DBRS Maintains Capital Power Income L.P.’s BBB (high) and Pfd-3 Ratings Under Review with Negative Implications

DBRS has maintained the Under Review with Negative Implications status on the BBB (high) Senior Unsecured Debt & Medium-Term Notes rating of Capital Power Income L.P. (the Partnership or CPILP) and the Pfd-3 Cumulative Preferred Shares rating of CPI Preferred Equity Ltd., where they were placed on October 5, 2010.

The rating action follows the joint announcement by Atlantic Power Corporation (Atlantic Power; not rated by DBRS) and CPILP that that they have entered into an arrangement agreement (the Agreement) pursuant to which Atlantic Power intends to acquire, directly and indirectly, all of the outstanding limited partnership units of CPILP for $19.40 per limited partnership unit (the Transaction). APC will pay the purchase price of approximately $1.1 billion using a combination of cash and APC shares, with the cash component capped at $507 million. APC has stated that while it has obtained committed debt financing sufficient to pay the cash portion of the acquisition, it intends on raising approximately $423 million of debt and $200 million in equity to fund the cash component, as well as to refinance certain of CPILP’s bank facilities. The Transaction is a result of the strategic review process undertaken by the Partnership, which was publicly announced on October 5, 2010. The agreed-upon price represents a 4% premium to the CPILP closing price on June 17, 2011.

The strategic review process was undertaken by a special committee of independent directors of CPI Income Services Ltd., the general partner of CPILP, in co-operation with Capital Power Corporation (CPC; rated Pfd-3 (low), with a Stable trend) and evaluated a broad range of alternatives to maximize unitholder value. As part of the Agreement, CPILP will sell its Roxboro and Southport facilities, located in North Carolina, to CPC subsidiary Capital Power L.P. (CPLP; rated BBB, with a Stable trend) for a purchase price (through a reduction in outstanding CPILP units) valuing the facilities at approximately $121 million. DBRS notes that details on the negotiated final power purchase agreements (PPAs) with Progress Energy for these facilities are still pending.

APC is an independent power producer, with all of its assets located in the United States. APC owns varying ownership interests in twelve operational generation projects and a 500kv power transmission line in California. APC’s 12 operational generating facilities represent over 1,900 MW gross capacity; approximately 871 MW net capacity is heavily weighted towards natural gas fired generation (77% of total capacity), with some geographic diversity (approximately 50% of capacity is located in Florida). While almost all capacity operates under off-take contracts, and some facilities feature longer-term tenors, just over 40% of capacity is operating under contracts that expire through 2013. A significant number of its off-take contracts also have matching fuel supply arrangements.

On a book basis, APC is more modest in size than CPILP, with total assets as of March 31, 2011, of US$1.0 billion compared with CPILP’s $1.5 billion. Market equity capitalization (as of June 17, 2011) for the two entities was approximately the same, at just over $1 billion. Whereas CPILP’s capital structure features primarily senior unsecured debt, APC’s debt structure features approximately US$241 million of various project-level non-recourse debts (over half of which is associated with the California transmission asset), and US$210 million of convertible debentures (approximately US$50 million of which are secured, the remainder subordinated unsecured). Additionally, a number of the equity-accounted-for projects also carry non-recourse project debts.

An initial assessment of the impact of the Transaction on APC’s financial profile based on publicly available information estimates that the combined entity’s credit metrics on a pro forma basis (for the 12 months ending March 31, 2011) would be approximately as follows: EBITDA-to-total interest of 3.0 times (x), cash flow-to-total debt of 12%, total debt-to-capital of approximately 50%, and total debt-to-EBITDA of just over 5.0x (note that APC’s EBITDA figures are adjusted to include project distributions). These compare with CPILP’s recent credit metrics of: EBITDA-to-interest of 3.8x, cash flow-to-total adjusted debt of 14%, total Adjusted debt-to-capital of 57% and adjusted debt-to EBITDA of 4.2x. While APC’s pro forma combined metrics appear to be weaker than those of CPILP, the resolution of the current ratings will follow a full assessment of the combined APC/CPILP business risk profile (including asset profile, corporate structure (i.e., depending on whether CPILP will remain a separate subsidiary of, or be amalgamated with, APC), off-take contracts and fuel supply exposure/mitigants, counterparty risk, growth plans, etc.), and the combined financial risk profile (debt structure, subordination implications, dividend policy, liquidity arrangements, forward-looking credit metrics, income tax profile, etc.). DBRS would expect APC to provide a number of details in a future management circular.
The Transaction is subject to customary closing conditions, including an APC shareholder vote and CPILP unitholder vote.

When DBRS placed CPLIP on Under Review with Negative Implications in October 2010, we noted that any potential transaction, when announced, could be positive, negative or neutral for the Partnership’s credit rating. DBRS believes that closing the Transaction would likely result in a downgrade of the ratings within the investment grade category.

In addition, the stability rating of CPILP has been discontinued at the request of the issuer.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on our website under Methodologies.