Research Capital’s Matthew Gowing Weighs in on Algonquin Power Income Fund/Emera Utilities JV

Apr 24, 2009
Author: SCP Editor

April 24, 2009 – Analyst Notes – Research Capital’s Matthew Gowing commented this morning on Algonquin Power Income Fund’s (TSX:APF.un) announcement of a JV with Emera Utilities (TSX:EMA) where the companies will be 50/50 partners.

The Deal:

The joint venture will purchase Calpeco (California Pacific Electric Company) from NV Energy Inc. (NYSE: NV), and will generate annual revenue and EBITDA of US$30mm and US$20mm respectively. Calpeco operates a peaking power facility with a capacity of 12 MW, and will also acquire electricity distribution infrastructure that provides power to 47,000 customers in the Lake Tahoe, California region. The deal is expected to close in mid 2010, at which time Calpeco will pay NV Energy US$116mm to purchase the assets. The JV will fund half of the acquisition through the issuance of debt.To finance their portion of the deal, Algonquin will issue to Emera 8.5mm units under a private placement at a price of $3.25 (CAD) per unit. The issue will be completed at the deal’s closing, provided the acquisition is approved by federal and state regulators.

Gowing’s Opinion – Positive, highlights Algonquin as a solid BUY for investors 

• Our impression of the Calpeco acquisition as it relates to Algonquin is very much positive. The acquisition requires a negligible amount of cash proceeds from APF, despite the Fund acquiring an additional $10mm in annual EBITDA.

 ·       The fact that Emera was willing to subscribe to a private placement of a 30% premium to APF’s current equity valuation is a significant endorsement from that company that they realize just how   undervalued the units in Algonquin have become. Furthermore, although management denied on the call that Emera’s actions represent a “creeping takeover” of Algonquin, we submit a plausible theory that Emera could move ahead to purchase the remaining outstanding units of APF when the standstill expires in two years. 

• We regard the financial metrics of the acquisition is attractive as we calculate Calpeco should be accretive to APF’s earnings per unit (EPU) by 3% in 2010, and by 5% in 2011, and that the $116mm asset price will have a payback to the joint venture of approximately 6 years.

• On an EV/EBITDA basis, the acquisition is priced favourably at 5.8x. This acquisition price is a discount to Algonquin's historical average range of forward EV/EBITDA of 10-14x, and is also below its current multiple of 6.75x. The acquisition is also at a discount to a group of diversified power generator and utility companies that trade at multiples of 7-8x forward EV/EBITDA.  

• The real focus for the market in our opinion should be a reminder to investors of the growth opportunities available to Algonquin, as well as management’s industry relationships and ability to strike accretive deals. The deal speaks to the strong demand for renewable power in California, and also puts Algonquin in a favourable light considering the scarcity of electricity distribution networks in the state.

           -  Management stated on the conference call that they were not currently working on the development of a 50 MW wind farm in the district of Calpeco, but they also pointed out that under California’s RPS, this is the amount of incrementally new clean power that will be required to satisfy the near term demands of the RPS in that area. We expect an announcement sometime soon on development plans or agreements of such a facility and this would be a catalyst for APF shares, in our opinion. 

• The drop-off in Algonquin's valuation following their October announcement of the trust's distribution is unwarranted in our view. The decision was a strategic move by Algonquin to position the Fund to take advantage of growth and development opportunities, such as the NV Energy deal just announced. Its primary reason was not a reactionary solution to a distressed cash flow levels.

• In the near future, We believe that the market will recognize just how cheap Algonquin's valuation has become, and understand that one can buy units in APF currently at a yield close to10%, and at an EV/EBITDA multiple which is at a discount of over 30% below previous trough levels. In addition to investing in a solid basket of low-risk, stable, cash flow producing, power and infrastructure assets, one can get exposure to the solid secular growth opportunities offered to developers of clean energy projects.

 Some Background on the acquisition and financial arrangement with Emera (TSX: EMA): 

• Calpeco will be held jointly by APF and EMA at stakes of 50% each respectively, and the two will co-manage the operation.

• The purchase price is US $116mm for 94 miles of electricity distribution lines, 13 substations, and the 12 MW regulated generating facility, all located in California. Electric distribution service is provided to approximately 47,000 customers in the Lake Tahoe region.

• The acquisition of the NV Energy assets will provide APF and Emera the opportunity to participate in further opportunities to invest in electricity generation and power distribution assets, in the company's opinion. APF mgmt also points out that California's aggressive 20% RPS by the year 2010 will result in extensive clean energy project development opportunities for the Fund.

• The NV Energy assets are strategically located in an area of California that is experiencing relatively faster economic growth as a result of a thriving local tourism industry.

• To finance APF's required equity contribution of US $27mm of the total US$54mm equity consideration required by NV Energy, APF will be issuing 8.5mm shares at a purchase price of $3.25 (CAD) per unit for total proceeds of $27.25mm (CAD) or US $23mm. Thus, EMA purchases a stake of $27.6mm for an equivalent 9.9% ownership stake in APF. This equity contribution satisfies all but $4mm of APF's requirements to purchase the NV Energy assets. APF should be able to comfortably source the remaining $4mm in equity by mid 2010 as we estimate the company to produce over $90mm of EBITDA in 2010, without including the approximate $5mm of cash flow provided by the NV Energy assets to APF in that year.

• The deal is expected to close in mid 2010, at which time, the APF shares will be issued to Emera

• The purchase will be subject to ordinary federal and state approval, and APF's share of the operations is expected to add $15mm of annual revenue and $10mm EBITDA. APF will consolidate this proportionate share of the financial results onto their financial statements. Note that these estimates are based on the approval by the utility regulators of filings or rate case increases. However the rate case assumes a modest 8.5% rate increase so the estimates above should not change that much should the unlikely event occur that the filing be denied.

• There is a standstill agreement for Emera not to be able to increase its stake in Algonquin from the 9.9% level to a max of 15% over the next two years following the closing of the transaction.