A painful correction

What looked to be a banner year in the making for US yieldcos in early summer 2015 ended in drastic compressions after it became clear that certain growth assumptions were unsustainable in the face of rising interest rates, commodity price upsets and demand-driven price hikes. 

Thus the latest poster child of investment bankers to enter the infrastructure space faltered, leaving the market to wonder if the underlying model of the maiden vessel chosen to raise low-cost capital for a young renewable energy marketplace was inherently flawed. 

But even as US yieldcos have suffered significant devaluations that have left some on the verge of demise, there are still those who staunchly support certain variants of the model and insist they have a place in the long-term renewable energy space. 

The essence of the US yieldco is, in some cases, vaguely akin to other total return vehicles (TRVs), including master limited partnerships (MLPs) and real estate investment trusts (REITs) – swapping tax incentives for sector-specific subsidies, of course – and in other cases their frameworks are directly derived from the MLP structure. 

We get the term TRV from Bank of America Merrill Lynch’s managing director of energy investment banking, Jason Satsky, who was on the team that designed the NextERA Energy Partners yieldco nearly two years ago. “We imported the whole concept of a partnership and set the distribution rights, which frankly aligned the interests between the limited partner and the general partner and worked very well over a very long period of time in the MLP space,” he says.   

Yieldcos’ guiding purpose is to house operating renewable energy assets – most of which benefit from long-term contracted off-taker agreements generating stable cashflows – and provide investors with equal shares of operating profits through dividend payouts, with dividend growth derived from project accretion. 

Even as yieldcos championed capital draw into the renewables sector, their very public summer stumble created many sceptics. In the face of continued, multi-faceted market volatility, a new middle ground is formed by way of warehousing vehicles meant to hold assets for as long as it takes for the market to normalise. It is for normalisation that investors yearn – whether or not they will get it is another matter.

CAPITAL DRAWERS

On the upside, infrastructure investors and advisors are generally in agreement about the positive effect yieldcos have had on raising capital for the renewables space. 

Allan Marks, partner at the Los Angeles office of Milbank, Tweed, Hadley & McCloy and member of the firm’s project finance group, says: “If you look at the development pipelines for renewable projects, there have really been two things that have supported it. First are the tax credits and subsidies that have been available and that are now continuing because Congress just enacted extensions to bolster those. Another driver has been yieldcos, for the ability that they provide to devcos [development companies] to recycle development capital.” 

The core assets underlying yieldcos display many characteristics sought by infrastructure investors.   

“The beauty of the assets that have been put into yieldcos is that they’re largely contracted assets with long contracts [and] very credit-worthy counterparties—in most cases, utilities,” Satsky says. “You don’t have the same re-contracting risk or commodity risk that you have in other TRVs, ie, MLPs that have short-dated contracts or processing plants that depend on commodity prices to determine the volumes flowing through them. When you offer the same total return proposition but with a lot more stability, I mean, that’s a great proposition to investors.”

DISLOCATIONS 

Positivity aside, a central concern among energy investors of all stripes at the moment is the price of crude oil, which had fallen below $30 per barrel at press time and seriously contributed to current dislocations. Another significant driver of price action in the yieldco space for the past six months has been hedge fund trades to other hedge funds, according to one US-based renewable energy equity investor.   

“Unfortunately, a few companies were ‘growthcos’ rather than yieldcos and that attracted a different type of investor,” says Mike Garland, president and chief executive of Pattern Energy Group. But while a great many early investors in the yieldco space were “trading liquidity for due-diligence”, as one investor put it, Garland points out that these misconceptions and their consequences shouldn’t be inextricably chained to the ankle of all yieldcos in the market. The vast majority of projects were good projects and demonstrated the model,” argues Garland. 

Michael Allison, senior managing director at Macquarie Bank who specialises in renewable energy investment banking, says there is a serious dislocation in the prices that yieldcos are currently trading at. 

“My view is that the current yields are probably too high for the risk profile of the underlying assets. You’re getting investment-grade off-takers with some small amount of operational risk and [assets that are] contracted for 20 years. If you look at the equivalent kind of bond, these [yieldcos] are trading at a high premium to those,” he says. “I can’t think of another investment that you can do with such a guaranteed cashflow where you’d be able to get an 11 percent return.” 

Given current market volatility, certain development companies have set up asset warehousing vehicles meant to hold assets until yieldcos can acquire them. As Garland points out: “There is a lot of reasonable skepticism about warehouse facilities, and some are very expensive, which detracts from their value,” though for investors who don’t want to lose their optionality, it’s worth the price. 

As Allison explains, asset warehouses “are very simple structures that allow the parent and the yieldco to not be beholden to the market forces at the time”. They are “a private capital solution for the times when there’s enough market volatility that the yieldco doesn’t want to buy the asset”. 

Marks adds that “if a warehouse is properly structured, it’s fairly low-risk”. 

What’s important to understand about these vehicles is that much like yieldcos, each warehouse should be evaluated on its own merits. While some rely on third-party capital – with the likes of First Reserve, Macquarie, Goldman Sachs and John Hancock having already provided some $800 million in equity for them – one that does not is the private warehousing arm of Pattern Energy, which is internally managed. As Garland points out, Pattern Energy has no need of additional equity to maintain its current course for the foreseeable future.

SEEKING NORMALCY   

Those who would be quick to judge US yieldcos a failed experiment would do well to consider that the same turbulence that has shaken this fledgling market has also unbalanced much more respected energy sector players. Already, low oil prices have contributed greatly to the rationalisation of the TRV space, but as of mid-January, investors report no knowledge of when the marketplace will normalise. 

“People are scared right now,” says Satsky flatly. “You don’t usually see volatility like this, where you’re seeing whipsaws of 10 percent a day. That’s not normal.”

If normalcy is achieved in the near term, though, there is a general confidence that yieldcos will remain a viable part of the renewable energy investment space. “But there will be certain scepticism based on what we’ve been through for the last six months here,” Allison concludes.