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IN DEPTH: The yieldco effect

A little more than a year has passed since NRG launched its yieldco vehicle, NRG Yield, onto the New York Stock Exchange, kicking off what many believe is a revolution in green-energy investment.

Since then US stock markets have seen a steady drumbeat of yieldco initial public offerings (IPOs) from major renewables developers — from Pattern last year, to NextEra, SunEdison and Abengoa over the past few months — and more are on the way.

There are differences between them — for instance, some include transmission and conventional power projects — but one thing can be said for all of them: their IPOs and subsequent performances on the stock market have been hugely successful.

Importantly, they are also showing themselves capable of pulling off big follow-on share offerings and bond issues. This ability to raise gobs of capital seemingly at will carries seismic implications for renewables developers, not to mention the financial sector serving them.

“They are absolutely shifting the plates underneath our feet,” says David Giordano, managing director at BlackRock Alternative Investments. “The discussion around yieldcos is just so dominant across the industry right now.”

For years, there was really only one way for smaller investors to gain exposure to renewables, and that was by owning shares in high-risk, crisis-prone wind and solar manufacturers.

Ownership of low-risk operating assets was largely the domain of major investors — fund managers, tax-equity investors and their ilk. Even for them, ownership of assets like wind and solar farms came with a significant downside, in that they were frustratingly illiquid. As a result, financing costs for developers were high.

But that equation has been tipped on its head, with a diverse group of liquid yieldco stocks now trading feverishly on US markets. For less than $34, anyone can buy a share in NextEra Energy Partners — which owns nearly 1GW of high-quality wind, PV and concentrating-solar-power plants across North America — and then turn around and sell it the next day.

“There was a theory at one point that the public shouldn’t be buying stock in renewables companies,” says Edward Zaelke, partner at law firm and lobbying outfit Akin Gump, and a former president of the American Wind Energy Association. “Yieldcos, having hit the market... would indicate to the contrary.”

Yieldcos are equally beneficial to many big investors, such as pension funds, which have long wanted to invest in renewables but have not always had the internal resources for doing so, says Michael Eckhart, global head of environmental finance at Citigroup.

“I don’t think many pension funds have the staff and capability to be direct project investors,” he says. “Yieldcos and green bonds are exactly what that investor class needs.”

Certainly, anyone lucky enough to have bought US yieldco shares at their IPO price or something close to it will be very glad they did so.

As of late August, shares in Pattern Energy have risen 41% on the company’s IPO price; shares in NRG Yield have more than doubled. Even shares in NextEra Energy Partners, spun out of NextEra Energy just two months ago, are up more than 35%.

One curious effect of these rocketing share prices is that the very generous dividends the companies were designed to pay investors — giving rise to the term “yieldco” — are no longer so very generous.

For example, the annual dividend of $1.25 per share that Pattern offered its investors last year was equivalent to a nearly 6% yield on the company’s $22 IPO price. But at the current share price, its dividend is only good for a 4.2% yield.

Shares in NRG Yield initially offered a nearly 5% dividend; today they deliver just 2.7%, and that includes the dividend increase the company announced earlier this year. But by comparison, the average dividend on the S&P 500, an index that includes many of the world’s most low-risk companies, is just 1.9%.

All the big yieldcos intend to continue buying projects and raising their dividends, but further share price appreciation may offset any future dividend hikes. Rising interest rates would also make them relatively less generous.

The huge share price gains seen in US yieldcos cut a stark contrast with a similarly timed crop of UK yieldcos, most of which have thinner plans for future growth, and as such have seen their shares trade within fairly tight windows.

Shares of Greencoat UK Wind, for example, have risen just 6% since their spring 2013 launch.

The chief executive of one big clean-energy asset owner sees “lofty” valuations when he looks at the share price of US yieldcos such as NRG Yield. But other experts argue that the run-up in yieldco share prices is simply a function of fairly conservative IPO prices and what appear to be safe businesses with concrete medium-term growth plans.

“What’s happening with these yieldcos is that the promoters are putting out very high-quality projects,” explains Zaelke. “The market is looking at them and saying, ‘This doesn’t feel like something I need a 5% return on’.”

Perhaps the most important consequence of the success of yieldcos on the market is the ability it gives them — and, indirectly, their developer parents — to raise even more money, either through selling shares or issuing bonds.

Take Pattern Energy, which owns 1.5GW of wind capacity across North and South America, and which raised $404.8m in its September 2013 IPO, selling 18.4 million shares for $22 each. This May the company’s parent, Pattern Development, sold 21.1 million of its shares at $27.75, raising another $586m.

Or consider NRG Yield, which raised $495m in its July 2013 IPO from selling 22.5 million shares at $22 a pop. This summer, NRG issued another 12.1 million of new shares for $54, worth a cool $652m, and a separate $500m green bond.

And it’s not as if these companies are saving their money for a rainy day. After its share sale, Pattern turned around and acquired controlling interests in Texas’ 218MW Panhandle 1 and Chile’s 115MW El Arrayán wind farms; NRG Yield will use the proceeds from its share issue to acquire the 947MW Alta Wind in California, the largest wind farm on the North American continent.

One unlikely beneficiary of the yieldco phenomenon has been rival developers that happen to have projects to sell.

Kevin Walsh, managing director at GE Energy Financial Services, a major investor in renewables projects, calls yieldcos “an opportunity or a threat, depending on your perspective”.

“If you’re trying to buy projects, you’re competing with yieldcos,” Walsh says. “If you’re trying to sell projects, [they’re] a good place to sell to.”

Indeed, the market has grown so favourable to sellers of North American wind and solar projects that some developers contemplating launching yieldcos of their own may be put off from doing so.

SunPower, for one, is openly pondering a yieldco as it pivots to owning more of the PV plants it develops. The company — owned by French oil giant Total — already has more than 500MW of operational PV capacity on its books, and a global pipeline stretching to more than 7.5GW.

But rather than launching its own yieldco, SunPower may elect to simply sell assets to other yieldcos, says chief financial officer Charles Boynton. “It’s a great time to be a project developer, and we will benefit whether we decide to do a yieldco or not.”

The appetite among yieldcos for new assets is so intense that it is fuelling concerns in some quarters that they may end up buying shoddy projects — or paying too much.

“They’re going to be way more sensitive to the volume of investment than to the return,” says Jeff Eckel, chief executive of Hannon Armstrong. “I think they’re going to overpay; that’s my prediction.”

Pattern chief executive Mike Garland recently acknowledged that due to the “frothy” market for third-party acquisitions, his company will probably need to lean more heavily on the pipeline of parent company Pattern Development.

“It is our opinion that many of the recent assets sold are being sold at relatively high prices given the long-term nature of these projects,” he says.

Other yieldcos, however, are more sanguine about market conditions. Brian Wuebbels, chief financial officer of SunPower, says the momentum for the company’s pipeline growth is “excellent”, and credits its recently launched yieldco, TerraForm Power.

“We see that the acquisitions for early-stage projects — now that we have a well-known, low-cost offtaker on the back end [in TerraForm Power] — are dramatically improving and increasing,” he says, pointing in particular to overseas markets as ripe for project acquisitions.

There is one segment of the renewables sector that has reason to feel less than cheery about the money-raising power of the yieldco model: the old-fashioned providers of capital, which may be elbowed out of the picture to some extent.

“What’s interesting,” says Zaelke, “is how this is going to impact banks and the traditional folks floating bonds, when they’re now in competition with what in essence is the public IPO market.

“The question is how far that can go.”

Jorge Camiña, head of US project and acquisition finance at Santander, concedes that “things are getting tougher out there from the perspective of a lender”, a situation exacerbated by historically low interest rates.

However, Camiña notes that issuing new equity is a “less flexible” instrument than debt financing, and is best suited for major transactions — such as NRG Yield’s acquisition of Alta Wind. “There’s still room for debt,” he says.

For the next year or two, at least, the flow of yieldcos onto public markets does not look ready to slow down. A number of major US-listed renewables developers, including First Solar, Canadian Solar and SunPower, continue to study the possibility — although some may elect to simply sell projects to existing yieldcos.

So what is next in the yieldco story? Most US yieldcos were born into a bull market, and have the right of first offer on a number of projects coming down their parents’ pipeline over the next few years.

But beyond that time frame, things become decidedly less clear.

Will yieldcos be able to acquire enough projects to keep their dividends attractive? How will they weather more adverse points in the interest rate cycle? How will the inevitable depreciation of their underlying assets play out in their share price?

“There’s visibility in the short term on what their growth is going to be, so they’re being well received by investors,” says Jerry Hanrahan, managing director at John Hancock Life Insurance, another major investor in US renewables projects.

“Over the longer term, I think the jury’s still out. Nobody really knows if that growth can be sustained, where those assets are going to come from.”

Whether yieldcos live up to their potential of representing a durable step-change in the cost of capital for renewables developers is “TBD [to be determined] at this point”, says Giordano.

But more than a year after the craze took hold, that potential is still very much alive. Should they stand the test of time, Giordano says, yieldcos will represent a “level of capital and liquidity for the market that you couldn’t get even if all institutional investors allocated a percentage of their investments to renewables”.

Heady stuff, indeed.

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