Yieldcos reprice renewable equity
Demand for the cashflows generated by renewable energy assets is accelerating the evolution of the yieldco sector on a global basis. Despite the fact that more than 900 funds own at least one yieldco, according to Lipper data, some market hopefuls have aborted attempts to jump on board. Joti Mangat reports.
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With the 15 yieldcos now publicly traded offering a relatively diverse selection of renewable assets, geographical exposure and dividend yields, rising awareness among both institutional and retail investors is supporting a bulging pipeline for 2015, according to renewable energy participants in North America.
“This asset class has become much better understood by investors over the past 12 months and we are seeing increased receptiveness translate into a packed IPO pipeline for next year,” says Andy Redinger, managing director and group head with KeyBanc’s utilities, power and renewables lending group in Cleveland, Ohio. Market sources concur that there are at least six and as many as 10 new yieldcos preparing to go public in 2015.
“Yieldcos and their underlying assets have similar characteristics to assets that are typically found in the US$400bn REIT sector but with some very positive attributes,” says Redinger. “Yieldcos house assets that are contracted typically for 20 years with large non-cyclical investment grade entities vs REITS that house assets generally contracted for less than 10 years with a mix of non-investment grade entities that may be cyclical in nature.”
After most of the yieldcos launched in 2013 focused on wind generation, including Transalta Renewable, Pattern Energy Group and NRG Yield, the three new yieldco IPOs in 2014 – Abengoa Yield, Nextera Energy Partners and SunEdison’s Terraform Power – have opened the market to utility-scale solar.
For example, Terraform came to market in July with a 100% solar 808MW project portfolio comprising 23 different projects across the US, UK, Canada and Chile. Utility-scale projects comprised 87% of the initial portfolio, with California accounting for 43% of the total capacity, according to the Moody’s presale report.
“The emergence of the yieldco vehicle has provided the renewable sector with access to a new investor class offering low-cost equity in return for certainty of cashflow. This has enabled more projects to reach NTP that otherwise would have been cancelled due to low returns,” Redinger notes.
Given the general popularity of yieldco related capital markets transactions over the past year, the dividend yields that investors were initially so excited about are now being eroded, with NRG leading the pack with a dividend yield of 3.21% versus its IPO yield of 5.45%. The stock has returned approximately 27% since its inception.
Furthermore, while owning renewable energy assets presents a list of technology and market risks that are relatively new among traditional equity investors, perhaps the biggest risk over the past 12 months has been paying too much. As both institutional and retail investors lined up to participate in both the current and future dividend growth promised by Abengoa, Nextera and Terraform, all three IPOs were significantly oversubscribed and printed at the top end of their expected ranges.
However, plunging oil prices at the start of the fourth quarter saw the new vintage yieldcos suffer significant losses, with Abengoa, Nextera and Terraform all falling below their issue prices and with the pain particularly bad for the solar-concentrated Terraform, which had lost about 21% in share value since launch.
Although the broader market had punished the solar yieldcos around a perceived inverse correlation between oil prices and solar project demand, smarter money saw a buying opportunity for an industry that is fast approaching cost parity with the grid.
“We believe investor concerns about a drop in solar power demand due to low oil prices, which in our view are overblown, are responsible for weakness in solar-driven stocks and yieldcos over the past couple of trading days. ‘Oil contagion’ is out of proportion in the solar/yieldco space, in our view. Our projected solar demand is heavily driven by improving solar economics and favourable regulatory dynamics,” said Morgan Stanley equity analyst Stephen Byrd.
Solar yieldco dividend yields, along with more diversified portfolios, are heading back to tighter levels, with some US-listed yieldcos testing 2%–3%. Assuming a general hurdle rate of 5% for dividend yield focused investors, it is becoming increasingly incumbent upon yieldcos in a growing market place to differentiate themselves by providing a solid plan for future dividend growth.
Most US-listed yieldcos offer aggressive forecasts of between 12% and 18% annual dividend growth in their public statements and are therefore committed to ever-increasing economies of scale and asset performance to drive future returns.
“Of the six yieldcos that are publicly traded in the US, the top performers have been the names that have indicated, and to some degree shown, the highest dividend growth rates. A typical investor in a yieldco is looking for a total return of 15% or above,” says Redinger.
In November, solar company SunEdison and TerraFormPower signalled their intention to achieve greater scale and sustainable growth by entering the US wind power market with the purchase of Boston-based wind company First Wind for US$2.4bn.
Both parent and yieldco shares rose in response to the announcement, which allowed SunEdison to increase its 2015 installation forecast to 2.1GW–2.3GW from 1.6GW–1.8GW. Importantly, Terraform was able to increase its 2015 dividend forecast to US$1.30 per share from 90 cents. The merger saw a sharp correction in the yieldco’s share price during the month of November of of some 11.3%, with its current dividend equating to a dividend yield of 2.88% by the beginning of December.
“Certainly, the acquisition of First Wind by Terraform and its sponsor SunEdison is a significant development both in terms of expanding beyond solar and ownership of such a large developer changing hands. Project developers and their backers continue to be focused on achieving exits through yieldcos,” says David Burton, a partner with Akin Gump in New York.
In the 18 months since NRG Yield made its public debut, investors have been gaining comfort with the elimination of development and construction risk achieved by the yieldco structure to the extent that the public equity markets have effectively re-priced the cost of ownership of energy projects. Jigar Shah, of Jigar Shah consulting and former CEO of SunEdison explains:
“A yield company allows institutional investors to invest in a liquid security that represents power projects like solar and wind. In the process, these institutional investors bid up the stock to achieve the dividend yield that the market views as ‘fair’. This in turn gives the yield company owners guidance on what the perceived cost of capital should be for these type of projects.”
The opening of a new, attractively priced equity market has reduced project developers’ reliance on traditional providers of sponsor equity and project debt, with the direct result that more projects are being placed in service now than was previously possible. Indeed, traditional bank lenders have begun to question their role in the renewable space and are positioning themselves more as providers of corporate finance, revolving debt facilities and holdco/opco debt favoured by yieldcos in an effort to maintain client relationships.
Participants at this year’s Renewable Energy Finance Forum on Wall Street noted a competitive rush to find new sources of business as the utility-scale sector depends on its yieldco financing activities. Distributed generation continues to be viewed as an interesting asset class with potential for project finance activity. Battery storage projects were also discussed frequently at the conference as a new potential avenue for project finance business, with some predicting the market may see its first deals in roughly 18 months, first reported by Project Finance International in July.
“Although pension funds continue to present the most attractive cost of equity capital, yieldcos have standardised access for utility-scale projects to a very attractive cost of funds. Pricing wider than yieldco equity we still find infrastructure funds and private equity looking for mid to high returns, but are more likely to be in the 9%–10% range as a cost of equity capital to project developers,” said one renewable energy-focused investment banker.
With project developers now raising funds at pricing levels that reflect a significant de-risking of their core assets, the typical discount rate used to value future cashflows and model yields from renewable projects is on a downward trajectory, although the yieldcos’ need to deliver continued upside to investors should temper developer greed in the short-term.
“Developers are starting to use the average dividend yield of comparable yieldcos to calculate the rate at which to discount future cashflows and value project portfolios. However, this ignores that the shareholders of a yieldco are expecting some upside above the dividend yield. If the yieldco is looking to launch at a dividend yield of 5%–6%, then the developer should employ a discount rate slightly higher than that yield when modelling projects,” says Burton.
Despite the obvious disruption to the traditional sponsor and tax equity investors, which are finding it increasingly difficult to meet their return targets of better than 12% in the utility-scale sector, most market observers feel that the overall improvement in capital efficiency for renewable power developers can only be a good thing for the sector and project finance risk pricing in general.
“I am hopeful that the yieldco sector will continue to enjoy success, as I believe they are good for the project finance industry. However, as the yieldco trend has only really been in existence since the middle of 2013, I think it is a little early to make a definitive determination about the overall impact,” Burton adds.
“Yieldcos have enabled developers to access to low-cost equity capital. This in turn has helped projects that were previously marginal from a return perspective to get built. The yieldco tool is a competitive advantage to developers who have access to it and puts many other developers without it at a competitive disadvantage,” says Redinger.
“With the utility-scale solar segment in the US growing by 100% from 6,048GW in 2013 to 12,303GW in the US in 2014, according to the US Energy Information Administration, utility-scale and, more recently, distributed solar projects have been a key beneficiary of improved capital efficiency. A scramble for sufficient portfolio scale to launch an IPO, which is currently trending in the US$500m area to support an IPO in the US$150m–$200m range has unleashed a hot sellers market.”
The renewable market has become very heated over the past year and assets are now trading through the discount rates implied by the dividend yields available in the secondary market. “Yieldco sponsors saying ‘I am close to being the size to go public and need a few more assets’ are increasingly willing to pay-up for incremental assets. We are definitely advising all of our project owners to sell,” said one investment banker.
For example, SunEdison’s notable activity includes the acquisition of a 25.5MW utility portfolio and a 4.5MW project pipeline both from Hudson Solar Energy, along with 77MW of distributed solar projects from Capital Dynamics US Solar Fund. Elsewhere, the developer added 50MW of UK-based utility-scale projects backed by a 15-year PPA with Statkraft in September, financed through a £40m short-term construction loan from Santander.
The focus on utility-scale projects within the current crop of yieldcos could soon give way to deals backed by cashflows from distributed solar and wind projects as issuers attempt to differentiate themselves from the crowd by offering investors exposure to commercial and even large residential asset portfolios.
Given the challenge of ramping up portfolios of sufficient size, and with enough scope for future asset and dividend growth, commercial and residential solar markets are likely to be smaller and the preserve of niche players such as First Solar, SunPower and perhaps US residential solar leaders SolarCity and Sunrun.
For example, SunPower reports that it is increasing its retention of residual interests in solar projects it develops, encouraged by conditions in the yieldco market that could allow it to extract greater value from its portfolio over the short-term.
However, the company’s management recently sounded a cautious note to investors that any transition to a yieldco model would depend on how fast it could build new projects. While investors are hopeful that SunPower will be the next pure-play solar yieldco to enter the market, the company is unlikely to make a definitive decision until next year or even 2016.
US solar technology provider First Solar illustrated the potential pitfalls of frustrating investor expectations for fresh yieldco opportunities when it suffered an 11% drop in its share price in November after it announced that it did not intend to pursue a yieldco structure, despite having a backlog of around 1.3GW in the pipeline.
Given the voracious appetite for dividend growth, only solar developers with strong near-term completion schedules and suitable tax structures are likely to enjoy success in the yieldco market. Although First Solar CEO Jim Hughes advised analysts that the company was not filing as a yieldco in 2014, he held the door open to the prospect in the future:
“The company has determined that we are not prepared to file a registration statement and pursue a listed yield vehicle at this time. However, we have also determined that the ownership and operation of a whole or partial interest in select solar-generating assets does have a role as a component part of our overall business model,” he says. “We feel that opportunities for maturation of the marketplace and further optimisation of such retained interest remain, and have decided to exercise patience.”
While most observers are bullish on the US residential and commercial solar markets as a source of asset growth over the next few years, its not yet clear if any developers in this market will be able to deliver a vehicle suitable for the yieldco structure prior to the sunset of the investment tax credit in January 2016.
As First Solar and SunPower pull back from the market to work on their near-term pipeline, residential solar developers are already taking advantage of the asset-backed securities market to refinance diversified asset pools. Any residential solar yieldco would have to compete with an ABS market that this year delivered SolarCity a weighted average coupon of 4.3% for a BBB+ rated deal backed by 16,000 residential solar leases, the tightest print for residential solar ABS so far.
SolarCity managed to overcome investor concerns that the sponsor would have to repay any investment tax credits associated with projects that end up in foreclosure. Instead of buying the individual solar projects used as collateral, the SPV only leases. Even in a situation where a new owner swoops in to buy the business at bankruptcy, it would continue to run the project under the original master lease structure – thus avoiding a sale and keeping the tax credits undisturbed, IFR reported in July.
“Residential renewable assets have not shown up in yieldco structures yet but there are several participants who are looking at ways of bringing investment-grade portfolios with structures that protect tax-equity investors to the yieldco market,” one underwriter says. The real question, though, is whether yieldco investors will be able to compete with the ABS market for residential risk. Distributed generation asset owners are now debating whether it makes more sense to sell assets or leverage them.
While an asset sale in today’s market might generate an attractive exit price, the owner will be giving up residual value to the purchasing yieldco. Cashflows from the leveraged asset, meanwhile, will be diverted to repay borrowing costs
However, SunEdison’s success in launching a yieldco partly backed by distributed solar assets offers a strong lead to follow and further variations on the distributed theme are expected to emerge over the next few years.
“Yieldcos have set the cost of capital for utility scale projects. There is still very little data for residential and commercial projects, but that will come with future yieldcos,” says Shah.