IN DEPTH: The yieldco phenomenon
No sooner had the rash of renewable-energy yieldco listings broken out last summer across stock exchanges in New York, Toronto and London than some observers were dismissing the phenomenon as a passing fancy.
The charge is certainly plausible; financiers, like most people, are susceptible to fads.
But others see something much more important at play — that yieldcos represent a breakthrough for renewables: a powerful new way for wind and solar developers to raise money on the capital markets.
Considering the billions of dollars and untold number of new investors that yieldcos have delivered to the renewables sector over the past year, the question of whether they are a flash in the pan or a trend with staying power is among the most interesting facing the industry in 2014.
In its purest form, the yieldco model is most easily exemplified by a company that both develops and owns renewables projects. The company calves off its low-risk operational assets into a separate business (in which it typically retains a majority stake); it lists the new company — the yieldco — on a stock exchange; and it ploughs the proceeds from the initial public offering (IPO) back into its riskier project-development activities.
On a fundamental level, nothing changes; the development pipeline and the operational assets are the same as ever. But the IPO allows the developer to monetise its operational assets earlier than it otherwise would have been able to, recycling its capital back into project development — and, in theory, quickening the pace at which it brings new wind and solar plants on line.
Meanwhile, the newly listed vehicle throws off predictable and generous dividends generated by its operating assets, hence the “yieldco” sobriquet.
The yieldco idea reflects the reality that investors often put a lower value on a single company with many units than they would put on those same units if they were broken into separate businesses — the so-called “sum of the parts” valuation principle.
It also reflects the fact that developing a wind or solar farm from scratch is a totally different — and far riskier — business than operating a finished project. In the minds of investors, that development risk often casts a pall over other parts of the business, denting the value the market puts on it.
The trend was ostensibly sparked by Greencoat UK Wind’s highly successful London IPO in March 2013, and it culminated in the biggest yieldco flotation of the year, in the form of NRG Yield, whose parent NRG Energy raised $470m by selling a one-third stake in the new company, which markets now value at nearly $5bn. (Unlike most renewables yieldcos, NRG Yield owns gas-fired assets in addition to wind and solar plants.)
NRG Yield was soon followed onto the markets by yieldcos such as TransAlta Renewables (which was spun out of Canadian power giant TransAlta and is now that country’s largest wind operator); and Pattern Energy (whose parent company Pattern is owned by private-equity firm Riverstone Holdings).
Since then a number of major renewables players — SunEdison and Abengoa most prominent among them — have confirmed plans to list yieldcos of their own in the US.
NextEra, the largest wind farm owner in North America, is openly discussing the yieldco option with its shareholders, and the model frequently crops up in conversations about major US power companies such as Sempra and Duke, and PV developers like First Solar.
In the UK, meanwhile, a number of yieldco-like companies have followed Greencoat, although they tend to be smaller in size than their North American counterparts, while there are also whispers of yieldco launches in South Africa and the Netherlands.
The rise of the yieldco has happened too quickly, too feverishly, to fully grasp its long-term ramifications just yet. But there is no question that it is “a big deal” for renewables, says Eric Davis, research manager at Energy Solutions Forum, a New York-based energy-policy consultancy.
With obvious benefits both for the companies floating them and outside investors, the popularity of yieldcos is easy to understand.
Pattern, a significant developer and operator of North American wind farms, had already gone through two rounds of private-equity fundraising, and was contemplating a return to the private markets, when it opted for a public yieldco last autumn, explains chief executive Mike Garland.
Pattern was in fundraising discussions with “some very good firms, some good pension funds. But because of the level of our growth expectations, we felt that a public vehicle was a better approach”, Garland tells Recharge. “You can grow more substantially and predictably with a public vehicle than a private one.”
Demand was so high for Pattern’s $352m IPO that Garland says the company could have raised that amount by selling shares only in the US, or in Canada, or in Europe.
Not only are yieldcos good for raising big sums of money; they are also the best way for raising equity at close to debt rates. That is a critically important edge as the pace of cost-reduction in wind and PV technology slows down, and “soft costs” such as financing account for an ever-larger proportion of the overall capital costs of a project.
Yieldcos are “the cheapest equity you can find in the market”, says Manuel Sánchez Ortega, chief executive of Spain’s Abengoa, which on 1 April filed to launch a yieldco in the US later this year.
With interest rates hovering just above zero, and the average company on the S&P 500 stock index kicking off just a 1.8% dividend, it is not difficult to see why investors are drawn to yieldcos, which typically offer dividends in the neighbourhood of 4-7%, despite being fairly low-risk investments.
Central to the future success of yieldcos will be their ability to grow their asset bases — and thereby their dividends. Most North American yieldcos have deals in place with their parent companies that gives them the right of first offer on big projects coming down the pipeline.
NRG Yield, for example, will have first crack at NRG Energy projects such as the 290MW (AC) Agua Caliente PV plant in Arizona. Two months after its IPO, Pattern Energy made its first acquisitions, paying its parent company $202m for sizeable stakes in two wind projects slated for commissioning this year.
In addition to this “drop down” mechanism, some yieldcos will buy finished or nearly finished projects on the open market — with the advantage of being able to issue shares as a form of currency.
One can wonder about the longevity of the yieldcos phenomenon, says Simon Currie, global head of energy at Norton Rose Fulbright, but “you can’t dispute the success of the new funds that have been brought into the sector. It’s been a phenomenal success”.
Beyond the question of why yieldcos have taken off, another key question is: why now?
It is partly because onshore wind and large PV have recently gained a large measure of respectability in the eyes of investors. Then there is the simple fact that there are many more operational wind and solar farms today than ever before.
“You need to have a large enough pool to gain interest and investment from public markets,” says Davis. “Yieldcos are becoming more prevalent, in part, because there’s a bigger pool of developed assets out there.”
Frederic Bastien, a Vancouver-based capital markets analyst at Raymond James, points out that the rise of the yieldco coincides with a highly favourable time for IPOs. Companies like Pattern “probably wouldn’t have been able to do that a few years ago, when the market was really volatile”, Bastien tells Recharge. “But we’ve had this 18-24-month time frame where the market has been very strong; a lot of money has been thrown at the market chasing stocks. The window was there.”
Yet for all the momentum behind the yieldco phenomenon, even strong advocates of the model admit that it may be vulnerable in the years ahead.
Even amid the roaring bull market of 2013, not all the companies planning a IPO were able to pull it off. Last summer Threshold Power Trust filed an IPO prospectus in Canada with an eye towards acquiring US wind farms, only to pull back a month later.
It was a similar story for Silver Ridge Power, which intended to buy solar assets owned by AES, one of its co-owners.
“We pulled back for the same reason everybody pulls back an offering,” Silver Ridge chief executive Bob Hemphill later explained. “We didn’t get the kind of price and volume response that we had anticipated.”
One commonly raised concern for yieldcos is the notion that spinning off high-quality generation assets may not be the healthiest thing for the parent company’s credit rating — a worrying prospect for large, public companies contemplating spin-offs, such as NextEra Energy.
Credit-ratings agency Moody’s muses ominously that spinning off a yieldco would “in the best-case scenario” be considered credit-neutral for most companies, implying that many firms would take a hit.
Another danger for the yieldco model is that it could simply become a victim of its own success and saturate the market — something that may already be happening in the UK, where recent offerings have been pulled or downsized.
The “biggest inherent risk” to the model is that as Western economies heal and interest rates begin to rise, the dividend yieldcos are able to provide will lose some of its edge over yield-bearing instruments such as government treasuries, says Bastien.
“But,” he adds, “that’s a challenge and a reality that any yield company has to deal with. Hence the importance of growing that yield.”
Under almost any scenario, renewable-energy yieldcos are likely to continue flourishing, at least throughout 2014. Mike Eckhart, CitiBank’s head of environmental finance, earlier this year predicted five to ten clean-energy yieldcos will be launched in 2014.
Abengoa and SunEdison, two renewables companies with a global profile, may between them seek to raise nearly $1bn.
A yieldco launch from NextEra — which owns a staggering 10.2GW of wind capacity — would give another major jolt to the sector. Morgan Stanley analyst Stephen Byrd expects NextEra to formally announce plans for a yieldco by mid-year.
“I believe the [yieldco] trend is going to be sustained,” says Bastien.
That said, it’s not as if every renewables developer will launch one, he adds.
“The ones you’ve seen going out — NRG Yield, Pattern, now SunEdison — these are the kinds of names you would have heard about beforehand. They’re leaders in their spaces, and if you’re going to handicap the odds of who would be successful, I would favour these kinds of companies over smaller guys.”
At this stage, it is fair to call the renewable-energy yieldco a trend. But there are two very different types of trends in the world.
There are those that burn brightly and then flame out. And there are those that burn brightly and, before anyone realises it, have become the new normal. The length of the yieldco wick is not yet known, but investors continue to bask in its glow.