Today TerraForm Power Inc. (TERP), a spinoff from SunEdison (SUNE), had its IPO making it the sixth yield corporation or “yieldco” to go public since NRG Yield (NYLD) became the first yieldco one year ago. High dividend yields and rising stock prices have encouraged a wealth of investment in these new companies. However, investors should be aware of the differences that exist between yieldcos and longer term risks associated with the application of this new corporate structure to the power generation industry.
The yieldco structure is not new; the basic idea has been used in the oil & gas (MLPs) and real estate (REITs) industries for many years. In the power generation industry, yieldcos are formed in order to separate a company’s riskier development activities from the consistent cashflows that come from ownership of operating assets with contracted offtake. The cash flows from these operating assets are distributed to shareholders as dividends that, at least to date, have higher dividend yields than those of a diversified equity portfolio. For example, the six yieldcos profiled in the table below had dividend yields ranging from 3.0% to 7.5% at the time of their IPOs, compared to an average dividend yield of 1.9% for the S&P 500. Dividend yields on yieldcos have dropped since their IPOs, but this is a function of the extremely strong performance of their stock prices. Total returns, which include both price appreciation and dividends, have outperformed the S&P 500 over the past year (see table below).
Besides producing strong yields, the yieldco structure is appealing to investors because the cash flows are very predictable and their ownership stakes are liquid. They also allow investors to gain access to pure power generation assets, which is not possible through the purchase of equity in a traditional utility or solar developer. For the company, yieldcos represent better ways to unlock the value of long-term power purchase agreements and access cheaper sources of financing.
The table below profiles six yieldcos that have gone public during the past year. One of the major differences between these yieldcos is the composition of their assets. NRG Yield and Abengoa Yield combine conventional and renewable assets whereas TransAlta Renewable, Pattern Energy Group and Nextera Energy Partners LP are primarily focused on wind. Alternatively, TerraForm is dedicated to solar. This distinction is important – it means that while NRG Yield can use tax credits generated from its renewable energy projects to offset taxes due on conventional generation, an entirely renewable energy yieldco must still utilize tax equity financing to fully monetize all available tax credits.
As shown in the table above, yieldcos as an asset class have enjoyed extremely strong performance since their respective IPOs. Such strong performance is encouraging for this asset class’s new application to the renewable energy industry and companies such SunPower and JinkoSolar are rumored to be interested in launching their own yieldcos as well.
However, there are several important risks associated with yieldcos such as: strength of project pipeline, exposure to interest rate risk, and long-term credit worthiness of offtakers. In order to ensure a steady stream of cash flows and tax benefits, there must be a steady pipeline of projects being developed or available for purchase. The inclusion of a right of first offer (ROFO) in yieldcos such as NRG Yield allows the company to have first bid on projects developed by NRG Energy, helping to ensure a stable project pipeline for NRG Yield.
Secondly, interest rates are currently low and equities with high dividend yields are particularly attractive to investors searching for yield in low interest rate environments. When interest rates do eventually rise yieldcos could lose some of their attractiveness to investors as yields on traditional fixed income investments also increase.
Lastly, over the past year there have been numerous reports published by banks, trade associations, and think tanks on the disruptive threats facing the current utility business model. In May, Barclays even downgraded electric utility bonds on the basis of viable competition from solar and storage. While not an endorsement of that view, it is appropriate to consider whether investors are including offtaker credit risk in their valuations of yieldcos that rely heavily upon cash flow from utility backed power purchase agreements.
About Sol Systems
Sol Systems is a renewable energy finance firm that provides secure, sustainable investment opportunities to investor clients, and sophisticated project financing solutions to developers. Founded in 2008, Sol Systems focuses on meeting the industry’s most critical solar financing needs, including tax structured investments, capital placement, debt financing, and SREC portfolio management. To date, the company has facilitated financing for thousands of distributed generation solar projects and hundreds of millions in investment on behalf of Fortune 100 corporations, utilities, banks, family offices, and individuals. For more information, please visit www.solsystemscompany.com.