22 June 2015

Building out the yieldco

With more yieldcos expected to come to market in coming months, how will this asset class evolve, asks Sophie Robinson-Tillett

Yieldcos were, this time last year, still a relatively novel structure, with only a handful of players in the North American space, alongside the six listed renewables funds in the UK. This allowed pretty strong consensus on what qualified as a yieldco: they were publicly-listed firms created to own operational energy assets – typically renewables. Those in the UK were all close-ended funds, while those in North America were firms spun-off from large utilities or developers, which remained sponsors and shareholders.

But, a series of major listings last summer – Abengoa Yield (ABY), NextEra Energy Partners and TerraForm Power – saw yield-hungry investors embrace the structure. As a result of these successes, the space has flourished, with new and proposed yieldcos, many of which have attempted to redefine those previously accepted parameters.

But despite a few cracks appearing, the market seems to be showing little sign of a slowdown

Hong Kong-listed renewables firm GCL New Energy, for example, created what is believed to be the first Asian yieldco when it set up GCL Yield Holding Company to own operational solar assets in China. However, the subsidiary did not raise money by floating on the stock exchange, as expected – instead it is funded, in part at least, through a $100 million private placement of convertible notes, bought by Goldman Sachs in April. Those notes entitle Goldman to more than 45% of the yieldco if it chooses to exercise its conversion rights in the future.

Italian firm Enel is reportedly planning a yieldco for its North American assets, which is also expected to remain unlisted.

SunEdison – which claims to be the world's biggest renewable energy developer – is set to split its huge portfolio of operational assets across two yieldcos: TerraForm Power and TerraForm Global (the latter has recently filed for registration on the Securities Exchange Commission). The assets will be divided by region – emerging markets vs Europe/North America – making SunEdison the first company in the world to have more than one yieldco – which it refers to as a 'platform' – to accommodate its mammoth portfolio and pipeline.

One constraint limiting the growth of the yieldco market is that these vehicles need scale in order to be viable. Opinion differs on exactly how big an operational portfolio is needed to spin off one of these companies, but estimates tend to sit between 700MW and 1GW. This is an obstacle for firms like Canadian Solar, for example, which announced plans to launch a spin-off last year, but is yet to come to market, as it buys up more assets to increase its capacity.

One interesting innovation, created to overcome the problem of critical mass, is dual-sponsorship. Taking the market by surprise in March, US rivals SunPower and First Solar combined their operational assets, giving them enough capacity to create 8point3 – the world's first 'joint yieldco'.

With all this activity, there have been claims that the market is reaching saturation point. Trevor Ingle, head of energy at law firm Squire Patton Boggs said in January that there was little room for new launches. This year has seen some of the first flops in the market: New York-based yieldco Sol-Wind – which was founded without a sponsor last year, and seeded with a modest portfolio spanning North and South America – has delayed its IPO, reportedly due to lack of investor interest. Saeta Yield, an offering from Spanish infrastructure and energy firm Actividades de Construcción y Servicios Group, made a disappointing start as its shares fell after listing at the bottom of its target range in February.

But despite a few cracks appearing, the market seems to be showing little sign of a slowdown – so much so that, in May, US firm GlobalX created the first exchange-traded fund dedicated to the space. Listed on NASDAQ, the fund tracks a yieldco index devised by Indxx, and currently includes 20 firms – a figure which GlobalX expects to rise by around 11 in the next year or so, as new vehicles are listed.

"Yieldcos will incentivise the market to develop projects more professionally, in order to meet their high standards. This will force those markets to mature" PJ Lee, EverStream

"Every month you see someone else talking about [launching a yieldco] in the press," says Mark Weitzel, co-chair of the energy and infrastructure practice at law firm Orrick, Herrington and Sutcliffe. Weitzel has been working on yieldco creation for three years and is currently assisting a company which expects to float this year; but he estimates that, altogether, "around 8 to 10" are seriously pursuing yieldcos in the market at present.

One such new entry is SunEdison's TerraForm Global. Its creation is a clear sign that investors are still hungry for new opportunities: before it has even floated, TerraForm Global has secured $175 million from three investors to help it buy assets in emerging markets.

EverStream, a fund manager specialising in renewables and project finance, is one of these investors. The firm normally invests in private equity, but three years ago, it launched its own yieldco, EverStream Yield which, a year later, was bought by SunEdison and ultimately became part of TerraForm Power. It now owns interests in both of SunEdison's spinoffs.

Peter 'PJ' Lee, co-founder of EverStream, expects more yieldcos to come to market, pointing to "a number of groups in China that are waiting and watching to see what happens with TerraForm Global" – a venture he praises for being the first serious attempt to roll the structure out in emerging and developing markets.

He hopes the asset class will continue to thrive, especially in emerging markets, where he says it has the potential to boost overall renewable energy capacity.

Can many other yieldcos join the IPO party?

"Yieldcos will incentivise the market to develop projects more professionally, in order to meet their high standards. This will force those markets to mature," he says, adding that – as well as regional diversification – he expects the space to expand into the transmission and distribution industries to accommodate the growing demand for assets.

Incipient floats from SunPower/First Solar and TerraForm Global will be followed by Canadian Solar's long-awaited spinoff, a planned IPO from Photon Energy's European Solar Holdings, and a float from US-based LightBeam Electric Company. Then there is speculation about launches from Enel, Trina and Jinko, as well as a series of potentially privately-owned yieldcos.

"We're seeing a lot of new companies looking at the market, and that's driven by the fact that the current yieldcos have been quite successful in acquiring assets, and are proving to be a competitive force to be reckoned with," says Orrick's Weitzel.

These acquisitions have been coming thick and fast over the past year – the biggest being completed in January, when SunEdison and its yieldco TerraForm Power paid $2.4 billion for First Wind.

Arguably, the characteristic that makes yieldcos so disruptive to the wider renewable energy market is the effect they have on the price of these assets.

Felix Goedhart, Capital StageCapital Stage is a German wind and solar operator specialising in European assets. Its CEO Felix Goedhart says that competition for operational assets has increased in the UK as a result of the number of yieldcos there – although elsewhere in Europe the structure is yet to have a substantial impact.

This may change, however: specialist merchant bank NextEnergy is following in the footsteps of SunEdison and launching its second yieldco. The firm will be called NextEnergy European Solar Utility, and will focus initially on assets in Italy and Spain.

"Additionally, some interesting projects may no longer make it to market, since developers will sell them directly to their own yieldcos," Goedhart adds.

Orrick's Weitzel says increased competition "tends to push the price up" but that these companies are also able to pay more for assets, because – by de-risking their activities through focusing on operational assets – they can pay lower returns to investors, leaving them more flexibility to pay higher prices for projects.

This split, in which the original business becomes two separate entities that retain strong links, is a key selling point of the structure, he adds, although this may change as the market develops.

There has, at least so far, been little demand for parent companies to sell down their stakes to give yieldcos more independence. Abengoa reduced its holding in ABY earlier this year, in a move some said would reassure investors there was no conflict of interest when pricing acquisitions between the two companies. However, most of the players Environmental Finance spoke to said investors want parent companies to have a controlling stake in their yieldcos for the foreseeable future.

"Current yieldcos have been quite successful in acquiring assets, and are proving to be a competitive force to be reckoned with" Mark Weitzel, Orrick

"It's important because the yieldco valuation is a combination of both yield and growth," explains EverStream's Lee. "And when a sponsor has a meaningful stake, it can speak more easily to the pipeline of development projects that will eventually come down to that yieldco."

Goedhart, on the other hand, prides Capital Stage on the fact that it does not have tie-ups with other companies, and warns that investors must be aware of the potential conflict of interest within the sponsor-led yieldcos that currently exist.

"We are independent of any developer, so there will never been any conflict of interest in our investment decisions," he says.

"Furthermore, the valuation of our share price is based on an existing… portfolio with real operational earnings, rather than dividend growth expectations resulting from assets we have yet to acquire."

Capital Stage says it has a dividend policy that prevents it from paying out money other than what has been "truly operationally earned" by its existing portfolio.

Mark Weitzel, Orrick, Herrington and Sutcliffe"So far, most yieldcos did not fully earn the dividends they are paying out operationally – this can't go on forever," he claims. "Investors should remain vigilant: if it turns out that the yieldcos will have to acquire overpriced assets from their sponsors, despite internal independence, it might keep them from producing the long-term dividend growth that market participants currently expect – and then investors will have a problem."

But Weitzel's experience suggests yieldcos understand the importance of meeting dividend projections. "They are very much focused on cash available for distribution, and they're very disciplined – focusing on dependable cash flows to back up the promises they've made to the market regarding expected dividends," he says.

"Our experience has been that, particularly when it comes to acquisitions, they really scrub the numbers and the projects to make sure that they can make the kind of dividends that they are pledging, because that's key to their credibility in the long term."

On top of some concerns about the long-term viability of dividend payments, there are two other elements that threaten the sustainability of the yieldco market – even in the eyes of its supporters. The capital markets are currently strong, but if they weaken, yieldcos will find themselves struggling, as they have largely been built on the back of public fundraising.

Secondly, if interest rates go up, particularly in the US, it will crank up the pressure on yieldcos to deliver a higher yield, which could prove problematic for many.

EverStream's Lee argues that any significant change in interest rates could trigger a self-correcting mechanism, which could lead to some consolidation and prevent the space from becoming overcrowded. EF