TerraForm Power, Inc. (TERP)

[Wildbilly]

Still some good things about yieldcos

There are still some good things one can say about yieldcos

- FT.com

John Dizard considers some interesting pieces of wreckage from the green-energy panic

Wrecking, or looting the washed-up debris of shipwrecks, was a big industry in Cornwall in the south of England in the 19th century.

Then along came the spoilsports with their lighthouses and closer policing of the coast and the seaside people had to get by with honest trades, most of the time anyway.

Just as the wreckers looked forward to stormy nights, some energy assets are looking interesting to investors who do not mind doing serious research and getting cold and wet.

Take “yieldco” securities, which are the green first cousins of the oil and gas master limited partnerships. Yieldcos were sold as a way for portfolio investors to earn growing dividends from captive entities sponsored by renewable energy developers.

The developers, on completing a wind or solar project, would “drop down” or sell the now-earning asset to the yieldcos, which would pay for the energy farms with sales of new equity and debt.

Since renewables assets in the US can take advantage of very rapid depreciation to shelter cash flow from the taxman, the payouts could be even fatter than those from oil and gas MLPs.

The risk-seeking general partners at the renewables developer would then use the cash from the drop down to start new projects, in a nice, clean, repeating cycle. It was, in a way, like the happy world of mortgage securitisation before 2007.

Nothing lasts forever, and the yieldco model did not really get through a full market cycle before breaking down. The first yieldco to be listed was NRG Energy’s NRG Yield in July 2013. By August 2015, the whole mini-boom was over with a rapid decline in prices for the entire group.

The common wisdom is that the then-developing decline in MLP prices, thanks to the hydrocarbon crash, led to a panicked loss of confidence in the comparable renewables.

Then everything seemed to go wrong at once. The Spanish parent of Abengoa Yield began a legal process that now threatens to put it into receivership.

SunEdison, the parent of yieldco TerraForm, drew shareholder rage with dilutive transactions and made the acquaintance of David Tepper of Appaloosa Management, a tough activist investor. NRG Yield’s parent, NRG Energy, fired its green-friendly chief executive and started formulating break-up plans.

There was a moment of sunshine, so to speak, when in mid-December the US Congress unexpectedly approved a five-year extension of the special tax treatment for renewables.

In one day, SunEdison shares were up 25 per cent, TerraForm’s 6.5 per cent, NextEnergy Partners 8 per cent, and NRG Yield’s 12 per cent. Some of this was fast short covering, but some was a real, if momentary, revival of hope.

Unfortunately, the acrimony and investor distrust quickly resumed. By Thursday, NextEra Energy Partners’ shares had registered a year on year decline of 28.3 per cent, NRG Yield was down 49.8 per cent, Terraform 67 per cent and Abengoa Yield 44.6 per cent. So much for offering the “de-risked” end of renewables assets.

There are still some good things one can say about the yieldcos. Their revenues are not as subject to the vagaries of the commodity energy markets. For the most part, they are based on contracts with investment-grade counterparties that stretch out up to 20 years. And the shareholder and bondholder rebellions are forcing some of the parent companies’ managements to show a bit more fiduciary responsibility than they have in the past.

The green-energy panic has led to some interesting pieces of wreckage floating on to the surf-pounded beach. Some of the junk bonds issued by the yieldcos are now trading at yields higher than those of the riskier traded equities. Since the equities no longer have much of an accepted growth story, this means that there is a pricing arbitrage that the careful investor could exploit.

Terraform B- rated junk bonds were, on Thursday, yielding between 9.7 per cent and 9.8 per cent, Abengoa Yield B+ rated bonds are yielding 10.9 per cent, and the NRG Yield bonds will give you 8.5 per cent. That is noticeably better than what you can get from the high-yield index products, and with better security than most junk provides.

Part of the current undervaluation, in my view, is created by the widespread suspicion that the renewables developers have engaged in abusive related-party transactions.

As Hugh Wynne, utilities analyst at Bernstein, the brokerage, says, “One of the things that worries me about the [yieldco] scheme is that it creates an enormous incentive to play three-card monte with the shareholders. Nobody knows the real value of the wind farms and solar projects they are selling to the yieldcos.”

And the renewables financing structures have just had too many moving parts that make it difficult to value the securities in illiquid markets. As with so many other securitisations gone wrong, they were dependent on the issuers having continuous access to the equity and debt markets. That was a mistake.

The green-energy industry had better come up with a simpler, more transparent set of financing models than it has.

http://www.ft.com/cms/s/0/0bdfc5cc-bb67-11e5-b151-8e15c9a029fb.html