Atlantic Power (NYSE:AT) is a power-generation and infrastructure company with assets in the US and Canada. They are traded on the NYSE and in Toronto. The company is small with revenues in the US$550m range and has a number of challenges that have decimated its stock price in the last 12 months. The stock pays a monthly dividend and was an income play until a surprise cut of the dividend in Q4 2012. After other issues and uncertainty of the current payout, we believe it has become an asset play. There are two small preferred stock issues, thinly traded, which are a more conservative way to play this situation.
AT is primarily a power generator operating in Canada and the US with a generating capacity of about 3,018 MW. This capacity is spread over 29 projects in 11 states and 2 Canadian provinces. Of these projects, 23 are wholly owned and the rest joint ventures. Most of the production is sold via long-term power purchase agreements (PPAs.)
The company has been selling several assets over the last 2 years, after making a $190m equity investment in a wind project in Oklahoma.
The steep decline in the company's securities this year (both common and preferred) can be explained by a number of issues:
Dividend Risk: Management cut the common dividend significantly, even after assuring shareholders they would be safe. Not good for trust, especially when most shareholders were holding AT for yield. Given skimpy coverage of capex and upcoming debt maturities, even the current payout maybe in jeopardy.
Indebtedness: AT carries a high debt to equity ratio. This has pushed up financial risk and cost of capital. While the company can probably handle 2014 maturities, management admits that there is no solution for 2015 yet.
Expiring PPAs: The company is not a regulated retail utility, earning a predictable margin. Instead, it has PPAs on most, but not all projects. Non-covered assets, and expiring PPAs, some with terms above current market, are a source of uncertainty. Conversely, new or extended PPAs would be positive catalysts.
Lawsuits: Following the surprise dividend cuts, several class action lawsuits were filed against the company and management. This is at best a distraction for management and shareholders, at worst a significant liability.
Lack of Scale: The company's assets could be managed much more efficiently within a larger company, reducing administrative expenses, cost of capital and raising management quality.
Management Quality: Management has shown incompetence in handling the dividend cuts, especially by issuing assurances to the contrary beforehand. Their reluctance in seeking "strategic alternatives" for the company also shows how they resolve significant conflicts of interest with shareholders: in their own favor.
The company is clearly in a crisis situation. We can see six ways of resolving this:
1. Muddle through
Management may succeed in refinancing, renewing PPAs and more or less keeping the status quo, maybe with slow improvements. This would, over time, help both common and preferred.
2. Issue new equity
Dilution for common, better cushion for preferred.
3. Cut dividend
A further cut of the common dividend will likely hurt the common price, while improving the economic situation of the senior preferred.
4. Sell assets
This, in conjunction with deleveraging, will help both common and preferred.
5. Sell company
Properly marketed in a non-distressed market, this will likely be the best outcome for all shareholders. Unfortunately, management's options are mostly under water, they own little equity, and they have shown great motivation in holding onto their jobs by installing a poison pill after shocking shareholders with a dividend cut shortly after giving assurances that they would not do so. The board may decide to do this, maybe forced by activist investors or in conduction with a redesigned incentive structure for management.
A forced reorganization will be the worst case scenario. We can see this coming about only if financial markets tighten up significantly making a refinancing impossible.
Preferred Stock Series
There are two series of preferred stock, both issued in C$ by a subsidiary (acquisition) but guaranteed by AT.
Series 1 (Symbol: AZP.PRA.CA): 2007, 5m shares, 4.85% cumulative redeemable pref, C$25 nominal, payable quarterly, C$1.2125 annually, currently redeemable at $25.75, declining to $25 by 2016
Series 2 (Symbol: AZP.PRB.CA): 2009, 4m shares, 7% cumulative, rate reset pref, C$ 25 nominal; pays $1.75 annually through 12/31/2014. After that, will reset at 5-year Canadian government bond yield plus 4.18% Holders can convert into Series 3 cumulative floating rate preferred shares at each reset date. Series 3 will pay quarterly floating rate dividends at 90-day Canadian government T-bills plus 4.18%
While the series 2 has a much higher indicated dividend yield, this will go away as it resets at the end of 2014. After that, the dividends should be fairly close to each other, although the series 2 has a built-in interest rate protection.
Both issues are traded in Toronto and, due to the small issue size, are fairly illiquid.
Valuing the preferreds, and AT common is not easy. As fixed-income securities, both Series yield well over 10%, and trade at a 50-60% discount to their nominal value, at which they would be redeemed. And a redemption is likely in several plausible scenarios (company sale, significant deleveraging.) While this is attractive, the main question is how safe are dividend and principal.
To evaluate that, we need to value the common which provides the margin of safety for the preferreds.
A simple asset valuation is difficult, as AT has a large number of heterogeneous assets. These have PPAs on them ranging from zero to 20+ years in duration, and may be on terms that are above or below market. Additionally, the company has investment projects that are not yet generating EBITDA, but will be coming on line shortly.
Referring to a very thoughtful article on AT common by Howard Winston which was a semi- finalist at this summer's Ira Sohn conference (and is available on seekingalpha.com), we can apply a multiple on EBITDA (he chose 9, close to the 10 paid by Warren Buffet's MidAmerican Energy for NV Energy this year). Project EBITDA will be around $270m for 2013. With a 9x, this leads to an EV of $2.43 billion. Subtracting $1.6 billion in net debt and $220 million in preferred equity leaves $610 million for the common, or about $5.08 per share.
A simple book value calculation leads to $7.50 per share. Stripping out all goodwill and intangibles leaves only $1.11 per share. This is certainly a very conservative approach.
On the NYSE, the common has traded in December between $3.08 (all-time low) and $3.70, down from a high of 13 in February.
All in all, it appears that there is a comfortable cushion behind the preferred issues.
Additional disclosure: We are long common and both series of preferred.