Growing the Yieldco Market for Renewable Generation
The most dramatic recent development in renewable finance has been the introduction and growth of YieldCos.
These publicly underwritten investment vehicles aggregate portfolios of electric generation assets with long-term contracted revenues, and pass through to investors a low-risk stream of earnings. Most YieldCo assets have been wind- and solar-powered generators, but other renewables and fossil plants have been included as well.
The growth of YieldCos have been 2014’s most important development in renewable energy finance. Their acceptance by issuers and investors reflects both the importance of access to attractively priced public capital markets and the increasing difficulty of achieving competitively priced financing based on existing renewable energy tax incentives.
Tax Oriented Alternatives
Ironically, in recent years renewable energy’s greatest hope for accessing the equity capital markets has been Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs), which both benefit from corporate level tax exemptions. This year, Windstream Holdings received IRS clearance to reclassify copper and fiber-optic lines as real estate, to be spun off into a REIT, providing hope for additional REIT rule liberalization.
In the past year the YieldCo structure has not only gotten traction, but has seen aftermarket prices bid well above their IPO offering levels.
While REITs can now own rooftop solar assets on buildings and land underlying solar farms, no real progress has been made on ownership of “pure play”contracted generation assets, and MLP legislation is not moving forward.
The YieldCo, on the other hand, works under current law and regulation. Despite its profits being taxable at both the corporate and shareholder levels, it is the only game in town allowing individual public market investors equity ownership in renewable generation assets with long-term contracted revenues. In the past year the YieldCo structure has not only gotten traction, but has seen aftermarket prices bid well above their IPO offering levels.
Access to the capital markets has been the missing link for many power project developers, who have had to rely on a combination of common and tax equity, and project finance debt. Although the debt capital markets have been successfully tapped with residential solar securitizations, these structures have not been applied to commercial/utility scale projects, nor can they offer developers 100% takeouts. The equity/tax equity/debt structures available to developers have been expensive, and high financing costs have been a significant barrier to achieving grid parity for renewable generation on a levelized cost of energy basis.
Since the expiry of the 1603 cash grant in lieu of ITC, considerable effort has been expended in structuring financings to utilize the investment and production tax credits. However, given the limited investor pool, and resulting high yields on tax equity, transactions designed to monetize tax credits have significantly haircut the economic benefits actually realized by developers, and increased their financing costs.
When the ITC is stepped down from 30% to 10% on January 1, 2017 (and with the future of PTC still uncertain), the efficient utilization of tax credits will be a smaller driver of overall financing cost than is currently the case in the renewables sector. As such, the focus of renewable energy financing may shift from structured finance products such as tax equity towards accessing attractively priced capital markets alternatives, such as YieldCos.
The good news, as noted above, is that there has been strong investor demand for YieldCos, with issues such as NRG Yield bid up as high as 87% from its IPO price, and investors accepting current yields below 3% (presumably in anticipation of future growth in assets and dividends). Other issues, including TransAlta Renewable, Pattern Energy Group, Abengoa Yield and NextEra Energy Partners have also performed well.
Some observers believe current favorable conditions won’t last, and cite two primary reasons. The first is the low general level of interest rates, and scarcity of competing investments, which they believe to be temporary. The second is the inability of YieldCos to continue to grow by the acquisition of contracted generation assets at attractive prices, as those asset values are bid up to uneconomic levels.
[A] dollar of cash flow in the public YieldCo market commands a much higher price multiple than the same dollar of cash flow in a private market acquisition, so the opportunity to trade a project for YieldCo shares (prior to an IPO), could result in a more profitable exit than a private sale.
Even assuming investment grade bond yields, for example, increase from their historically low current rates, YieldCos don’t need to compete with them directly. There is room for the cost of YieldCo financing to increase, and offer investors a yield premium over investment alternatives perceived as less risky, as long as YieldCo financing is cheaper than other market alternatives available to renewables developers. With regard to competing YieldCos bidding up asset prices to uneconomic levels, the same case could be made for REITs and office buildings, or MLPs and gas pipelines, yet those markets are large and well established. While all markets experience cycles, the existence of competition alone does not make them unsustainable.
Most of the existing YieldCos have been launched by large corporate developers. They have taken advantage of the opportunity to inexpensively refinance balance sheet assets, by spinning them off into public vehicles in which they retain a significant ownership position or outright voting control.
Growing Opportunities for Independent Developers
Going forward, YieldCos will hopefully offer additional opportunities for independent developers as well. Many developers cannot afford to build their contracted projects, while YieldCos are in the business of acquiring completed projects in revenue service. However, knowledgeable project finance investors can bridge this gap. For projects with committed power purchase agreements, performance and completion guarantees, interconnections, required permits, etc., and forward purchase commitments from YieldCos, opportunistic investors could provide construction financing, or acquire development projects outright, for completion and resale. YieldCo investment could thereby facilitate incremental renewable generation, as opposed to merely transferring existing facilities from one balance sheet to another.
There are two significant valuation issues to be considered in assembling a YieldCo portfolio. At present, a dollar of cash flow in the public YieldCo market commands a much higher price multiple than the same dollar of cash flow in a private market acquisition, so the opportunity to trade a project for YieldCo shares (prior to an IPO), could result in a more profitable exit than a private sale. Aside from the public vs private market valuation issue, there is also the question of relative valuations of assets in the same YieldCo portfolio. If portfolio assets have been financed with different capital structures, or are located in different tax jurisdictions, their relative values will depend not on top line revenues, but on their relative net earnings. Each project’s net contributions to the YieldCo, will have to be calculated after project level debt service, lease payments or other encumbrances, and individual tax considerations are taken into account, and these issues may be extremely complex in diverse portfolios.
About Rushton Atlantic
Rushton Atlantic, LLC is a New York and Chicago based valuation consulting practice focusing on renewable and conventional energy, infrastructure, manufacturing and transportation. The company is a member of Global Asset Valuation Advisory Network, an international consortium of valuation consultancies. Rushton Atlantic’s services support financing, investment, financial reporting, tax and insurance.
About Ken Kramer
Ken Kramer is a founding partner of Rushton Atlantic. He served as a subcommittee chairman on the Renewable Energy & Energy Efficiency Advisory Committee to the US Secretary of Commerce.