Why This German Solar Executive Is Skeptical About American YieldCo Assumptions

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by Tom Konrad CFA

Ever since the first YieldCo, NRG Yield (NYSE:NYLD), went public in 2013, it and other similar YieldCos have been reshaping the market for operating renewable energy assets, especially wind and solar PV farms. 

A YieldCo is, to put it simply, a publicly traded subsidiary of a developer and operator of clean energy farms that uses the cash flow from its assets to return a high current dividend to shareholders. Most large, publicly traded clean energy developers have already launched or are preparing to launch a YieldCo. The current crop includes NRG Yield, Pattern Renewable Energy Partners (NASD:PEGI), NextEra Energy Partners (NYSE:NEP), Abengoa Yield (NASD:ABY), TerraForm Power (NASD:TERP), and TransAlta Renewables (TSX:RNW, OTC:TRSWF). First Solar (NASD:FSLR) and SunPower (NASD:SPWR) are jointly planning the IPO of a YieldCo to own PV farms to be called 8point3, after the time it takes the sun’s rays to reach the Earth.

This rush to launch YieldCos is unsurprising, given that investors can’t seem to get enough of them. Since their IPOs, the YieldCos listed above have advanced between 15 percent (Abengoa Yield) and 127 percent (NRG Yield), while at the same time paying dividends and selling large amounts of stock in secondary offerings to fund their growth plans and raise cash for their sponsors.

The new kids on the block

YieldCos were not the only, or the first, publicly listed companies to use clean energy assets and pay a dividend. Long before they came along, there were the Canadian Income Trusts, many of which were focused on clean energy. The tax advantages that first made Canadian Income Trusts a tax-favored structure have since been changed, but several of these trusts survive in a similar form, the most notable being Brookfield Renewable Energy Partners (NYSE:BEP / TSX:BEP.UN), which differs from the YieldCos only in that it develops some projects internally, rather than buying them from a sponsor.

Another is Capital Stage AG (XETRA:CAP), the largest operator of solar PV parks in Germany. Capital Stage also has large holdings of PV in Italy and France, and wind in Italy and Germany, and is in the process of acquiring PV parks in the United Kingdom. It bought its first PV project in 2009.

German skepticism

In an interview, Felix Goedhart, Capital Stage’s CEO, expressed mixed feelings about the YieldCo phenomenon. “We like having peers,” especially highly valued peers like the YieldCos, but they are also competitors for buying PV and wind projects. Many such projects do not even make it to the market, since they are sold directly by developers to their captive YieldCos. 

Goedhart is confident, however, that Capital Stage will continue to find attractive deals at after-tax internal rates of return well in excess of what is available to “anyone with a pot of money” who takes part in solar and wind mergers and acquisitions. 

He says that his firm’s experience and reputation for reliability allow it to find special situations that less experienced players are not able to touch. When Capital Stage finds such deals, it can act quickly because it does due diligence internally, and can handle “complex situations” such as the current acquisition of solar in the U.K. 

He said some investors new to the business would have backed away from that deal because it looked complex. Capital Stage, on the other hand, knows “basically everything” about the deal and has “seen so many things [that] we know what to do to take on these challenges.”

Goedhart’s skepticism of YieldCos centers on their accounting practices, and the inherent conflict of interest when they purchase assets from their sponsors. He asks, “Are you worried by the fact that [developers] and some ‘independent’ decision-making body decides which asset goes at which price?”

This conflict of interest has not worried investors yet, but it will doubtless begin to worry them if purchasing overpriced assets from their sponsors keeps YieldCos from producing the long-term dividend growth they currently expect.

A kind of Ponzi scheme?

Goedhart’s other point of skepticism lies around the source of YieldCo dividends. He contrasts Capital Stage’s own dividend, which is “paid out in cash, not paper, not on a business plan, [but] real money operationally earned. Not in a kind of Ponzi scheme where you’re raising real funds and taking parts of the funds to pay out a dividend which you haven’t earned operationally.”

Do YieldCos pay out dividends in a kind of Ponzi scheme as he claims?

In 2014, NRG Yield produced $223 million in cash flows from operations (CFO), and paid out $122 million in dividends to shareholders and distributions back to its parent, NRG. Cash flow from operations is a very broad measure, and does nothing to account for cash needed to replace its assets at the end of their useful lives. Actual income, which does include depreciation, was only $16 million, far below what would be needed to pay its current level of dividends and continue as a viable business beyond the useful life of its current assets.

Other YieldCos operate in a similar fashion. Abengoa Yield paid $24 million in dividends, created $44 million in CFO, but produced a net loss in 2014. Although their track records are short, most YieldCos seem similar: they have cash flow from operations to comfortably pay their dividends in the short term, but insufficient earnings to both pay a dividend and invest for the future.

Is Capital Stage any different? The company has not yet released its 2014 results, but in 2013, it earned €14 million from which it paid €7 million in dividends in 2014. Its dividend is easily covered by both earnings and cash flow. 

Summing up

YieldCo dividends are not supported by earnings, and so they are not sustainable in the long term unless the companies continue to raise capital to re-invest. Further, there are reasonable questions about the conflicts of interest when YieldCos purchase assets from their controlling sponsors.

While the YieldCo model is valuable in that it matches the strong cash flow producing characteristics of operating clean energy projects with the cash flow needs of income oriented investors, dividends from YieldCos are not directly comparable to dividends from operating companies which have earnings, not just cash flow, sufficient to replace their assets over time. 

Instead, investments in YieldCos should be viewed as amortizing assets. Over the 15- to 30-year typical remaining life of YieldCo assets, the value of those investments will slowly be paid out as a dividend, causing the share price to fall when aging assets are no longer able to support the dividend, or because early investments become diluted by the capital needed to invest in newer assets.

That does not make YieldCos any sort of Ponzi scheme, but it does mean that YieldCo dividends is not worth as much as dividends from operating companies that can fully cover their dividends with earnings.

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Tom Konrad is a financial analyst, freelance writer, and portfolio manager specializing in renewable energy and energy efficiency. He’s also an editor at AltEnergyStocks.com.

Disclosure: Tom Konrad and/or his clients have long positions in PEGI, FSLR, ABY, RNW, BEP, and a debt investment in GridEssence, a private company which Capital Stage AG is in the process of buying. They have short positions in NYLD and TERP.

This article was first published on GreenTech Media, and is republished with permission.

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