strategic review.

Meanwhile, Algonquin's regulated wastewater, water, electricity and natural gas utilities, under the Liberty Utilities name, serve more than 1 million customers in a dozen US states, the Canadian province of New Brunswick, Bermuda and Chile.

In its letter, Starboard points out that Algonquin is "significantly greener than peers" even after a potential sale of its unregulated renewables business, receives about 20% of rate base from its "extremely valuable" regulated water utility business, and "has historically grown its rate base faster than peers."

"In other words, we believe the remaining regulated utility business, once the unregulated business is sold, should be highly attractive to public market investors," Starboard wrote.

The New York-based investment management company also signaled that there could be value in Algonquin spinning off its "hidden gem" water utility business.

"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," Starboard's Smith wrote. "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 cents."

Algonquin said in January that it would lower its dividend by about 40% to free up about $1 billion over a five-year period to help fund organic growth and offset headwinds. The company also suspended its dividend reinvestment plan and provided below-consensus earnings guidance for 2023.

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