New avenues for financing for solar companies, allowing them to raise debt and equity by issuing securities that can be traded in the open market.
Jun 17, 2014
Project financing has proven to be an obstacle for solar project developers in the past.
Developers in the United States have largely relied on complex tax equity investments or expensive bank debt to fund their projects, as they have had difficulty tapping into cheaper sources of capital due to the lack of long-term data on solar power, and the perception of solar being a risky and unproven form of energy.
However, things have been changing of late. The continuing decline in prices of solar systems, the improvements in panel technology and the commissioning of several large-scale solar projects have brought about a greater acceptance of solar power and have made solar assets increasingly attractive even to mainstream investors.
This has opened up new avenues for financing for solar companies, allowing them to raise debt and equity by issuing securities that can be traded in the open market
In this note, we take a look at the Yieldco structure of equity funding and why it could prove useful for companies such as SunPower, which have significant exposure to the project development space.
We have a $31 price estimate for SunPower, which is slightly below the current market price.
See Our Complete Analysis For SunPower
What Are Yieldcos?
A Yieldco or yield company is a separate corporate subsidiary set up by energy companies to transfer a portfolio of operational energy projects. Yieldcos are typically listed after they are spun off from their parent companies and offer among the lowest costs of equity funding for renewable energy projects. The reasons for the low capital costs are manifold. These companies generate stable cash flows by selling electricity under power purchase agreements with utilities and distribute most of the cash through quarterly dividends. While yieldcos are currently subject to corporate taxes, there can be tax advantages depending on the yieldco’s structure. The Yieldco model also allows investors to single out the cash flows generated by the power plant assets without giving investors exposure to other aspects of the parent company’s business. Additionally, Yieldco investments are relatively liquid, since they trade in the open markets.
The concept of Yieldcos has been steadily gaining acceptance. Last year, NRG Energy listed one of its subsidiaries, NRG Yield Inc., which held some natural gas and renewable generation assets. The stock has performed well, gaining close to 90% since it went public. More recently, solar project developer SunEdison filed for an IPO for its solar project spin-off, called TerraForm Power. Given the recent success of these yield vehicles in the capital markets, solar project developers such as First Solar and SunPower could take steps to form their own Yieldcos. For instance, SunPower has roughly 517 MW of projects which it intends to retain on its balance sheet post-completion. The company could monetize these assets by forming a Yieldco and thereby raise relatively cheap equity funding to drive its project business.
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The YieldCo Boom and Bust: The Consequences of Greed and a Return to Normalcy
The YieldCo model is not broken. But investor expectations have changed.
by Tom Konrad
May 13, 2016
The YieldCo bubble popped almost exactly a year ago after a virtuous cycle turned vicious.
Last May, I explained how these public companies (which own solar farms, wind farms and similar assets) could grow their dividends at double-digit rates despite no internal growth or retained earnings. This “weird trick” can work so long as the YieldCo’s stock price is rising, allowing it to sell stock at higher valuations and increase the amount of money invested per share.
As long as investors expected dividends to continue to rise rapidly, they fed this virtuous cycle by bidding the stock price up, which in turn increased the expected dividend growth. Many YieldCos increased their dividend increase projections in 2014 and early 2015, when the bubble was at its height.
YieldCo boom and bust
Then the YieldCos got greedy.
In the spring of 2015, new YieldCo IPOs and secondary offerings reached a crescendo, with every YieldCo raising new money over a three-month period. There were two IPOS: 8point3 Energy Partners’ (CAFD) for $420 million in June and TerraForm Global (GLBL) for $675 million in July.
In addition, TransAlta Renewables (TSX:RNW) raised $226 million in April; Abengoa (now Atlantica) Yield (ABY) raised $670 million in May; NextEra Energy Partners (NEP) raised $109 million in May; NRG Yield (NYLD) raised $540 million in June; Hannon Armstrong (HASI) raised $18 million in June; TerraForm Power (TERP) raised $689 million in June; and Pattern Energy Group (PEGI) raised $225 million in July.
Before that flurry of new offerings, the existing seven YieldCos had raised only $12.5 billion in total capital. The additional $3.5 billion flooded the market and halted the rise of most stocks. Investors began to scale back their estimates of future dividend increases accordingly. Lower dividend estimates led to lower demand for the stocks, even lower stock prices, and the cycle began to feed on itself in reverse.
Over the next few months, the departing tide of YieldCo shares deprived sponsors of an important source of cheap finance for over-leveraged business models. It soon became clear which sponsors had been swimming naked: SunEdison (SUNEQ) and Abengoa (ABGB).
Mostly unbroken
SunEdison’s downfall in particular led many to ask if the YieldCo model is broken. Reporters (not to mention investors) have asked me this question on multiple occasions. My answer has always been "No -- except..."
The exception is the double-digit dividend per share growth that YieldCos led investors to expect during the bubble. With the YieldCo bust in the rearview mirror, I don’t think that investors are likely to bid up stock prices to the point where YieldCos can restart the virtuous cycle of secondary offerings at higher and higher prices feeding back to rapid dividend increases.
What isn’t broken is the idea of funding clean energy projects with (relatively) cheap stock market capital. When YieldCo stocks were near their bottom, solar and wind developers were openly talking about private equity being a more cost-effective form of capital than the public markets and YieldCos.
That situation is inherently unsustainable. The liquidity, better information, and broader spectrum of participants in the public markets ensure that private capital will not remain cheaper than public equity permanently. Private-market participants have the ability to operate in public markets as well. When the prices are better in the public markets, that is where they will go.
The opposite is not true for most public market investors: Regulations, lack of knowledge, and the need for liquidity keep them in publicly traded stocks and bonds, even when the returns are better elsewhere. It was only investor hesitancy in the wake of a crash that kept YieldCo stock prices so low for as long as it did. Now YieldCo prices are rising, and these entities can once again think about raising new equity on reasonable terms.
Pulling out the ATM cards
While clouds of uncertainty remain over the TerraForms because of SunEdison’s bankruptcy, other YieldCo stocks have begun to recover, and many are returning to the capital markets to issue new equity.
The strongest (and lowest yielding) YieldCo, NextEra Energy Partners, announced an “At The Market” -- or ATM program -- to sell small amounts of equity during its third-quarter 2015 conference call. Subsequently, NEP raised $26 million in the fourth quarter and approximately $40 million in the first quarter by issuing equity via the ATM. It also closed a $252 million secondary offering in the first quarter.
Toronto-listed YieldCo TransAlta Renewables has also returned to the capital markets by selling CAN $172 million of new equity in December. Unlike American YieldCos, it never promised double-digit dividend growth, did not see its stock price spike during the bubble, and did not suffer a severe decline when the bubble burst. What decline it did see has now been completely erased by its recent stock rally.
In their first-quarter conference calls, both Pattern Energy Group and Hannon Armstrong put ATM sales agreements in place to enable more flexibility depending on market conditions.
"We view this ATM as one tool in a broader toolkit, and we intend to use it judiciously for future project-related investments that are accretive and other corporate purposes. Again, to be clear, we do not plan on issuing under the ATM at this time, and at the current stock price. The ATM is only an option for the future," said Pattern CEO Mike Garland.
Hannon Armstrong seems a little closer to using its ATM than Pattern. Hannon CFO Brendan Herron described it as a “filler to help us increase leverage as the larger equity raises result in a lower leverage until we can reinvest and de-lever. We believe...the ATM will benefit shareholders and do not expect it to be a primary source of equity.”
Clearly, neither Hannon nor Pattern is planning on issuing large amounts of equity with this mechanism. But it's a positive signal that they are getting ready to tap the public equity markets.
Most YieldCos have rallied significantly from their post-bubble lows, but are still far below their highs a year ago. This recovery has allowed several to once again begin to tap the markets for new equity, an early sign of the return to normalcy.
Because of the YieldCos’ lower share prices and the relatively small size of these new equity offerings, they will not increase the investable funds per share nearly as much as previous offerings. Hence, despite better prices available for the clean energy assets YieldCos buy, the investments made with the funds will have more modest effects on the YieldCos’ dividends per share.
YieldCos are returning to normalcy. We are no longer in the bubble.
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Disclosure: Tom Konrad manages and has a stake in the Green Global Equity Income Portfolio (GGEIP), a private fund which invests in YieldCos and other high-income green stocks. GGEIP holdings currently include CAFD, GLBL,TSX:RNW, ABY, NYLD/A, HASI, TERP and PEGI.
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What are YieldCos?
What are YieldCos?
YieldCos are an emerging asset class of publicly traded companies that are focused on returning cash flows generated from renewable energy assets to shareholders. These assets largely consist of solar and wind farms that have entered into long-term energy delivery contracts with customers. Many YieldCos are able to distribute a high percentage of their cash flows by utilizing tax incentives to minimize tax liabilities. As of January 2016, there were 20 publicly traded YieldCos, 16 of which had IPO’d since the beginning of 20131.
What are the Potential Advantages of Investing in YieldCos?
Yield: The average dividend yield of listed YieldCos was 6.2% in 2015. YieldCos achieved this high yield by generally distributing 70-90% of available cash flows to shareholders2. (past performance is no guarantee of future returns)
Dividend Growth: YieldCos are designed to offer the potential for dividend growth by acquiring new cash flow generating assets. 14 YieldCos2 increased their dividends payments in Q4 of 2015 over Q4 of 2014, amounting to an average dividend growth of 15%3.
Lower Volatility: YieldCos generally consist of fully developed assets that have entered into long-term contracts to deliver electric power to customers. By mitigating development risk and price uncertainty, YieldCos seek to avoid a few of the riskier aspects of traditional renewable energy investments.
Diversification: YieldCos offer investors a source for alternative income that has historically demonstrated low correlations to fixed income, traditional equities, MLPs and REITs.
Tax Efficiency:
Unlike MLPs, the majority of YieldCos are structured as corporations, not partnerships. Therefore, they distribute 1099s to shareholders, rather than K-1s.
YieldCos can be held in ETFs, Mutual Funds, and Closed End Funds structured as Regulated Investment Companies (“RICs”), without subjecting the funds to fund-level taxation, which is not the case with MLPs.
Due to net operating losses, cash distributions are often considered return of capital, which lowers an investor’s cost basis. Taxes are often paid upon sale of the asset at the long-term capital gains rate.
What are the Potential Risks?
Conflict of Interest: Undue influence of a YieldCo’s parent company could subject the YieldCo to conflicts of interest. The risk can be mitigated by the existence of an independent board.
Tax Policy: Reliance on tax incentives to minimize tax liability could result in distribution cuts if tax policy changes.
Geography: Due to YieldCos’ reliance on renewable energy sources to generate electricity, changing weather patterns can result in fluctuations in output. Investing in YieldCos with multiple projects, or selecting a diversified basket of YieldCos, can potentially moderate this risk.
Valuation: Valuations are heavily based on multiples of cash available for distribution (“CAFD”) and expectations of future distribution growth. Changes in either of these factors or the external interest rate environment can impact a YieldCo’s value.
What is a YieldCo’s Structure?
A YieldCo is created when an energy company (the “parent”) spins off a completed renewable energy project or number of projects that have begun producing stable cash flows. In most cases, the parent company continues to hold a majority interest in the YieldCo and sells a minority stake to public shareholders in an initial public offering.
Typically, subsidiaries of the YieldCo are responsible for the day to day operations of each of the projects. The cash flows earned from each of the projects moves up the corporate structure from the subsidiaries managing the projects to the YieldCo. A high percentage of the cash remaining at the YieldCo level (often referred to as cash available for distribution, or CAFD) is distributed to the YieldCo’s shareholders.
An independent Board of Directors pursues opportunities to acquire additional assets from the parent company to the YieldCo. Any conflicts of interest between the parent company and the YieldCo are expected to be mitigated by this independent Board of Directors.
YieldCo image 1
How are YieldCo’s Taxed?
YieldCos are structured to avoid double taxation which occurs once at the corporate level on earnings and a second time at the shareholder level on dividends. YieldCos, however, are not exempt from corporate level taxation like REITs or MLPs. Therefore, they strive to achieve tax efficiency through the utilization of tax incentives to minimize taxable earnings at the corporate level.
Most renewable energy projects do not generate taxable income for years after they begin operations because depreciation expenses exceed revenues. Based on current tax laws, in instances where a YieldCo is able to offset all revenues with depreciation expenses, it will not owe corporate taxes. In addition, excess depreciation beyond current year revenues can be carried forward for up to 20 years as a tax-loss carryforward, which can be used to offset future tax liabilities. YieldCos will typically continually acquire new assets in order to maintain high annual depreciation expenses.
Without current-year earnings, cash distributions to shareholders are considered a return of capital. Return of capital lowers the cost basis of an investment and is taxable at the capital gains tax rate upon sale of the shares.
How do YieldCo’s Compare with MLPs?
In many respects, YieldCos mirror the investment characteristics of midstream-energy MLPs. The table below highlights the similarities and differences between the two structures5:
YieldCo vs. MLP
Author:
Jay Jacobs, CFA
Date:
Jan 7, 2016
Category: Insights
Topics: Income, YieldCos
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FOOTNOTES
1. Source: Bloomberg, as of January 6, 2016
2. 3 of the 20 YieldCos had not IPO’d prior to Q4 2014, and therefore distribution growth for these YieldCos is not included in the analysis
3. Source: Bloomberg, as of January 6, 2016
4. Source: Cohen & Steers ‘Market Update’, September 2014
5. Source: Latham & Watkins. Yield data as of March
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Investing involves risk, including the possible loss of principal. In addition to the normal risks associated with investing, investments in smaller companies typically exhibit higher volatility. The value of securities issued by companies in the energy sector may decline for many reasons, including, without limitation, changes in energy prices; international politics; energy conservation; the success of exploration projects; natural disasters or other catastrophes; changes in exchange rates, interest rates, or economic conditions; changes in demand for energy products and services; and tax and other government regulatory policies.
Investments in securities of yieldcos involve risks that differ from investments in traditional operating companies, including risks related to the relationship between the yieldco and the company responsible for the formation of the yieldco (the “Yieldco Sponsor”). Yieldco securities can be affected by macro-economic and other factors affecting the stock market in general, expectations of interest rates, investor sentiment towards yieldcos or the energy sector, changes in a particular issuer’s financial condition, or unfavorable or unanticipated poor performance of a particular issuer (in the case of yieldcos, generally measured in terms of distributable cash flow). Prices of yieldco securities also can be affected by fundamentals unique to the company, including earnings power and coverage ratios. Yieldcos may distribute all or substantially all of the cash available for distribution, which may limit new acquisitions and future growth. Yieldcos may finance its growth strategy with debt, which may increase the yieldco’s leverage and the risks associated with the yieldco. The ability of a yieldco to maintain or grow its dividend distributions may depend on the entity’s ability to minimize its tax liabilities through the use of accelerated depreciation schedules, tax loss carryforwards, and tax incentives.
This information is provided for educational purposes only and is not intended to be individual or personalized investment or tax advice. Please consult a financial advisor or tax professional for more information regarding your tax situation.