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Western Wind: A Clean Energy Rodney Dangerfield?

Tom Konrad CFA

Renewable energy power producer Western Wind Energy Corp (WNDEF.PK, WND.V) feels it gets no respect.  In particular, they have long felt that the investing public does not recognize the value of the company's existing and nearly completed wind farms. 

Kingman solar and wind.png
Western Wind's Kingman I Wind & Solar park. Photo courtesy of the company.

Independent Valuation

Almost every company will tell you that their shares are undervalued, but what's a bit more unusual in this case is that their assets (Wind farms with a little solar thrown in) are fairly easy to value with a rigorous discounted cash flow (DCF) model.  While wind and solar resources vary from hour to hour and even year to year, the expected energy production from wind and solar farms is fairly predictable over time, and all Western Wind's projects except for Mesa have Power Purchase Agreements (PPAs) with electric utilities that specify the prices those utilities will pay for as long as 20 years, leading to fairly predictable revenue streams over time, and fairly low uncertainty in asset valuation.  The company is currently selling electricity from Mesa at the spot price, but they are in the process of negotiating a longer term PPA.

Last year, company management decided to back up their words by hiring the independent DAI Management Consultants, Inc to value the company's equity stake in their renewable energy projects.  Western Wind has a 30MW operating wind farm (Mesa), an operating combined wind (10MW) and solar (500kW) farm (Kingman I), a 120 MW wind a farm and that is nearing completion and expected to be fully operational by the December 2011, and a 30 MW solar farm in Puerto Rico (Yabucoa) that is expected to be completed by the end of 2012.  Windstar and Kingman have signed PPAs and debt financing in in place, and Mesa is fully financed and operating under a spot price sale agreement. Yabucoa has a signed PPA and the company expects to close financing for it by the end of 2011.

Assumptions

Western Wind has released the results of DAI's valuation in a series of press releases as the valuation of each project was completed.  The complete valuation is not public because it depends on the terms of the PPAs, which are confidential.  (Confidential PPAs are a practice which I believe is counterproductive as well as counter to free market principles.  Nevertheless, keeping PPAs confidential is standard utility industry practice, and could only be banned by utility regulators; it's not something I or Western Wind have the power to change.)  They did, however, release the assumptions on which DAI's valuation was based.  These assumptions are included in the table below.

Assumptions used by DAI in valuation model.

 

Windstar

Kingman I

Mesa

Yabucoa

Project type and size

120MW wind

10MW wind, 0.5MW Solar

30 MW Wind

30MW Solar

Commercial operation date in valuation model

Dec 31, 2011

Dec 31, 2011

Existing operations

Dec 1, 2012

Remaining asset life

30 years

30 years

20 years (older assets)

30 years

Power Purchase Agreement  (PPA)

fixed price for years 1 to 20 via signed PPA and merchant prices thereafter

fixed price for years 1 to 20 via signed PPA and merchant prices thereafter

fixed price per CPUC MPR for years 1-20

fixed price for years 1 to 20 via signed PPA and merchant prices thereafter

 

 

 

 

 

Land

Owned

Owned

27 year right of way

40 year lease

Tax incentives

30% cash grant and 100% bonus depreciation

30% cash grant and 100% bonus depreciation

None

30% cash grant, 50% bonus depreciation and 50% Puerto Rico investment tax credit

Source of key assumptions

Independent engineer

Independent engineer

Management

Management

Debt --to-capital ratio

54%

54%

35%

43%

Term of debt

20 years

20 years

15 years

20 years

Cost of debt

6.0%

6.0%

5.1%

6.0%

Discount rate on equity returns

Under PPA: 11.48% Merchant generator:15.75%

Under PPA: 11.51% Merchant generator:15.85%

Under PPA: 10.52%
Merchant generator:NA

Under PPA: 10.96% Merchant generator:14.74%

Weighting of income approach vs cost approach

75%

75%

100%

75%

Construction cost contingencies

5%

5%

NA

5%


One assumption that I would have liked to see is the expected capacity factors for each of the wind farms, since that is key to knowing how much energy each project is likely to produce, but otherwise the disclosure seems comprehensive. 

Assuming the capacity factor estimates are accurate, an assumption which shows the fairly conservative nature of the valuation is the second-to-last row "Weighting of income approach vs cost approach."  This row indicates that for each of the incomplete wind farms, only 75% percent of the valuation given is based on a DCF model; the other 25% of the valuation is a replacement cost approach using comparable market transactions.  This is conservative because the DCF model should give a considerably higher value than cost when valuing a wind project because unfinished projects trade at a discount: Why invest money if the expected returns (DCF valuation) are below what you could get by selling the project?

Another row worth noting is the third to last, "Discount rate on equity returns."  This is extremely important because DCF valuations are highly sensitive to the discount rate assumption: a slightly lower discount rate can lead to a much higher project valuation.  Discount rates vary with the riskiness of the project, and with interest rates in the economy in general. (Risky projects should have higher discount rates, and we see this reflected in the fact that when power is to be sold on the spot market rather than under a PPA, DAI used a significantly higher discount rate.) 

As an inve