Yieldco problems: systemic or a speed bump?
Yieldco shares have taken a hit across the board, raising questions about the viability of the investment vehicle
SunEdison’s bankruptcy filing has brought into question the viability of a financing tool widely used by renewable energy companies.
SunEdison, like many other renewable energy companies, created a “yieldco” to help drive down transaction costs and expand market share. SunEdison, in fact, created two yieldcos: TerraForm Power and TerraForm Global.
From the outset, SunEdison encountered problems with the second yieldco, TerraForm Global. The shares fell below their $15/share debut price when the IPO was launched in July 2015, and it has never risen above that price. The shares are now hovering around the $3 mark. Since then, many other yieldcos have suffered steep declines, and there are quite a few of them.
In some ways, yieldcos were imported from Canada, where a financial vehicle known as the income trust had attracted the attention of U.S. financiers looking for ways to raise cheap capital for renewable energy projects.
In that respect, the November 2011 launch Brookfield Renewable Energy Partners, a publicly traded partnership, was the first yieldco, though Brookfield argues it is different in structure, outlook and strategy than the yieldcos that followed.
Yieldcos took off in the United States in July 2013 when NRG Energy launched NRG Yield to great fanfare, with some analysts suggesting that it would “transform” the market.
Since then, at least at least seven more yieldcos have hit the market – including offerings from Abengoa, First Solar, NextEra Energy, Pattern Energy, TransAlta, SunEdison and SunPower – raising an aggregate $3.8 billion, according to data assembled by Utility Dive:
Then, about a year ago, a series of events hit the market, tanking yieldco shares across the board. It began with investors concerns about the effect falling oil prices would have on master limited partnerships (MLP) and with the overall decline in stock prices. Those conditions were exacerbated when SunEdison’ announced plans to acquire Vivint Solar using $789 million from TerraForm Power to partially fund the acquisition. The deal collapsed in March, but it scared potential investors.
Yieldcos were created to attract yield hungry investors and to provide cheap capital to develop more renewable energy assets. Developers, such as NRG Energy or SunEdison, spun off yieldcos and moved assets, wind farms and solar parks with contracted income streams, to yieldcos. Like the MLPs they were patterned on, the cash flow of the assets provided yieldco investors with a steady stream of dividends. But yieldcos went a step further, promising both dividends and growth. Growth would come from the steady supply of fresh projects from the parent company, but the yieldco would have to perpetually offer new shares to fuel continued growth.
As more and more yieldcos tapped the market to raise capital, it became evident that investor appetite for yieldco shares was waning. By September 2015, NRG CEO David Crane was warning investors that the market for yieldco equity investment was closed.
Investors became even more skittish when SunEdison essentially said it would use debt to grow its yieldco. Both scenarios were toxic for yieldcos. Lower share prices translate into lower multiples, making capital more expensive. And injecting debt into their capital structure changes yieldcos’ business model.
In the first seven months of 2015, yieldcos and their parent companies raised at least $8.9 billion in the public markets, but only about $1.5 billion in the seven months since then, according to Bloomberg New Energy Finance.
That raises the question: Is the yieldco model broken?
“The growth model broke because it was unsustainable,” says Tom Konrad, a financial analyst and money manager at AltEnergy Stocks.
SunEdison has taken some of the blame for the collapse of yieldcos. The company did push the yieldco model “as far as it could go,” says Konrad, but the problems were baked into the yieldco model when investors were promised dividends, as well as growth.
A 'speed bump'?
Yieldcos were fueled by cheap capital, and they kept pushing growth expectations higher. In its second quarter 2015 earnings call, NRG Yield raised its guidance 19% above current rates, equal to a 67% increase since the company’s IPO in the fourth quarter of 2013.
In its prospectus, TerraForm Power targeted a 15% compound annual growth rate in distributions over a three-year period and later doubled that target to 30%.
That model worked when stock prices were rising and interest rates were low. Yieldcos were able to achieve dividend growth by public stock offerings at successively higher prices to produce more capital per share to invest. More capital per share allowed dividend growth and higher share prices. And, as Konrad points out, each link in this virtuous cycle depended crucially on the last. When share prices broke down, the ability to raise cheap capital did too.
In some respects yieldcos were the victims of their own success because their business model encouraged asset price inflation. The model worked when stock prices were rising. If a yieldco was able to issue stock at a multiple of book value, assets bought from the parent at book value were accretive to earnings. But if the value of the yieldco falls below book value, it can no longer afford to buy assets from the parent company without “massive dilution,” Travis Miller, director of utilities research at Morningstar, told Utility Dive.
Or, as one critic noted, something has to give when you are trying to squeeze a 15% return out of contracted assets that only returns 8%.
These flaws don’t necessarily mean that yieldcos will disappear. “They will return and be very important,” Konrad said, but “they will not be as dominant as they once were.”
Investors are still hungry for yield, and developers of renewable power assets are still looking to lower their cost of capital.
“The fuel for this industry is capital,” said Haresh Patel, CEO of Mercatus Energy Investment Management.
Right now there are about a dozen yieldcos on hold, Patel says, but as renewable energy prices continue to fall and the technology becomes more competitive, there will be more excitement in the market.
“We will look back and this will be a speed bump," he said.
But the experience of the last eight or nine months means investors will bring a higher level of scrutiny to new offerings. The problems yieldcos are experiencing are not systemic but related to execution. Going forward, investors will demand a higher level of compliance and transparency, Patel said.
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