In last week’s Energy Letter (“First Solar Takes a Shine to Yieldco“) I covered the concept of yieldcos. In brief, yieldcos are similar to master limited partnerships (MLPs) in that they are investment vehicles spun off with income-generating assets to provide a predictable tax-deferred yield in exchange for cheap equity capital. There are some differences as to how they are treated for tax purposes, which I explained in the aforementioned article.

Details have now been released for the joint First Solar (NASDAQ: FSLR) and SunPower (NASDAQ: SPWR) yieldco. According to a filing with the Securities and Exchange Commission, the new venture will be called 8point3 Energy Partners. The name is derived from the 8.3 minutes on average that it takes for light from the sun to reach the earth. According to the S-1, the two sponsors have developed, built or supplied solar modules to approximately 39% of the 18.1 GW of solar power capacity installed in the United States and approximately 11% of the solar power capacity installed in the developed world.

The venture will initially consist of solar projects with an aggregate generating capacity of 432 megawatts (MW), dropped down from the sponsors. It will also have a right of first offer on interests in 1,131 MW of advanced development stage projects. Eighty-seven percent of that initial capacity will come from six utility-scale solar energy projects, four of which are operational and two of which are in late-stage construction. The remaining 13% will be from commercial and industrial assets and a residential portfolio of some 5,900 homes. Most of the offtake agreements for these assets are for 20 years or longer.  

Financial projections, such as projected cash flow, minimum quarterly distribution, annualized yield — and even historical cash available for distribution — are still blank in the initial filing. Therefore, at this early stage it is impossible to evaluate this new venture. If recent history holds then the initial yield is likely to be low (~3%) and therefore more appropriate for investors seeking growth rather than those seeking income.

The sponsors will retain the incentive distribution rights (IDRs). Thus, while the long-term value proposition of yieldcos to investors remains to be proven, there is no doubting its immediate utility to the sponsors, who have the aforementioned IDRs and a pool of ready capital for projects that can be dropped down into the yieldco. So, our strategy to date has been to recommend yieldco sponsors — like Sun Edison (NASDAQ: SUNE) and First Solar — over the yieldcos themselves.

Still, the yieldco model is intriguing. Following last week’s article, I was put in touch with Edward Einowski, a partner at the law firm Stoel Rives who specializes in renewable energy project finance and who is an expert in yieldcos. I took the opportunity to pick his brain, primarily to gain a better understanding of the risks and rewards. The following is a partial, lightly edited transcript of a 40-minute interview I conducted with him. I am identified below as RR, and he is EE.

RR: How do you describe yieldcos to people?

EE: Yieldcos are essentially the Fannie Mae of the renewable power industry. They have emerged to allow project developers to monetize all or a significant portion of the developer’s remaining interest in the project. This is similar to the way a bank will monetize mortgage loans by selling them to Fannie Mae, freeing up the money for the bank to make additional loans. Project developers who monetize their assets into yieldcos free up capital to execute new projects. The yieldco will own the assets and have a power purchase agreement with utilities that ensures years of cash flow, some of which is passed on to investors.

RR: How does an individual investor go about buying into a yieldco?

EE: There are so far three different types of yieldco. The best known yieldco is the public offering (i.e. NRG, Pattern Energy, etc.) where anyone can invest. This is a good way to broaden participation for renewable projects. However, the second, less well known yieldco, is the private yieldco, a limited group of institutional investors or even just one institutional investor. It is more discreet, more flexible, with no public stock offering and therefore less pressure to respond to markets. It might be open ended or up to X billions of dollars for the next X number of years. The third type of yieldco is private equity funds (even though they aren’t often referred to as yieldcos). These are often overseas but in the U.S. as well.

RR: There is at least one Canadian yieldco in TransAlta Renewables (TSX: RNW), which owns 1,255 MW of generating capacity (92% wind and 8% hydropower). Is this structured in the same way as a U.S. yieldco, and are there any special considerations for investors who might be interested in TransAlta Renewables. I ask because of the differences in the tax regimes of the U.S. and Canada, which result in typically lower yields for Canadian midstream companies relative to U.S. midstream MLPs.

EE: I am not aware that they are structured any differently, but it’s something you would have to look into. [RR: I did look into it, and TransAlta Renewables looks to have a very similar structure to U.S. yieldcos. Further, the yield is 6%, which is significantly higher than most U.S. yieldcos.]

RR: With an MLP, some of the distribution is treated as a return of capital until the cost basis is reduced to zero. Thus, distributions are not fully taxed. Most MLP investors receive K-1 forms instead of the 1099s that one would receive for dividends from a corporation. How does this compare to the distributions from a yieldco?

EE: While a yieldco that is taxed as a corporation isn’t shielded from corporate income taxes as an MLP is, accelerated depreciation and other tax benefits can allow such a yieldco to generate cash flow for years. The depreciation and other tax benefits (such as interest deductions for debt incurred to purchase a project and any production tax credit or investment tax credit that is not transferred to the sponsor) can serve to shelter its taxable income. That is true for yieldcos that are publicly held via stock offerings — they are taxed as corporations. But keep in mind that for the non-public yieldcos, they can elect to be taxed as a partnership in most cases, and thus can function from a tax standpoint in a manner similar to MLPs. [RR: While most yieldcos issue 1099s, I have learned that Brookfield Renewable Energy Partners (NYSE: BEP) issues K-1s, which may be because they have a mix of U.S. and Canadian assets. For the Canadian assets, a portion of the dividend is treated as a return of capital.]    

RR: One thing I have wondered is why these kinds of assets can’t be bundled into an MLP? I understand the MLP rules that have always been almost exclusively fossil fuel-based, but there have been a number of exceptions. There are MLPs based on amusement parks, asset management and even cemeteries. I understand that there is a pending bill that would make renewable energy projects eligible for MLP status (which I don’t think will pass), but I just don’t understand why they can’t apply for that status now.

EE: Current law simply doesn’t allow that for renewable power projects in publicly traded companies.

RR: How many publicly traded yieldcos are available now? Half a dozen?

EE: That sounds about right. [RR: I count six U.S.-based and one Canadian-based that are currently publicly traded].

RR: I have identified the possible elimination of the tax credits as a potential downside risk. Would you agree? What other downside risks do you see?

EE: Keep in mind that the Production Tax Credit (PTC) and the solar Investment Tax Credit (ITC) are in place through the end of 2016. Projects that are in place by that time are eligible for the full tax credit. Could Congress eliminate that tax credit retroactively, hence eliminating 10 years of future tax credits for a wind energy project that was installed before the end of 2016? Well they could, but it would be unprecedented and is highly unlikely. The only risk there is that the tax credit is allowed to expire, and that slows down future projects which may negatively impact future dropdowns, and hence future growth of the yieldco. [RR: The ITC is a 30% federal tax credit for solar systems on residential and commercial properties. The PTC is a tax credit paid for each kilowatt-hour (kWh) of renewable electricity produced. The PTC provides 2.3 cents per kilowatt-hour (¢/kWh) for wind, geothermal, and closed-loop biomass systems, and 1.1¢/kWh for other eligible technologies, typically through the first 10 years of operation].

RR: How safe are the cash flows?

EE: The cash flow is coming from a utility to the yieldco via a long-term power purchase purchase agreement (PPA). Unless the utility goes bankrupt — which is pretty rare due to the way they are regulated — then the cash flow should continue through the life of the PPA. Most of the risk is on the project side, which disappears once the project is up and running and dropped down into the yieldco.

RR: I notice that most of the yields for yieldcos are in the 2% to 6% range. The recent tendency due to strong demand is that yields have been declining. If I buy into a yieldco with a 5% yield, do you think that’s sustainable over time?

EE: Sure, if you look at the internal rate of return of these projects, you can get a good idea of whether that kind of yield is sustainable. And for the projects I have seen, I think that’s a reasonable assumption.  

RR: Thanks for taking the time to visit with me today, Ed, and for helping to clear up a few questions around the yieldcos.

I will conclude with a brief description of the seven publicly traded yieldcos of which I am aware.

Brookfield Renewable Energy Partners (NYSE: BEP) is primarily a hydropower producer, with 6,700 megawatts of installed capacity across 13 power markets in the U.S., Canada, Brazil, Ireland and Northern Ireland. BEP has a current enterprise value (EV) of $15.6 billion, an Enterprise Value/EBITDA of 13.7, and yields 5.6%. As noted above, BEP does issue a K-1 for tax purposes instead of a 1099.

NextEra Energy Partners (NYSE: NEP) owns 1,240 MW of generating capacity from wind and solar projects in the U.S. and Canada. NEP has a current EV of $2.6 billion, an EV/EBITDA of 10.4, and yields 2.1%.

NRG Yield (NASD: NYLD) was formed by NRG Energy (NYSE: NRG). It has a portfolio that includes four natural gas or dual-fired facilities, four thermal generation facilities, 11 utility-scale solar and wind generation facilities and two portfolios of distributed solar facilities that collectively represent 2,984 net MW. The average remaining duration of the related offtake agreements is approximately 17 years. NYLD has a current EV of $5.5 billion, an EV/EBITDA of 14.4, and yields 3.2%.

Canada-based TransAlta Renewables (TSX: RNW) is the only non-U.S. entity in the group. TransAlta was formed from TransAlta (TSX: TA) and owns the largest portfolio of wind assets in Canada with a generating capacity of 1,100 MW. The company also has 155 MW of hydropower capacity. RNW has a current EV of $2.1 billion, an EV/EBITDA of 12.4, and yields 5.9%

Pattern Energy Group (NASDAQ: PEGI) owns and operates 12 wind power projects in the U.S., Canada and Chile with a total owned capacity of 1,636 MW. 92% of the electricity to be generated will be sold under power sale agreements which have a weighted average remaining contract life of approximately 17 years. PEGI has a current EV of $3.3 billion, an EV/EBITDA of 21.5, and yields 5.2%.

Abengoa Yield (NASDAQ: ABY) was formed by Spain’s Abengoa (NASDAQ: ABGB). The company owns 13 assets with 891 MW of renewable energy generation, 300 MW of conventional power generation and 1,018 miles of electric transmission lines. Assets include two newly constructed concentrating solar power plants in the U.S. (in California and Arizona), as well as two smaller ones in Spain. ABY has a current EV of $6.4 billion, an EV/EBITDA of 24.4, and yields 3.2%.

TerraForm Power (NASDAQ: TERP) is a spinoff from SunEdison (NYSE: SUNE). The company has a portfolio of 1,507 MW of solar (67%) and wind (33%) generating capacity, and a further 3.3 GW pipeline of committed SunEdison drop-downs. The company expects such drop-downs to help it increase its dividend from $1.08 per share annualized from Q4 2014 to $2.61 per share by 2019. TERP has a current EV of $3 billion, an EV/EBITDA of 43.6, and yields 3.1%.

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