Algonquin Power's US$2.6B deal to buy Kentucky Power unlikely to close: analysts

The Ontario-based company could face a $65M break-up fee if the deal falls through

·4 min read
Ontario-based Algonquin Power could face a $65 million break-up fee if its deal to buy Kentucky Power falls through. (GETTY)
Ontario-based Algonquin Power could face a $65 million break-up fee if its deal to buy Kentucky Power falls through. (GETTY)

Algonquin Power & Utilities (AQN.TO)(AQN) is fighting a losing battle to buy Kentucky Power, according to analysts who increasingly see the US$2.6 billion deal's failure as a blessing in disguise for the Oakville, Ont.-based company, and its shareholders.

Algonquin's US$17 billion portfolio of utility and renewable energy assets scattered across Canada and the United States spans hydroelectric, wind, and solar power facilities, as well as water, wastewater treatment, electricity, and natural gas. In 2021, Algonquin announced a deal to enter the Bluegrass State with the purchase of American Electric Power's (AEP) Kentucky operations.

CEO Arun Banskota said at the time that Algonquin will replace Kentucky Power's coal power generation with economical, non-emitting renewables, while snapping up nearly a quarter-million new customers in the region. Dubbed "greening the fleet," he says the strategy was successful in Missouri, where Algonquin invested in wind power to support the early retirement of a coal plant after buying the Empire District Electric Company in 2017 through its U.S. subsidiary, Liberty Utilities.

Citing the risk of consumers being hit with higher rates, the U.S. Federal Energy Regulatory Commission blocked Algonquin's acquisition of Kentucky Power on Dec. 15, 2022. Banskota called the rejection "a surprise" on a January earnings call.

We believe that it is likely that the Kentucky Power transaction will not close by the outside date.Nelson Ng, RBC Capital Markets

Algonquin says a new application was filed on Feb. 14. A 45-day comment period expires at the end of this month. If the deal is not closed by April 26, either party may terminate the transaction under certain conditions. Algonquin could face a $65 million break fee. The company did not respond to a request for comment on Monday.

With the clock ticking, Nelson Ng of RBC Capital Markets is among the analysts casting doubt on the deal.

"The timing is very tight, and we believe that it is likely the Kentucky Power transaction will not close by the outside date," he wrote in a note to clients on Monday. "The market prefers that Algonquin not proceed with the transaction."

A lot has changed since the deal was first announced. In a bid to control rising inflation, the Federal Reserve and the Bank of Canada have rolled out a series of rate hikes, putting pressure on capital-intensive businesses like energy infrastructure companies. At the same time, global interest in renewable energy has climbed in the wake of Russia's invasion of Ukraine, and the passage of major climate spending in the U.S. via the Inflation Reduction Act (IRA).

Algonquin's stock sank last November after Banskota called for rising interest rates and a tough economy to weigh on earnings into 2023.

On Jan. 5, Wells Fargo analyst Neil Kalton said Algonquin was facing a "crisis in confidence," with the stock having lost about 45 per cent of its value in a matter of weeks. Since then, Algonquin has slashed its hefty dividend and announced a plan to sell US$1 billion in assets this year.

Kalton continues to see the Kentucky Power deal gaining FERC approval by April 26 as unlikely, adding he would be surprised if Algonquin and AEP extend the deadline.

"We continue to view not closing [Kentucky Power] as the path of least resistance for the company in terms of balance sheet repair," he wrote in a report on Sunday. "The [Kentucky Power] outcome remains a critical data point, as Algonquin cannot fully spell out the strategy until clarity is achieved."

Scotiabank Global Equity Research analyst Robert Hope says Algonquin shareholders could be in for a volatile month ahead of the April 26 deadline.

"Investor sentiment is that if Kentucky Power were to fall through, Algonquin's balance sheet would be stronger, which would be supportive of a higher valuation," he wrote last week. "If the deal does proceed, management highlighted that its 'greening the fleet' thesis is intact, with the IRA providing long-term tailwinds."

Banskota was tight-lipped about the deal last week when Algonquin reported fourth-quarter and full-year financial results. He says between the utility and renewables sides of the business, the company finds itself in a target-rich environment for acquisitions.

"I don't want to speculate on what happens," he told analysts on a March 17 conference call.

"We have lots of options to deploy capital."

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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