Submitted by Anonymous on Wed, 09/03/2014
By: Marley Urdanick
Yieldcos seem to be the renewable energy financing mechanism in vogue lately. As the newest 2014 headliners, TerraForm Power and NextEra Energy attract media attention, and NRG Yield continues to exceed expectations, many industry stakeholders are asking: what is a yieldco and why is it attractive from an investment and finance perspective? To answer these questions, this article summarizes key elements of the yieldco structure and provides an overview of the current U.S. market.
The Basic
A yieldco is a dividend growth-oriented public company, created by a parent company (e.g., SunEdison), that bundles renewable and/or conventional long-term contracted operating assets in order to generate predictable cash flows. Yieldcos allocate cash available for distribution (CAFD) each year or quarter to shareholders in the form of dividends. This investment can be attractive to shareholders because they can expect low-risk returns (or yields) that are projected to increase over time. The capital raised can be used to pay off expensive debt or finance new projects at rates lower than those available through tax equity finance, which can exceed 8%.
The case for yieldcos can be compelling, especially as an alternative to master limited partnerships (MLPs) and real estate investment trusts (REITs). Yieldcos, sometimes referred to as "synthetic MLPs," are structured to simulate the avoided double-taxation benefit of MLPs and REITs. This means that rather than taxation taking place twice (once at the corporate level and again at the shareholder level), the yieldco is able to pass its untaxed earnings through to investors [1]. This is achieved by matching strong positive cash flows (income from assets) with losses that exceed taxable income (losses due to renewable asset depreciation and expenses). These "net operating losses" reduce the company's taxable income so that the company is taxed on lower annual earnings, or may not even owe taxes at all. Net operating losses can "carry forward" for future taxable events and therefore, many yieldcos do not expect to pay significant income tax for a period of years. Additionally, dividends may also receive favorable tax treatment at the shareholder level if the returns are treated as return of the original investment, as opposed to return on investment. When earnings are taxed at only one level, the company is able to raise capital from shareholders more affordably [2]. Class A Common Stock shareholders typically receive a 1099-DIV form for tax purposes, rather than the K-1 form associated with MLPs. This is good news for many investors accustomed to the K-1, which can be cumbersome across multiple states and have limitations on utilization in a tax return [3]
Below is a general representation of the yieldco organizational structure, adapted from NRG Yield. The parent company must own a majority share of the yieldco (Class B Common Stock), while public shareholders are entitled to a minority share (Class A Common Stock). The revenue generated from projects owned and/or operated by "operating subsidiaries" is passed through this structure to deliver returns to shareholders.
Bubble chart of a hypothetical yieldco structure showing the relationship between 'Parent Company' (upper left), 'Public Shareholders' (upper right), 'Yieldco Inc.' (middle tier) and 'Operating Subsidiaries' (bottom)
Renewable energy projects face some uncertainty during the development stage but tend to produce low-risk cash flows once they are operating [5]. Yieldcos have the potential to unlock the value of these renewable assets. Yieldcos may attract new investors who may otherwise perceive unacceptable risk or lack the appropriate channels to invest capital in renewables. In exchange for the opportunity to invest in relatively low-risk assets, yieldco investors typically receive 3%–5% returns and long-term dividend growth targets of 8%–15% [6] [7]. For instance, TerraForm Power's prospectus targets a 15% compound annual growth rate in CAFD over a three-year period. Investor return is directly linked to the operating performance of the underlying assets and the resulting CAFD, 70%–90% of which is distributed as dividends.
Each yieldco establishes a dividend policy and method for calculating CAFD; a generalization based on NRG's CAFD calculation is illustrated in Figure 2 below [4]. Generally, a yieldco will distribute quarterly earnings (in the example below, $40M), less: interest and tax paid, maintenance capital expenditures, and principal payments on existing debt ($26M), and reserves for prudent conduct of business ($3M). About 70 - 90% of the remaining CAFD ($11M) is paid out shareholders.
CAFD = [Quarterly Earnings] – [Interest and Tax paid + Maintenance and CapEx + Principal Payments] – [Reserves]
CAFD = [$40 M] - [$26 M] – [$3 M] = $11 M
Figure 2. Generalized CAFD Calculation (in millions)
Which Companies Can Use The Yieldco Model?
To date, Yieldcos have been spinoffs of large industry players with the capital necessary to purchase third-party assets or build projects themselves [8]. They can emerge from unregulated arms of large utilities that own a mix of renewable and traditional generating assets (e.g., NextEra), independent power producers (IPPs), and pure-play solar or wind developers [9]. Currently, six renewable energy yieldcos operate in the US market: NRG Yield Inc., Pattern Energy Group, Inc. (NASDAQ:PEGI), TransAlta Renewables, Inc. (TSE:RNW), Abengoa Yield Plc (NASDAQ:ABY), Next Era Energy Partners, LP (NYSE:NEP), and TerraForm Power, Inc. (NASDAQ:TERP). TerraForm Power closed its initial public offering on July 23, 2014 [10].
Table 1 presents the current landscape of yieldcos in the United States (each yieldco listed has at least one project operating in the United States, but many have projects in their portfolio operating outside the United States as well). Each yieldco's portfolio is assembled according to each parent company's expertise and the desire to balance income with tax benefits. Some yieldcos have chosen to include conventional assets, while others have elected to remain a pure-play renewable. Since 2013, yieldcos have acquired over 8 GW of assets in their portfolios (renewables account for 78%) and have raised a total of $3.8 billion.
Table 1. The Yieldco Landscape
Portfolio Renewable Assets (MW-electric) Total Assets (MW) Total Capital Raised Market Cap Yield (Annual)
NRG Yield, Inc. Conventional, solar, wind, thermal 1401 2984 $840 million $3.9 billion 5.45%
Pattern Energy Group, Inc. Wind 1932 1932 $938 million $1.9 billion 6.25 %
Abengoa Yield Plc. Solar, wind, conventional, electric transmission 710 1010;
1018 mi $829 million $3.0 billion 3.6 %
TransAlta Renewables, Inc. Wind,hydro 1378 1378 C$346million
(US$323) $1.3 billion 7.5 %
NextEra Energy Partners, LP Wind, Solar 989 989 $406 million $3.1 billion 6.25%
TerraForm Power, Inc. Solar 523 523 $500 million $3.0 billion 4.5%
(expected)
All market cap information gathered from Bloomberg on August 1, 2014, unless noted otherwise. Asset, capital raised, and yield data from Kaye Scholer [11]
One detail that a parent company may consider when moving forward with a yieldco is the potential effect on credit rating. When a parent company moves operating assets off of its balance sheet and into the yieldco, it may be left with the same debt liability [9]. If credit rating agencies perceive this change in assets-to-liabilities as a risk, they could downgrade the parent company's credit rating. However, this has yet to occur.
Portfolio size and structure
For a developer interested in this structure, Martin [2] suggests that a yieldco hold at least $500 million in operating project value and enough shares sold to raise at least $100 to $200 million in the initial public offering. Diversification of risk related to construction, system operation, offtaker creditworthiness, and geography may strengthen portfolios. For instance, all of the yieldcos listed in Table 1, with the exception of NRG yield, own a combination of U.S. and non-U.S. assets with varying offtaker characteristics. It is good to keep in mind that the portfolio is more likely a function of the yieldco's business model and the parent company's management expertise, and not one size fits all."
For example, TerraForm Power's portfolio contains many small- to mid-size distributed generation (DG) projects. Two of the most notable assets within TerraForm's initial portfolio are the 46.5 MW "U.S. Projects 2014" and 19.6 MW "Summit Solar Projects." Each project is a conglomeration of 42 and 50 sites, respectively, with offtakers that include utilities, municipalities, commercial, and governmental entities [12]. This profile differs from a yieldco portfolio like NRG's, which houses a mix of large, conventional, utility-scale solar and thermal projects.
To ensure steady revenue streams, yieldcos may stock their portfolios with a diverse mix of assets. Asset types may include conventional generation, renewable energy (solar, wind, biomass, hydro, thermal, etc.), as well as transmission lines and natural gas pipelines. Abengoa Yield's portfolio includes 86 miles of transmission lines, while TerraForm Power's portfolio holds solar DG projects and is expected to acquire natural gas and hybrid energy assets in the future [13] [12]. NRG Yield chose to assemble an initial portfolio of approximately 36% conventional generating assets, 16% renewable, and 48% thermal energy/co-generation. The NRG Yield portfolio contains 25 assets across 10 states [14].
"Drop downs" Fuel the Yieldco
In order to retain favorable tax benefits and steady yields, the yieldco business model calls for acquisition of new generation assets as initial portfolio assets approach their contract expirations. This pipeline of assets, or "drop downs," is intended to fuel the yieldco with stable cash flows to deliver above-average dividend growth with below average risk [7]. This drop-down schedule is critical to maintaining cash-flows and beneficial tax treatment and subsequently, is essential to the yieldcos future growth and viability as a long-term financing structure. To reduce the uncertainty of future cash flows and ensure access to assets, agreements such as right of first offer or call rights are common between the yieldco and the parent company. Yieldcos can continue to schedule drop downs for as long as the company wishes to maintain its tax advantaged status and sufficient supply of new operating assets exist [15] or until the business strategy dictates otherwise.
References
[1] Porter, L., Hurley, P., Bradley, D. (2013). "Alternative Investment Structures." Navigant. Accessed July 29, 2013: http://www.navigant.com/~/media/WWW/Site/Insights/Energy/Alternative%20Investment%20Structures%20-%20Navigant%2011-13.ashx
[2] Martin, K. (December 2013). "Yield Cos Compared." Chadbourne & Parke LLP.
[3] Settle, E. (August 2014). Personal Communication.
[4] NRG Yield, Inc. (February 2014). Form 10-K Annual Report for the Fiscal Year ended December 31, 2013. U.S. Securities and Exchange Commission.
[5] Conneally, Tim. (July 2014). “SunEdison’s Transformative Solar Yieldco.” Green Chip Stocks.