NextEra’s renewable assets enable formation of high-yield spinoff

Source: Rod Kuckro, E&E reporter • Posted: Thursday, June 26, 2014

The latest wrinkle in the transformation of the electric utility business model is playing out on Wall Street this week as investors weigh the initial public offering of NextEra Energy Partners LP, a “yieldco” that is designed like master limited partnerships in the oil and natural gas industry to deliver predictable, long-term income to investors.

The new company will be majority owned by Juno Beach, Fla.-based NextEra Energy Inc. and would be the first one — and maybe the only one — to be created by a utility holding company. NextEra launched the IPO on June 19, and the stock is expected to be priced tomorrow.

The company is not talking while Wall Street sets the price, but NextEra Chairman and Chief Executive Officer James Robo has said he sees a huge upside, expecting renewable generation to grow by 10 percent a year, spurred by state renewable portfolio standards and federal rules to control emissions from fossil-fueled plants.

The yieldco as a corporate entity in the electricity sector is less than a year old. The first one was established by NRG Energy Inc. in July 2013. Since then, independent power producers (IPPs) Pattern Energy Group LP, TransAlta and Abengoa have established yieldcos.

“NRG was the first company to do that and it’s been so successful and so well-received by Wall Street that other companies are doing it. … It’s the theme of the year,” said Mihoko Manabe, senior vice president with Moody’s Investors Service and author of Monday’s report on NextEra’s dive into the yieldco pool.

In addition to NextEra’s move, SunEdison has filed with the Securities and Exchange Commission to offer shares in its yieldco, TerraForm Power Inc., this year. Moody’s late Tuesday issued a rating on the debt TerraForm Power plans to issue. The Ba3 rating is the first time the ratings agency has taken action on the debt of a yieldco, it said. The rating is “underpinned chiefly by our expectations for stable distributions arising from a low business risk asset portfolio and an attractive industry environment for solar projects” said Swami Venkataraman, Moody’s vice president and senior credit officer.

Yieldcos are “the power industry take on the MLP. The corporate finance model is the very same thing. It’s going after the same sort of investors, but you’re putting power assets into it,” Manabe said in an interview. A company establishing a yieldco would seed it with existing, operating power or transmission assets and then grow the yieldco portfolio through either the purchase of assets from other companies or the “drop down” of assets it has developed into the yieldco.

A key aspect of the assets in the yieldco is that they hold long-term power purchase agreements (PPAs) with utilities or other customers that ensure consistent cash flow for the company and its investors.

One of the benefits to investors is steady dividend income of 5 percent or more during a period of stagnant, low bond yields. “Investors are hungry for yield; they’re willing to pay up for it,” she said. Because of that, she expects to see more of them proposed this year.

Manabe said Moody’s expects the creation of yieldcos “will come more from the IPP side” because they have “a pipeline of projects” developed by their parent company to draw into the yieldco.

Manabe thinks NextEra will be “the only major utility holding company to utilize the yieldco structure” because “most other diversified utility holding companies don’t have a big renewable portfolio in the way NextEra does.” Citing Duke Energy Corp. as an example, with 1.7 gigawatts of renewables, it pales in comparison to NextEra’s wholesale portfolio of 18.4 GW “and more on the way,” she said.

Keith Martin, co-head of the project finance group at Chadbourne & Parke LLP, says a company would need to have projects producing more than 1,000 megawatts with an operating value of at least $500 million to justify a yieldco, as well as plans to raise up to an additional $200 million in an IPO.

By another measure, a company eyeing a yieldco should have annual cash flows available for distribution in the $50 million to $100 million range, said NRG Executive Vice President and CEO Kirkland Andrews.

‘Yieldcos are like vacuum cleaners’

Yieldcos are not without risk. Yieldcos rich in renewable energy assets avoid the commodity risks faced by generators that rely on fossil fuels. “That helps,” said Manabe, because “if there’s a commodity price sensitive component, your cash flows are going to be more volatile and that makes them less attractive to put into a yieldco.”

However, the life cycle of a wind farm or utility-scale solar plant is unknown. And therein, the quality of the technology could affect a project’s output, said one industry analyst who declined to be identified. For example, solar modules degrade over time in their capacity to produce electricity, and if they degrade before the PPA is concluded, the yieldco may have to replace equipment and renegotiate the PPA.

In the view of Chadbourne’s Martin, “the two biggest risks for investors are interest rates rising and that there aren’t enough operating projects to vacuum up. Yieldcos are like vacuum cleaners; they are not limited to buying assets that their affiliated development companies produce.”

Investors in the yieldcos are not “looking for a 3 percent yield; they’re not looking for a 6 percent yield. They’re looking for what they can earn from alternative investments in the market and that might be 13 or 14 percent — so to the extent the dividend yield is low, they’re looking to make up the rest through capital gains” from a stock sale, Martin said.

Right now, private equity firms that bought and have held a lot of renewable projects from early-stage developers in 2005 and 2006 are putting them on the block, Martin said. And the yieldcos are displacing buyers such as MidAmerican Energy Co. and Sempra Energy as winning bidders for assets.

“We’ll go through this phase and a lot of the assets will be bought up,” Martin said. “Everything will be vacuumed up after a while. There’ll be a run of these for a little bit and then others will have a hard time.”

Martin thinks the company that created the yieldco may be the “greatest beneficiary” from this new financial model. The yieldco effectively serves as “a captive buyer for the development company,” he said. “It’s a ready outlet for [the parent company] to transfer its development assets and realize their value at perhaps a higher price than is otherwise available in the market.”