Restructuring in the Yieldco Space: Implications for Renewable Energy Access to Capital Markets
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RESTRUCTURING IN THE YIELDCO SPACE: IMPLICATIONS FOR RENEWABLE ENERGY ACCESS TO CAPITAL MARKETS by Elise Johnson, Sam Matias, Danny Suits & Heather Wiggins John Buley, Professor of the Practice, Fuqua School of Business, Adviser April 28th, 2017 Masters project submitted in partial fulfillment of the requirements for the Master of Environmental Management degree in the Nicholas School of the Environment of Duke University Table of Contents Abstract 3 Executive Summary 4 I. What is a YieldCo? 6 Introduction to YieldCos 6 Overview of the YieldCo Structure 7 Financial Benefits of YieldCo Structuring 9 Liquidity 10 Tax Benefits 10 Dividend Growth 11 II. Historical Overview – Market Events & Reactions 12 Market Overview 12 IPO/Launch Phase 12 Summer 2015 14 Current 15 III. Methods 16 Macroeconomic Factors 16 Firm-Specific (Microeconomic) Factors 17 Investor Sentiment 17 IV. Discussion 17 Summer 2015 Results/Observations 17 Macroeconomic Analysis 17 Firm-Specific Analysis 23 YieldCo Structure 24 Project Valuation 24 IDRs 25 Post-Summer Discussion 25 Equity Research Sentiment 27 IPO/Launch Phase 27 Summer 2015 28 Current 29 Summary 29 Case Study: SunEdison 29 1 V. Conclusions & Potential YieldCo Solutions 31 Project Valuation 31 Incentive Distribution Rights 32 Corporate Governance 32 “End Game” Clarification 33 Project Takeaways 33 Appendix 35 Company Profiles 35 8point3 Energy Partners LP 35 TerraForm Power 37 Atlantica Yield plc. 37 Nextera Energy Partners, LP 38 NRG Yield, Inc. 40 TransAlta Renewables, Inc. 41 Terraform Global, Inc. 42 Pattern Energy Group, Inc. 43 2 Abstract A YieldCo is a publicly traded investment vehicle that owns operating energy assets, the majority of which are typically renewable, and whose stated purpose is to distribute the majority of its available cash to shareholders while minimizing corporate taxes. After three successful years in the market, multiple events during the summer of 2015 led investors to question the fundamental nature of the YieldCo structure. This project seeks to understand if the uncertainty surrounding the long-term viability of the YieldCo as a financing vehicle for renewable energy is well founded. Our analysis uses market data, firm disclosures, and equity research reporting to evaluate the macroeconomic, firm-specific, and intrinsic risks of the YieldCo structure. We explore several explanations for the sector’s turbulence since 2015 and propose recommendations to align YieldCo, sponsor, and shareholder incentives. This assessment of the YieldCo financing vehicle can be used to inform future action in the sector, as well as renewable energy financing more broadly. 3 Executive Summary Since their debut in 2012, YieldCos have been one of the most important financial innovations in the renewable energy industry. They significantly changed the long-term asset ownership model for renewable energy assets and were market darlings during their early growth years in 2013, 2014, and 2015. However, during the summer of 2015, the YieldCo sector lost 37.60% of its market value in 3 months. The events surrounding this market collapse signaled that there may be significant risks to the YieldCo structure, which further suggests that the financing of renewable energy via the current mechanism may be in trouble. This project seeks to understand if the uncertainty surrounding the long-term viability of the YieldCo as a financing vehicle for renewable energy is well founded. Our objectives can be summarized by these key questions: 1. What factors caused the YieldCo market collapse during the summer of 2015? 2. Was the summer of 2015 a one-time market correction or is the YieldCo an inherently unsustainable financing structure? A YieldCo is a financing structure that aims to “recycle” capital in a tax efficient manner while allowing the parent company to retain significant control of the YieldCo subsidiary and generating demand from a non-core portion of the public investor base. Like Master Limited Partnerships (MLPs) and Real Estate Investment Trusts (REITs) before them, the principle goal of YieldCos is to own and operate assets, distribute income to shareholders, and maintain an advantageous tax position. The primary differentiator between these other structures and YieldCos is that YieldCos principally focus on renewable energy projects whereas MLPs focus on oil and gas upstream and midstream assets and REITs focus on real estate. Since the first YieldCo was formed in 2012, the sector has seen significant growth, swelling to over 10 entities with a cumulative market capitalization of almost $18 billion as of 2015. Many firms and analysts saw the YieldCo as an ideal way to capitalize on the growth trajectory of renewable energy, particularly in the United States, allowing firms to separate their long-lived, stable cash-generating renewable energy assets from their remaining businesses as a means to raise and deploy additional capital generated from the YieldCo public offerings. Since the summer of 2015, the YieldCo sector as a whole has been turbulent. Low oil prices have had an unexpected impact as MLP investors, seeking higher yield, demanded the same of YieldCos. There has also been a general trend of diversifying away from energy market exposure across investors. And perhaps most saliently, there were a series of negative company specific events during this time period, most notably from SunEdison, that gave investors reasons to be skeptical. Uncertainty also remains surrounding future growth expectations and if YieldCos will be able to maintain their yields as access to capital becomes increasingly uncertain. If growth slows, yields will increase and the ability to fund accretive acquisitions will be hampered. As investors began to feel the impacts of macroeconomic and microeconomic shocks during the 4 summer of 2015, the viability of the YieldCo financing vehicle was put into question. Our analysis utilizes market data, firm disclosures, and equity research reporting to evaluate the macroeconomic, firm-specific, and intrinsic risks of the YieldCo structure. We explore several explanations for the sector's turbulence since 2015 to explain what factors caused the YieldCo market collapse in 2015 and whether the devaluation was a one-time market correction or a signal of an inherently flawed corporate structure. Our findings show that YieldCo performance was significantly correlated with negative sponsor events, and MLP performance (and concurrently oil prices), but that these correlations have decreased over time. Additionally, we see that missed earnings and dividend expectations during the summer of 2015 were significant drags on equity values. Investor and research analyst sentiments also became increasingly concerned during this period. This confluence of events led to the YieldCo market crash. Post-summer, the YieldCo market stabilized and has begun to recover as investors and analysts focus on the firm-specific characteristics of each YieldCo, rather than treating all firms as equivalent entities. This is shown by decreasing correlations between YieldCos, which were >90% correlated during the downturn. It appears that market expectations for YieldCos have been reset and that individual firms are now able to succeed or fail on their own merits. Our overall view is that YieldCos are not inherently flawed and that the events of 2015 were temporary setbacks. However, we propose improvements to the corporate governance structure, project valuation methods, and "end game" strategy of YieldCos that may significantly improve the structure. This assessment of the YieldCo financing vehicle can be used to inform future action in the sector, as well as renewable energy financing more broadly. 5 I. What is a YieldCo? Introduction to YieldCos A YieldCo is a financing structure that aims to “recycle” capital in a tax efficient manner for its parent company. YieldCos are separate entities from their parent companies (or ‘sponsors’) though the parent company retains significant control of the YieldCo subsidiary, which generates demand from a non-core portion of the public investor base. Since the first YieldCo was formed in early 2012, the sector has seen significant growth, swelling to over 10 entities with a cumulative market capitalization in 2015 of almost $18 billion. Many firms and analysts saw the YieldCo as an ideal way to capitalize on the growth trajectory of renewable energy, particularly in the United States, allowing firms to separate their long-lived, stable cash-generating renewable energy assets from their remaining businesses as a means to raise and deploy additional capital generated from the YieldCo public offerings. The idea for a YieldCo originated in 1960, when President Eisenhower signed the Real Estate Investment Trust law. REITs were extremely popular, since it created a new investment vehicle for investors unwilling or unable to directly own property. This popularity led to the creation of Master Limited Partnerships (MLPs) in the 1980s, a similar investment vehicle, but with a focus on natural resources. Like MLPs and REITs, the principle goal of a YieldCo is to own and operate assets and distribute income to shareholders through long-term predictable cash flows. The primary difference is that YieldCos principally focus on renewable energy projects, whereas MLPs focus on oil and gas upstream and midstream assets, and REITs focus on real estate. Solar industry growth in the early 2000s created a need for additional low-cost capital to fund an influx of new renewable