Algonquin Power & Utilities Corp's Riviere-du-Loup hydroelectric generating facility near the town of Riviere-du-Loup, Quebec, in 2010.Courtesy of Algonquin Power
There’s a well-worn playbook rolled out by activist fund managers targeting underperforming public companies.
Hedge funds such as Starboard Value LP buy a stake in a laggard public company such as Algonquin Power and Utilities Corp. AQN-T and begin pushing to break up the company and sell off assets, also known as a bust up.
The hedge funds argue there’s more value in the company’s underlying assets – in this case, renewable energy and water distribution businesses – than investors appreciate.
In a past market distinguished by low interest rates, easy credit and buyers with a voracious appetite for all things infrastructure, bust ups proved extremely effective. Companies were routinely selling divisions, or being sold in their entirety, for far more than anyone expected.
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That’s not today’s market. In the past year, rates soared and banks pulled back on the leveraged loans that finance acquisitions. The combination is giving private-equity funds an acute case of indigestion. When deals do take place, valuations are dropping compared with what buyers paid as recently as last fall.
At Algonquin and a number of other public companies – Artis Real Estate Investment Trust AX-UN-T and energy and retail conglomerate Parkland Corp. PKI-T – activists face dog-that-caught-the-car challenges. They’ve bought businesses that, for one reason or another, were valued at a discount to peers, on the thesis that selling divisions would improve the stock price.
That thesis is no longer valid. The hedge funds need a new playbook.
Last week, when New York-based Starboard launched its campaign at Algonquin, the hedge fund published a letter detailing which divisions should be sold, and the price they would fetch.
Two other activists – Ancora Holdings Group LLC and Corvex Management – are also significant investors in Oakville, Ont.-based Algonquin. The company is already in the midst of a strategic review, launched by the board in May, aimed at paying down debt by selling divisions.
This week, analysts took apart Starboard’s number-crunching and found it didn’t add up. A number of investment banks said the hedge fund is overly optimistic on the price the utility’s divisions could fetch and is misreading market sentiment.
For example, in its letter, Starboard estimated Algonquin could vend its power plants, including facilities in Texas, for 12 times their earnings before interest, taxes, depreciation and amortization (EBITDA).
In response, analysts pointed out the flaws in these assets: Algonquin own minority stakes in several of these facilities, they are old plants, and some are coal fuelled, which limits the number of potential buyers because of concerns over carbon emissions. Based on recent transactions in the sector, the analysts estimated Algonquin will get nine to 10 times EBITDA for this business.
“We believe that spinning out or divesting the assets in the current environment may not lead to a sustainable higher Algonquin share price,” said Nelson Ng, at RBC Capital Markets, in a report. CIBC Capital Markets’ Mark Jarvi took the same view, saying in a report: “Algonquin shouldn’t rush to sell all its power assets – it could potentially wait for better market conditions.”
In a high-interest-rate, tight-credit environment, what is the new playbook for hedge funds? It looks a lot like the patient approach taken by institutional investors.
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Algonquin owns a 42-per-cent stake in Atlantica Sustainable Infrastructure PLC, which has a US$2.7-billion (about $3.6-billion) market capitalization. Atlantica’s board put the company up for sale in February. If that process fails to find a buyer, Mr. Ng said Algonquin “should wait for the right opportunity to divest its interest, and collect dividends while waiting.”
Rather than outright sales of its renewable energy assets, which include hydro plants, Mr. Ng. said Algonquin could raise cash from selling minority stakes, pay down debt with this cash and continue to collect fees for running the facilities.
Hedge funds such as Starboard don’t typically earn outsized fees – compared with traditional fund managers – by making long-term commitments to businesses that need to improve operations. Activists, as the name suggests, want quick solutions to corporate problems.
For a past generation, busting up underperforming public companies was every hedge fund’s quick fix. It’s a playbook that’s aging poorly.
Andrew Willis