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The Emerging YieldCo Landscape


US Renewable Investment Backdrop

Historically, US renewable energy projects have been equity and debt financed by the usual suspects: utilities, independent power producers (IPPs), banks and private investment vehicles such as infrastructure funds. However, strong forecasted growth in renewable capacity installations over the next decade will generate sizeable demand for capital. To reduce the cost of equity capital, project developers and current asset owners have been keen to tap into additional sources of financing – especially innovative vehicles that can appeal to a broader range of prospective investors.

Emergence of Liquid Vehicles

One constraint to attracting new equity capital into the renewable energy project market is the lack of pure-play, liquid public vehicles that would allow investors such as mutual funds and retail investors to invest in these yield-focused infrastructure assets. While proponents of public vehicles have been pushing for Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs) to apply to renewable energy infrastructure, legislative and regulatory policy hurdles have not yet been cleared for the use of these relatively tax-efficient vehicles within the sector.  As such, several market players have developed “YieldCos” that can fill this gap. This brief piece discusses the YieldCo structure and provides some examples of recent market offerings.

YieldCos

A YieldCo is an entity that owns cash-generating infrastructure assets and, similar to REITs or MLPs, spins out ownership to the public markets. They have been championed by established players within the market, and may play a significant role in the build-out of US renewable infrastructure in the coming years. Clearly not all YieldCos are the same, but some general strengths and weaknesses are listed below:

Strengths

  • YieldCos enable access to dividend-yielding, de-risked operating assets – i.e., often times no risk of development or unrelated market segments is assumed.
  • The securitized nature of YieldCos makes them highly liquid investments for institutional investors, as opposed to the status quo, where investments made via private vehicles are fairly illiquid.
  • As YieldCos often pool a number of assets, they diversify geographical and technological risk, as well as any other idiosyncratic risk associated with a standalone project.
  • A Yieldco may be designed to have access to a steady inflow of additional assets and thus have dividend growth upside. This strategy has been used effectively by NRG Yield, which has a right of first offer (ROFO) on projects currently owned by NRG Energy.
  • Although a YieldCo does not qualify for REIT-like or MLP-like entity-level income tax exemption, using excess depreciation to shelter earnings in underlying projects can be used effectively to avoid income taxes for much of an asset’s expected life.

Weaknesses

  • As alluded to above, a YieldCo is not as tax-efficient as other structures that might be available in the future.
  • Projects with a tax equity investor, where a sizable portion of cash flows are consumed by the tax equity partners in pre-flip years, might not be suitable for YieldCos due to the lack of available cash flows.
  • A YieldCo requires significant scale to garner institutional interest, with industry consensus indicating a minimum of $500mm in asset base and $150-200mm in IPO value.
  • YieldCos have to compete with other varieties of liquid securities in public capital markets and might be at a disadvantage since their unique attributes are not as well understood as more commonly traded yield based assets.

Select Cases

Brookfield – One of the earliest and largest examples of publicly traded vehicles, Brookfield Renewable Energy Partners (NYSE: BEP) holds a geographically diversified 6GW portfolio that generates dividends through long term PPAs, with a 5-6% yield. Although initially a pure-play vehicle, BEP now includes some development assets as well.

NRG – In July 2013, NRG Energy successfully spun off a 1.3MW portfolio that consists of 15 natural gas, solar and wind facilities, each with long-term off-takes, through a $430mm IPO as NRG Yield (NYSE: NYLD). The offering received strong interest from income-based mutual funds. Offered at $22, the stock now trades at around $30, boosted by dividend growth expectations based on additional assets that will enter the portfolio through the ROFO agreement with NRG Energy, resulting in a yield of 4.7%. NRG Energy still holds a majority stake in NYLD, and will use NYLD dividends to partly offset the dividend obligations of its own stock.

AES Corp. – Silver Ridge Power, a solar-power plant company formed by AES Corp, attempted to raise $150mm in an IPO in March 2013 in order to purchase solar assets around the world, but pulled the deal in response to weak demand. One investor concern seems to have been that the majority of proposed cash flow was generated in countries where there have been retroactive regulatory changes. AES is expected to re-attempt next year when additional North American assets come online.

TransAlta – Another recent deal has been executed by TransAlta corporation, whose subsidiary TransAlta Renewables (TSX: RNW) carried out a $200mm IPO covering a 1.1GW portfolio encompassing 28 wind and hydro assets, all based in Canada. It currently trades roughly at the offering price of $9.7, yielding around 7.2%.

Threshold – In July 2013, Threshold Power Trust filed a preliminary prospectus for an IPO in Canada whose proceeds would be used to acquire and own 9 operating wind projects in the US totaling 805MW. In August 2013, the IPO was shelved indefinitely in response to weak market demand.

Pattern – In September 2013, Pattern Energy raised $320mm in an IPO representing 6 operational and 2 development assets totaling 1GW in the US, Canada and Chile.

Conclusion

YieldCos are not a new concept, but evolving market conditions have brought about their recent resurgence. They provide yet another avenue for broader capital markets to enter the ever-growing renewable asset market, though not without risks. We project an increase in the use of these structures in the next few years.

To discuss renewable energy project finance market opportunities, contact Joshua Herlands at (646) 833 0381 or Craig Wetmore at (646) 553-5210.

Lead image: Finance theme via Shutterstock

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