Tom Konrad CFA
It Could Have Been The First Yieldco
|Light at the End of the Tunnel photo via BigStock|
I first became interested in Power REIT (NYSE MKT:PW) in 2012 because of the company’s plans to become what would have been the first US-listed “yieldco,” i.e. a clean energy power producer paying a high level of reliable dividends to investors. The company was an infrastructure Real Estate Investment Trust (REIT) with a single asset: its subsidiary, Pittsburgh & West Virginia Railway (P&WV) which owned 122 miles of track leased to Norfolk Southern Corp. (NYSE:NSC), which had in turn subleased the track to Wheeling & Lake Erie (WLE.)
The rent on the rail asset was fixed at $915,000 per year with no adjustment for inflation, meaning that the expenses of remaining a public company had been taking a larger and larger share of income.
In 2011, David Lesser was an executive with experience running REITs and a passion for renewable energy looking for his next opportunity. He realized that solar and wind farms produce reliable, long term cash flows, but at the time, there were no publicly traded vehicles for income oriented investors to benefit from these cash flows. He saw the opportunity for a REIT to buy the land underlying wind and solar development, lease it back to the wind and solar operators, and deliver the payments to investors in the form of a sustainable yield. Lesser and his allies saw P&WV as an appropriate vehicle for this, and began buying its stock. In 2011, he became Chairman and CEO, and formed the holding company Power REIT to own P&WV and future renewable energy real estate assets as a publicly listed holding company.
The immense appetite that investors have shown for the yeildcos launched by renewable energy developers in 2013 and 2014 has amply demonstrated Lesser’s business plan to be a good one, but P&WV’s railroad asset has side tracked its execution. The company has only done two smallish solar deals because of the distraction.
Side Tracked On West End Branch
The side track started with a minor dispute over legal fees. The lease is somewhat unusual, in that (according to the court filings of the lessees) it was designed to give the lessees as much control of the property as possible without taking legal ownership under US tax laws. Since P&WV retained ownership of the property, but ceased to be an operating company when the lease was signed, the lease provides for the lessees to pay any of P&WV’s expenses which are “necessary or desirable” to protect its interest in the property, unless those expenses were “solely” for the benefit of its shareholders.
When Lesser received notification in 2011 that WLE intended to sell a part of the property known as “West End Branch” he consulted with his attorneys to understand P&WV’s rights and obligations under the lease. While WLE does have the right under the lease to sell parts of the property it does not need as long as it follows the appropriate procedures, it refused to pay the resulting attorney’s fees. Since the lease seemed to be clear to Lesser and his attorneys in this regard, after several attempts to get WLE to pay, this refusal became an incurable default under the lease. Since the default was incurable, P&WV’s only recourse was to foreclose.
WLE and NSC wanted to maintain what had become a very attractive agreement in their favor over the fifty years since it had initially been signed, and so they filed a civil action against P&WV and Power REIT to prevent the foreclosure in early 2012. Over the last two years, increasing amounts of PW management and resources have been required in the litigation against two larger and much better funded companies, but Lesser feels firmly that the time and expense will eventually prove to be very attractive investments. Not only does a reasonable interpretation of the lease provide for WLE and NSC to pay all the expenses (which seem to be a clear example of expenses which are “necessary or desirable” to maintain P&WV’s interest in its property), but numerous other violations of the letter of lease have come to light since the initial dispute about West End Branch legal fees.
If PW is able to foreclose, a bookkeeping “settlement account” under the lease worth at least $16 million and as much as $68 million will be due, and it (or part of it) may be due even if the court finds the lease not in default.
The State Of Litigation
The current litigation is complex, with multiple accusations in both directions. Power REIT has posted an archive of most of the court documents on its website. The most recently filed documents are each party’s opposition to the other’s Motion for Summary Judgement, and these documents do an excellent job of summarizing each party’s position in a very complex case.
Perhaps the most remarkable feature is just how far apart the two sides are. Power REIT spells out several counts on which WLE and NSC have violated the wording of the lease. WLE and NSC deny them all, and say that Lesser is a money-grabbing capitalist whose intention has all along been to manufacture defaults under the lease to extract money out of them. Their main argument is that the parties had been doing everything their way all along, and so that should not change, even if the lease says otherwise. They also claim, somewhat hypocritically considering the above argument, that Lesser is trying to change the terms of the lease, and that should constitute a default.
I’m not a legal expert, and I have no way of knowing which side is in the right when it comes to the legal issues. How much does the intent behind the lease count compared to the words of the lease itself? How important are the previous actions of the parties?
All that said, my layman’s reading of the lease tends to support PW’s side in almost all cases. I am also repeatedly shocked that WLE and NSC repeatedly say things in their testimony that I find impossible to believe. For instance, I know from my many interactions with Lesser that his business plan for Power REIT was always been to turn the company into a yieldco: The lease is a distraction, even if it may turn out to be a very lucrative one.
The evidence in the case also seems to directly contradict some of their testimony. For example, on page 4 of Document 210 “Plaintiff Opposition to PWV Motion for Summary Judgement”, they state that the West End Branch invoice I discussed above “did not relate to the West End Branch sale,” and that the attorney’s testimony supported this statement. Yet the attorney said that he recalled reviewing the lease with Lesser for “the general purpose of determining [P&WV’s] rights under the lease” relating to the sale of such property (Document 211-4, pp.49-50.)
I found this contradiction because the opposing side’s motions seemed to directly contradict each othe
r when it came to the evidence in the exhibits. Having found one such contradiction, I expect there are more.
Likely Outcome and Timing
With the opposition documents filed, the parties have two more weeks to file another round of attempts to refute each other, after which the judge will decide on each of the motions for summary judgement. Given that the parties are so far apart, it seems unlikely that many (if any) of the issues will be decided in summary judgment. At the judge’s behest, the parties have also agreed to attempt mediation and have agreed on a mediator. This seems even less likely to lead anywhere, given the complete lack of common ground, although if the judge were to rule mostly in one party’s favor in summary judgment, the other party might be spurred to compromise on the remaining points rather than to go to trial before a clearly unsympathetic judge.
The most likely course seems unsuccessful mediation leading to a trial in early 2015. I have no idea how long a trial will take, but with three years having past since the dispute began, the judge has been pushing for the speediest possible resolution.
If WLE and NSC get their way on every count, the lease will continue as it was before PW’s attempt to foreclose. The company will be out its substantial legal fees, but will be able to write off the $16 million at which the “settlement account” is carried on its tax records as an asset. This will cause future distributions to PW common and preferred shareholders to be characterized as return of capital rather than income, increasing their value to taxable shareholders.
If PW is able to foreclose, the settlement account will be due, as well as the likely reimbursement of its legal costs. It will be able to re-lease or sell the track at market rates. All this could be quite substantial: $16 million is $9.25 per share of common stock, which is currently trading around $10/share. The company does have liabilities, but it also has other assets such as its solar land and leases and the railroad property itself.
I first bought Power REIT stock because I saw a very promising yieldco in the making. After this legal case is resolved, the company will be able to get back on track to becoming a promising if minor yieldco which takes advantage of the REIT tax structure. (The only other REIT yieldco is Hannon Armstrong Sustainable Infrastructure (NYSE:HASI.)) The long litigation caused Power REIT to lose its first mover advantage, but it also offers the potential of a substantial upside and limited downside for shareholders. Three years have passed since the dispute began, but it will likely reach a conclusion before the end of a fourth.
Disclosure: Long PW, PW-PA, HASI
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