Water Island Capital, LLC (“Water Island”), the manager of investment funds beneficially owning 4,034,572 or 4.10% of Pattern Energy Group, Inc. (NASDAQ: PEGI) (“Pattern Energy”) common stock, issued an open letter today in response to the February 19, 2020, press release issued by Pattern Energy’s Board of Directors, which made a series of false and misleading claims about the merger with the Canadian Pension Plan Investment Board (the “CPPIB Merger”) and the process undertaken by the Pattern Energy Board in connection with the transaction.
The full text of the letter follows below:
February 24, 2020
Dear Fellow Pattern Energy Group Shareholders,
On February 19, 2020, Pattern Energy Group’s (“Pattern Energy” or the “Company”) Board of Directors (the “Board”) issued a press release with a series of misleading claims that we believe needs to be addressed.
Misleading Claim 1: The Canadian Pension Plan Investment Board transaction monetizes Pattern Energy’s growth prospects, including realizing the value of Pattern Development 2.0, at an attractive value.
In our prior letter1 to Pattern Energy shareholders, we laid out our belief that the merger consideration offered by Canadian Pension Plan Investment Board (“CPPIB”) is woefully inadequate. We stand by that analysis. Following our outreach to Pattern Energy shareholders, we have heard from many fellow stakeholders who are supportive of our position and in agreement with our view that this transaction fails to provide shareholders with a fair value for their shares. Several credible Wall Street analysts concur:
RBC (February 19, 2020) – “We estimate that since August 9, 2019, the last trading day prior to unconfirmed media reports regarding a potential transaction, PEGI’s total return lagged the group by roughly ~16%. If PEGI’s total return performed in-line with the peer group over this timeframe, it would imply a current share price of ~$32/share.”
National Bank Financial (February 19, 2020) – “We believe that the $26.75/sh offer represents a ~7.25% discount rate on future life cycle cash flows (from our model) for PEGI, which is 0.75% higher than the 6.5% discount rate we use for its closest peers. If we were to use the same discount rate on PEGI that we use on the peer group today, we could see the addition of ~$2.50/sh to PEGI’s equity value.”
Morgan Stanley (February 19, 2020) – “Many renewable sale announcements do not provide the buyer’s FCF/equity yield, though we would note that recent sales to utility buyers likely were at equity yields only somewhat above their earnings yield (the inverse of the relatively high P/E multiple for these buyers, which is in the 5-6% level [emphasis added]).” (See corresponding Table 1 as reference.)
Table 1: Morgan Stanley “PEGI’s Hypothetical Strategic Optionality Valuation Scenarios”
CAFD Yield Sensitivities
Asset Purchaser Required CAFD Yield
2020e CAFD, Adding Back Parent Interest Expense
Value of Equity + Parent Debt
PEGI Equity Value, Net of Holdco Debt
PEGI Equity Value/Share
Upside to Current Share Price
Holdco Debt/2020e CAFD (x)
Note: Valuation of 5.0%-6.0% range bolded based on Morgan Stanley’s view of strategic value interest
Source: Morgan Stanley Research – “YieldCos – Updating Our Strategic Valuation Given PEGI, AY Updates” (February 19, 2020)
Potential Undisclosed Conflicts
One assertion made by the Board with which we do agree, however, is how successful they were in realizing the value of Pattern Development 2.0 (“Pattern Development”). The valuation realized is so outrageously high – potentially north of a 50% gross return2 from Pattern Development’s most recently stated book value – that we can’t help but wonder why the Board has refused to disclose the valuation attributed to Pattern Development in the recently filed definitive proxy statement (“proxy”).3 Given the woefully inadequate price public shareholders of Pattern Energy are receiving in the CPPIB Merger, perhaps the Board prefers not to highlight the significant value Pattern Energy’s own management stands to reap based on their economic interest in Pattern Development. If this is untrue, we call on the Board to disclose the value being attributed to Pattern Development in the Contribution Agreement between CPPIB and Riverstone affiliates, and how much management will stand to gain once the CPPIB Merger and Contribution Agreement close.
Misleading Claim 2: If it were to proceed standalone, the Company would need to raise substantial equity in the public market to execute on its growth plan. The Company has historically traded at a material discount to peers, which has made raising accretive equity challenging.
We find it interesting and convenient that once shareholders questioned what is effectively a low-ball, management-led buyout of Pattern Energy, the Board proclaims Pattern Energy’s status as a standalone entity to be precarious and in need of additional funding lest shareholders accept CPPIB’s offer. This posturing is in stark contrast to management commentary as recent as the Company’s 2Q’19 earnings, on which CEO Mike Garland said, “Last week, we also raised $250 million to fund growth with a three-year bank loan priced to take advantage of the recent softening in the interest rate environment. This facility offered us a great way to enhance liquidity at a low price ahead of future acquisitions [emphasis added] … the debt transaction enhances our liquidity substantially and is a supplement to what we expect to be a series of capital raises to fund our growth which we expect to achieve without raising common equity. [emphasis added]”4
In fact, on Pattern Energy’s Q1’19 earnings call, CFO Esben Pedersen remarked on the vast multitude of options available for Pattern Energy to raise capital to fund growth before ever touching common equity:
“We believe we have flexibility to access cost effective capital to fund growth without requiring us to issue new common equity. The new capital could take a variety of forms including monetization of the portion of portfolio Japan. As Mike discussed, recycling additional assets, given the success we achieved in the sale of K2 and El Arrayan, the consideration of hybrid equity options, making use of available capacity at the project level, to add or consolidate debt at certain projects including refinancing of our Canadian portfolio. And making use of the available capacity at the corporate level, either by expanding our convertible debt, issuing additional unsecured notes, or separately expanding our revolver facility. We maintain a conservative capital structure, which provides us an opportunity to access additional capital, while maintaining our stated financial policy. In short, we believe there are multiple options available to us that demonstrate the flexibility of our balance sheet prior to returning to the Capital Markets. [emphasis added]”5
On what basis can the Board claim that the Company needs to raise substantial equity in the public markets to fund its growth plans when management’s recent commentary suggests otherwise? These disingenuous claims conflict with recent comments from management. Shareholders should question the Board’s motives behind this change in messaging regarding the company’s future financing prospects. The Board must provide full disclosure to shareholders on what financial benefits, if any, will accrue to members of management, the Board, or senior executives as a result of these related company transactions. Is the Board fulfilling their fiduciary duty to shareholders or simply looking the other way while certain members of management and the Board enrich themselves?
Misleading Claim 3: In light of historic volatility in the sector, a short-term spike in prices should not be viewed as a reliable basis for predicting long-term value.
For a Board that seemingly rejected an all-stock merger with Company A – reportedly6 TerraForm Power (NASDAQ: TERP) – we are skeptical of their ability to call short-term spikes in prices or predict long-term value. If Company A is indeed TERP, its implied offer on October 28, 2019, would have been valued at $32.94/share7 compared to the $26.75/share cash offer that was accepted with CPPIB. Following the seismic shift in the ESG (Environmental, Social, and Governance) sector, TERP’s old proposal is now worth $42.30/share.8 In hindsight, the management team of Pattern Energy has short-changed investors to the tune of $1.5bln (98,200,000 shares outstanding times $15.55), or $15.55 per share ($42.30 minus $26.75). Instead of lecturing their own shareholders about whether the sector is going through a “short-term spike in prices,” perhaps the Board should re-engage with Company A and allow shareholders to make that determination themselves.
Misleading Claim 4: The Board also believes “unique events” at certain other renewable energy companies has elevated their stock prices.
While certain peers in Evercore’s fairness opinion are now undergoing unique events, excluding them from the share price performance table yields similar results as our original analysis (see Table 2).
Table 2: Share Price Performance from August 9, 2019 through February 21, 2020
Share Price (Local Currency)
Aug 9, 2019
Feb 21, 2020
NextEra Energy Partners LP (NYSE: NEP)
Northland Power Inc. (TSX: NPI CN)
TransAlta Renewables (TSX: RNW CN)
International YieldCos (Reference Only)a
Atlantica Yield (NASDAQ: AY)
Average of Evercore Peers (ex-peers undergoing unique
Pattern Energy Group, Inc. (NASDAQ: PEGI)
(a) Peer set based on Evercore Fairness Opinion - Selected Public Company Trading Analysis
(b) CPPIB Offer
Executive Compensation Total Shareholder Return Peer Group
We would be remiss not to mention that Evercore’s comparable peer set excluded peers that Pattern Energy’s management determined fair in measuring the Company’s relative Total Shareholder Return (“TSR”) performance.9 The use of TSR is a performance metric in executive long-term incentive plans. Many compensation committees believe this is a direct way to align executive pay and performance. Relative share performance against a group of “peers” – similarly situated companies in the marketplace – is the primary measure of management success. In the context of Pattern Energy’s TSR peer group set, they included Algonquin Power & Utilities (TSX: AQN CN), Boralex (TSX: BLX CN), and Hannon Armstrong Sustainable Capital (NYSE: HASI). Including these peers into Evercore’s peer set and excluding companies undergoing unique events would result in an average share price performance of 35.7% from August 9, 2019 through February 21, 2020.
Table 3: Peer Group to determine Pattern Energy’s relative TSR Performance
Share Price (Local Currency)
August 9, 2019
February 21, 2020
Northland Power Inc (TSX: NPI CN)
Algonquin Power & Utilities Corp (TSX: AQN CN)
Nextera Energy Partners LP (NYSE: NEP)
Boralex Inc (TSX: BLX CN)
Hannon Armstrong Sustainable Infrastructure Capital Inc. (NYSE: HASI)
TransAlta Renewables Inc (TSX: RNW CN)
Innergex Renewable Energy Inc. (TSX: INE CN)
Brookfield Renewable Partners LP (TSX: BEP-U CN)
Average of Peer Group to Determine PEGI’s TSR Performance
Average of Peer Group to Determine PEGI’s TSR Performance (ex BEP-U CN & INE CN)
Misleading Claim 5: The Canada Pension Plan Investment Board transaction was the result of a robust process.
In light of the Board’s failure to restrain a conflicted management team from leveraging a previously undisclosed Pattern Development “consent right” in order to block any merger that did not enrich their own self-interests, the Board’s claim of a robust sales process couldn’t be further from the truth.
When Pattern Energy went public in 2014, Pattern Energy was party to a Shareholder Agreement with Pattern Development’s predecessor, PEG LP, which restricted any mergers with Pattern Energy so long as PEG LP owned more than 33 1/3rd of Pattern Energy shares:
“We will enter into a shareholder approval rights agreement, or the “Shareholder Agreement,” with PEG LP concurrently with the consummation of this offering. Pursuant to the Shareholder Agreement, for so long as PEG LP beneficially owns at least 33 1/3% of our shares, PEG LP’s consent will be necessary for us to take certain material corporate actions, including: (i) our consolidation with or merger into an unaffiliated entity; (ii) certain acquisitions of stock or assets of a third-party; (iii) our adoption of a plan of liquidation, dissolution or winding up; (iv) certain dispositions of our or our subsidiaries’ assets; (v) the incurrence of indebtedness in excess of a specified amount, (vi) a change in the size of our board of directors (subject to certain exceptions) and (vii) issuing equity securities with preferential rights to our Class A shares.”10
Despite PEG LP reducing its ownership interest in Pattern Energy below 33 1/3rd in 2014, thereby rendering the Shareholder Agreement expired, Pattern Energy’s 2014 Form 10-K continued to highlight as a risk PEG LP’s ability, but not its right, to influence Pattern Energy’s ability to merge with other parties:
“In addition, even though a recent sale of shares by Pattern Development resulted in a decrease of its ownership interest in our company from 35% to 25% such that it is no longer entitled to certain contractual approval rights pursuant to the Shareholder Approval Rights Agreement, Pattern Development or its affiliates through its remaining shareholdings still may have the ability to exercise substantial influence over our company, including with respect to decisions relating to our capital structure, issuing additional Class A shares or other equity securities, paying dividends on our Class A shares, incurring additional debt, making acquisitions, properties or other assets, merging with other companies and undertaking other extraordinary transactions.”11
However, any such language was stripped from the Company’s 2018 Form 10-K filing. Thus, we find it surprising that seemingly out of nowhere the Board is now claiming in the merger proxy statement that Pattern Development retains certain consent rights allowing it to limit Pattern Energy’s “ability to merge with, or to transfer its interest in Pattern Development to, any third party without Pattern Development’s consent.”12
We believe these consent rights refer to Section 12.01 of the Second Amended and Restated Agreement of Limited Partnership of Pattern Energy Group Holdings 2 LP13 that restricted the transfer of Pattern Energy’s 29% ownership of Pattern Development without the Pattern Development Board’s approval – one that remains controlled by three Riverstone designees and two Pattern Energy designees.
By leveraging this “consent right” – one that the Board previously viewed as immaterial enough to remove from disclosing as a risk factor in Pattern Energy’s most recent Form 10-K – the Board allowed a conflicted management team to collude with Riverstone and use Pattern Development as a de facto “poison pill” for any sale of Pattern Energy unless it served their own best interests.
If Pattern Development did not receive the terms that they asked for, no interested party would be allowed to acquire Pattern Energy. All the parties that showed interest, including those identified during the go-shop period, likely realized that the only way to purchase Pattern Energy would be to include a handsome price for Pattern Development as well – a situation that likely siphoned value from Pattern Energy.
This classic “rob Peter to pay Paul” scenario was clearly highlighted in the definitive proxy background on July 23, 2019, when Party A was willing to pay a 20% premium for Pattern Energy, but only a 15% premium if it had to also purchase Pattern Development:
“On July 23, 2019, Pattern received a revised indicative proposal from Party A, offering to combine Company A and Pattern in an all-stock transaction at an exchange ratio to reflect an implied 15.0% premium to the trading price of Company Common Stock. Party A’s proposal contemplated that the combined entity would purchase Pattern Development in a transaction financed by the sale to Party A of shares in the combined company. Party A’s proposal also indicated that it would be willing to acquire Pattern without also acquiring Pattern Development at an exchange ratio to reflect an implied 20.0% premium to the trading price of Company Common Stock.”14
In addition, given Public Sector Pension Investment Board (“PSP”) will also reap its own reward through its ownership interest in Pattern Development, we find it unconscionable that the Board agreed not to exclude PSP’s 9.5% Pattern Energy share ownership in the upcoming majority-of-the-minority vote.
We also find it highly improper that the Board agreed to place $260 million in convertible perpetual preferred stock to CBRE Caledon, an investment led by CBRE Caledon’s Jeff DeBlock who most recently came from CPPIB.15 This preferred stock, convertible to almost 10% of Pattern Energy stock, will be voting with common stock as a single class.
When added together, does the Board really think shareholders are naïve enough to believe the CPPIB Merger is the result of a robust process or that the additional go-shop had any shot at being successful?
Water Island believes the CPPIB Merger is fraught with serious conflicts and that the proxy contains myriad false disclosures which have deprived shareholders of the ability to make an informed vote on the transaction. These disclosure issues can be summarized as follows:
Failure to disclose the purchase price of Pattern Development or the price for Pattern Development in any offers of interest for both Pattern Energy and Pattern Development.
Without knowing the valuation attributable to Pattern Development, it is impossible for Pattern Energy shareholders to understand how much value they are forgoing in order to subsidize a payout to the owners of Pattern Development – i.e., management, Riverstone, and PSP. Even in the Board’s response to our original letter to shareholders, they remain steadfast in hiding the purchase price of Pattern Development, only referencing the acquisition price as “an attractive value.”
Failure to disclose the impact of Pattern Development’s consent right on the auction process for Pattern Energy.
We believe the Board has exhibited a clear pattern of failure. Time and again they have failed to understand and deal with important terms in the principal agreements binding the company, failing over and over again to disclose the material terms of those agreements, including a supposed “consent right” tying the sale of Pattern Energy with a sale of Pattern Development. Pattern Energy purportedly believed that it could not merge with, or transfer its interest in Pattern Development to, any third party without Pattern Development’s consent. It is imperative to understand whether any potential bidder was dissuaded from engaging based on Pattern Development’s consent right. Moreover, Pattern Energy shareholders are entitled to know whether Pattern Development blocked higher bids for Pattern Energy pursuant to the consent agreement, thereby lowering the merger consideration to be received by Pattern Energy shareholders.
Failure to disclose that Public Sector Pension Investment, a 9.5% shareholder in Pattern Energy, should be considered a conflicted party and should not be able to participate in the majority-of-the-minority vote.
On June 19, 2017, PSP acquired their entire equity stake from Riverstone. In addition, PSP agreed to co-invest $500 million in projects acquired by Pattern Energy under the Company’s Right of First Offer with Pattern Development, including investments in the Meikle, Mont Sainte-Marguerite, and Panhandle 2 projects.16 In addition, it was disclosed that PSP would gain an indirect ownership interest in Pattern Development. Given this conflict, the Board should disclose PSP’s economic interest in Pattern Development and PSP should be considered a conflicted party who is excluded from the majority-of-the-minority vote.
Failure to disclose Pattern Energy’s management’s conflicts of interest.
The proposed CPPIB merger is a conflicted transaction that benefits a private company and the management of that private company (many of whom are jointly employed at Pattern Energy) at the expense of Pattern Energy public shareholders. It is imperative to understand on what grounds, if any, the independent directors concluded that the proposed CPPIB Merger, a transaction that allows management and Riverstone to capture a substantial sum of money, is in the best interests of Pattern Energy shareholders. Additionally, the proxy fails to detail the negotiations by Pattern Energy’s management to retain their employment at Pattern Energy and Pattern Development.
Failure to disclose vital valuation metrics.
As explained in our prior letter and above, the proxy, which was issued on February 4, 2020, fails to account for recent market developments. Additionally, the proxy omits half of the projects relied upon by Pattern Energy’s financial advisor, Evercore, and key inputs into Evercore’s financial analysis.
Water Island Capital believes there are compelling arguments that the current transaction with CPPIB and subsequent Contribution Agreement with Riverstone are fraught with serious conflicts and disclosure issues.
We continue to believe the CPPIB Merger, in its current form, is not in the best interests of Pattern Energy minority shareholders. Water Island is considering all options, including available litigation remedies, to respond to the disclosure failures noted above and other process failures by the Board in connection with the transaction.
We urge you to preserve your ability to receive full and fair value for your investment in Pattern Energy by voting AGAINST the CPPIB Merger at the upcoming Special Meeting. Send a message to the boards of Pattern Energy and CPPIB that you believe the merger consideration offered by CPPIB to be woefully inadequate.
Roger P. Foltynowicz – Portfolio Manager, Water Island Capital, LLC
Edward T. Chen – Portfolio Manager, Water Island Capital, LLC
Certain statements contained in this letter, and the documents referred to in this letter, are “forward-looking statements” and are prospective. These statements may be identified by their use of forward-looking terminology such as the words “expects”, “projects”, “believes”, “anticipates”, “intends” or other similar words. Forward-looking statements are not based on historical facts, but rather on current expectations and projections about future events, and are therefore subject to risks and uncertainties which could cause actual results to differ materially from the future results expressed or implied by the forward-looking statements. These statements are subject to inherent risks and uncertainties surrounding future expectations. Important factors that could cause actual results to differ materially from the expectations set forth in this letter include, among other things, the factors identified under the section entitled “Risk Factors” of Pattern Energy’s special meeting proxy statement and other risk factors contained in Pattern Energy’s Annual Report on Form 10-K for the year ended December 31, 2018. Such forward-looking statements should therefore be construed in light of such factors, and Water Island Capital is under no obligation and expressly disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
About Water Island Capital, LLC
Water Island Capital LLC is a privately-owned asset management firm focused solely on event-driven investment strategies with approximately $2.5 billion under management as of December 31, 2019.
2 $1 billion Pattern Development valuation versus estimated carrying value of $657 million ($183 million from Pattern Energy and $474 million for Riverstone) based on 35% / 65% ownership split between Riverstone and CPPIB; $2.05 billion equity contribution from CPPIB; $550 million equity contribution from Riverstone; CPPIB contribution of 29% stake in Pattern Development; Riverstone contribution of 70% stake in Pattern Development. Assumptions based on January 22, 2020 WSJ article: https://www.wsj.com/articles/riverstone-seeks-a-replay-through-pattern-energy-deal-11579690801
4 2Q’19 Pattern Energy earnings transcript, August 6, 2019 https://seekingalpha.com/article/4282201-pattern-energy-groups-pegi-ceo-mike-garland-on-q2-2019-results-earnings-call-transcript
5 1Q’19 Pattern Energy earnings transcript, May 10, 2019 https://seekingalpha.com/article/4262713-pattern-energy-group-inc-pegi-ceo-mike-garland-on-q1-2019-results-earnings-call-transcript [subscription required]
6 RBC Pattern Energy research note titled “Activist shareholder looking for more value” dated February 19, 2020; https://www.bloomberg.com/news/articles/2019-08-12/pattern-energy-is-said-to-draw-takeover-interest-from-suitors
7 Based on 2.00x exchange ratio and TerraForm Power price of $16.47/share
8 Based on 2.00x exchange ratio and TerraForm Power price of $21.15/share
12 Definitive merger proxy statement filed February 4, 2020, page 36 https://www.sec.gov/Archives/edgar/data/1561660/000119312520024256/d816812ddefm14a.htm
14 Definitive merger proxy statement filed February 4, 2020, pages 43-44 https://www.sec.gov/Archives/edgar/data/1561660/000119312520024256/d816812ddefm14a.htm