DBRS Confirms Algonquin Power & Utilities Corp. and Subsidiaries Following the Completion of the Empire District Electric Company Acquisition, Removes UR-Dev. Status

DBRS Limited (DBRS) has today confirmed the ratings of Algonquin Power & Utilities Corp. (APUC) and subsidiaries, Liberty Utilities Finance GP1 (LUF) and Algonquin Power Co. (APCo), as follows:

• APUC, Issuer Rating confirmed at BBB (low), Stable trend
• APUC, Preferred Shares rating confirmed at Pfd-3 (low), Stable trend
• LUF, Issuer Rating confirmed at BBB (high), Stable trend
• LUF, Series A, Series C and Series D Senior Notes ratings confirmed at BBB (high), Stable trends
• APCo, Issuer Rating confirmed at BBB (low), Stable trend
• APCo, Senior Unsecured Debentures confirmed at BBB (low), Stable trend

The above rating actions remove all ratings from Under Review with Developing Implications under which they were placed on February 10, 2016. The rating actions follow the announcement that APUC’s indirect subsidiary, Liberty Utilities Co. (LUC), has completed the acquisition of the Empire District Electric Company (Empire) and its subsidiaries (the Acquisition). LUC is a wholly owned subsidiary of APUC and owns a diversified portfolio of regulated assets. LUC is the guarantor of the Senior Notes issued by Liberty Utilities Finance GP1 (LUF). APUC also owns 100% of APCo, which owns and operates a portfolio of non-regulated renewable power generation assets.

The rating actions for APUC and LUF reflect DBRS’s view that the Acquisition will have a positive impact on APUC’s and LUC’s business risk assessment (BRA). The impact on their financial risk assessment (FRA) is modestly negative. However, the overall impact on the ratings of APUC and LUF is neutral. The rating actions for APCo reflect DBRS’s view that the Acquisition has no impact on the BRA or FRA of APCo.

Empire is an approximately 100% regulated electric, gas and water utility (mostly electric), serving approximately 218,000 customers primarily in Missouri and also in Kansas, Oklahoma and Arkansas. Empire engages in the generation (approximately 1,400 megawatt net capacity, 60% natural gas), purchase, transmission, distribution and sale of electricity. The Transaction is all cash and total consideration is approximately $3.2 billion (USD 2.3 billion), including the assumption of approximately $1.3 billion of debt (USD 845 million). All the outstanding debt from the acquired assets is at the regulated utility level. The purchase price represented a 21% premium to the closing price on February 8, 2016. The Acquisition closed on January 1, 2017.

FINANCING
For the Acquisition, APUC issued $383 million in Convertible Debentures in the first installment (March 1, 2016) and $767 million Convertible Debentures in the final installment (payment due February 2, 2017). DBRS treats the Convertible Debentures as equity reflecting the following: (1) holders who do not exercise their conversion right subsequent to the final installment date will receive 0% interest from the final installment date until maturity (March 31, 2026); (2) debentures that are not converted will be redeemable by APUC on any trading day following the final installment date; (3) at maturity, APUC can repay the debentures in cash or in common shares valued at 95% of the weighted average trading price for the 20 consecutive trading days ending five days preceding the maturity date. The remaining portion of the debt is financed by USD 100 million from LUC’s credit facility and USD 650 million debt to be issued by LUF and to be guaranteed by LUC with the same terms and conditions as the existing guarantee provided by LUC on LUF’s existing USD 525 million.

IMPACT ON BRA
Pre-acquisition, APUC’s BRA was supported by its indirectly owned non-regulated power generation assets (Non-regulated Assets) and regulated distribution assets (Regulated Assets). The Non-regulated Assets are owned by APCo and accounted for approximately 46% of APUC’s pre-acquisition consolidated EBITDA. Cash flow generated by Non-regulated Assets is supported by long-term contracts and solid counterparties. The Regulated Assets are indirectly owned by LUC and accounted for approximately 54% of APUC’s pre-acquisition consolidated EBITDA. DBRS is of the view that the BRA of Regulated Assets is more favourable than that of the Non-Regulated Assets, supported by reasonable regulations within their respective jurisdictions and with very minimal exposure to commodity price risk.

Post-acquisition, APUC’s BRA is estimated to improve notably as a result of Regulated Assets accounting for approximately for 70% of APUC’s 2017 EBITDA. DBRS has reviewed the APUC’s business strategy and expects that this Non-regulated and Regulated Asset mix will remain at this level going forward. In addition to the asset mix, Regulated Assets, post-acquisition, are expected to benefit from increases in regulatory diversification, size and scale. Post-acquisition, the rate base of all Regulated Assets will increase by approximately USD 2 billion, to USD 3.75 billion, a little more than double the pre-acquisition rate base. DBRS notes that the Acquisition will also increase LUC’s earning contributions from Missouri, a state in which LUC already operates (Midwest Gas) and that is considered to have a reasonable regulatory environment in line with LUC’s overall portfolio. DBRS notes that the rate base in Missouri accounts for approximately 85% of total rate base of Empire. The Acquisition will also increase LUC’s exposure to electricity distribution earnings to approximately 57% from 24% and will reduce exposure to water utilities to approximately 20% from 30%. In DBRS’s view, electricity distribution operations have lower business risk than water utilities. In addition, the Acquisition has no impact on the BRA of the Non-regulated Assets.

IMPACT ON FRA
From a non-consolidated perspective, the Acquisition will not have material impact on APUC’s non-consolidated metrics reflecting the fact that APUC will not issue any debt to finance the Acquisition.

From a consolidated perspective, the Acquisition is expected to have a modestly negative impact on APUC’s consolidated ratios as a result of new debt issued for the Acquisition (USD 650 million) and the debt assumption from Empire (USD 845 million). Cash flow/debt is expected to decrease to 14.8% in 2017 pro forma (as per DBRS’s estimate) from 15.8% during the last 12 months ending September 30, 2016. Debt/capital is expected to increase to 51.3% (as per DBRS’s estimate) from 43.8% over the same period and EBIT interest coverage is expected to marginally improve to 2.76 times (x) (as per DBRS’s estimate) from 2.45x. DBRS is of the view that the overall impact on APUC’s consolidated metrics is not material as the pro forma consolidated metrics (post-acquisition) would still remain supportive of the current rating.

For LUC, the Acquisition modestly weakened LUC’s overall consolidated ratios (including guaranteed debt), with the 2017 pro forma credit metrics as follows: the cash flow/debt increasing to 14.4% (as per DBRS’s estimate) from 13.5% (last 12 months ending September 30, 2016), EBIT-to-interest coverage lowering to 3.03 times (x) (as per DBRS’s estimate) from 4.28x and the debt/capital increasing to 55.9% (as per DBRS’s estimate) from 51.2%. DBRS is of the view that the impact on LUC’s consolidated metrics is not material as the pro forma consolidated metrics (post-acquisition) would still remain in the “A” range.

In addition, with the assumption of the debt at Empire’s regulated utilities that will be indirectly owned by LUC, LUC’s new debt issue will be subject to structural subordination. However, this issue is partially mitigated with the fact that over 50% of EBITDA and cash flow is generated from regulated assets that have very modest debt.

In terms of the financing strategy, debt at Empire will be gradually reduced by debt issued by LUF, further mitigating the impact of structural subordination.

The Acquisition has no impact on the FRA of APCo.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (October 2016), Rating Companies in the Independent Power Producer Industry (June 2016), DBRS Criteria: Rating Holding Companies and Their Subsidiaries (December 2016), DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2016) and DBRS Criteria: Guarantees and Other Forms of Support (February 2016), which can be found on our website under Methodologies.