|Shares Out. (in M):||121||P/E||0||0|
|Market Cap (in $M):||303||P/FCF||0||0|
|Net Debt (in $M):||1,111||EBIT||0||0|
Atlantic Power is an independent power producer with generating capacity of 1500 MW from a fleet of 23 mostly gas fired power plants in the United States and Canada. With a market cap of $300 million and just over 1 billion of debt, Atlantic Power was originally a yieldco sold to Canadian retail investors. It grew quickly through largely debt supported acquisitions and reliably grew its dividend. About three years ago, too much leverage and some troubled projects led to the first in a series of dividend cuts and eventually the management team and indeed, much of the board, was replaced. A well known activist investor filed in the company in early 2015 and successfully pushed to nominate new directors. Hired at the end of 2014, the new CEO, Jim Moore, has embarked on a turnaround of the company that, first, removed the imminent possibility of financial distress and now is focused on creating a better balance sheet and a more sustainable operating model.
Significant progress has been made on reducing debt levels. In aggregate, debt has fallen from $1.851billion at year end 2013 to $1.018B at year end 2015. Most notably and the immediate catalyst for our original investment, last June Jim sold AT’s wind power portfolio for an excellent price and used the proceeds to retire the company’s most expensive high yield paper. More recently in April of this year, the company upsized its Term Loan facility to take out $112 million of debt that matures in March and August of 2017. The next maturity is in 2019 and that is easily managed so investors need no longer worry about a financial crisis at the company. Indeed, the balance sheet strengthening has been such that the company has used available free cash to both buy back its common equity, albeit in small amounts, and to invest capital in growth initiatives.
In addition to improving the balance sheet, management has also pursued an operational turnaround. Overheads have been cut in half from $54 million/year in 2014 to a projected $27 million for this year. Most critically, management is focused on extending the contract lives for its fleet. Roughly 30% of AT’s approximately $200 million in 2016E EBITDA comes from contracts that expire over the next five years. Indeed, the weighted average life of its contracts is some 7.5 years, which is anywhere from three to five years less than many of its peers and certainly one reason for its significant valuation discount. AT trades around 6.5x 2017 EBITDA while its peers trade at an average of 8-10x. Progress on extending contracts, while slow, is starting to occur. Last fall, an important contract was extended for its facility in Illinois and negotiations are well under way to extend a big contract with BC Hydro in British Columbia, with news on that deal likely coming this summer. We think that as more extensions are announced the valuation discount will start to narrow.
We see two key benefits from increased visibility on its future cash flows. Most important, its financial flexibility will improve. Though, as noted, the company solved its imminent financial distress problem by selling assets and upsizing its Term Loan facility, the latter occurred during the recent difficult credit market and imposed onerous constraints on the company. Specifically, the company must dedicate at least 50% of its annual free cash flow to amortizing the Term Loan. This “cash sweep” means the company may have to forgo attractive investment opportunities and leaves little room for error if financial projections are materially missed. With greater visibility from contract extensions the company will be in a position to seek more favorable terms in the credit markets. Greater visibility might also attract analyst coverage which essentially disappeared as the company’s troubles accumulated.
At 8x EBITDA, at the bottom end of where peers trade, the stock is worth about $4.80/share or about 90% upside from current levels. Significant insider buying by both new board members and senior management adds to our confidence that the turnaround is on track for continued progress and that there is substantial upside in the stock. If the company is ever in a position to employ its considerable free cash in larger growth initiatives there may be more upside still. Conversely, if contract extensions fail to occur or are renewed at substantially lower rates then the equity will be impaired, potentially mitigated by the debt reduction that will have occurred in the interim. Said differently, as absolute debt levels continue to decline value should accrue to the equity even with continued uncertainty about the cash flow outlook.
Deleveraging over time.
Renewing power contracts.