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Jul 17, 2013

A Rock that Churns out Cash: Solar YieldCos


Own a piece of the rock. For years the slogan served Prudential Financial, whose logo is a rendering of the Rock of Gibraltar. The implications were clear—if you want investments that are solid and reliable, go with Prudential.

Not to take anything away from Prudential, but there’s a new “rock” in town: solar. We’re talking photovoltaics (i.e., slabs of, most often, silicon rock), which have been called, “a rock that makes electricity.” Think about it: no moving parts, no fuel, with 20-years-or-more of contract-able electricity production. Like inventor and marketing personality Ron Popeil’s famous rotisserie, you basically “set it and forget it.” In other words, solar PV is a rock … that produces electricity. (Granted, it does so with some minor, yet caring and intelligent, O&M over the years.)

And now, with the July 16th initial public offering (IPO) of NRG Yield (NYSE: NYLD) it looks like solar can now take a page out of Prudential’s playbook and be a rock that can also provide you, as the individual investor, steady and solid yields.

NRG Energy, the largest independent power producer in the nation, created NRG Yield, Inc., a subsidiary that owns, operates, and acquires renewable and conventional electricity generation projects, primarily solar, wind, and natural gas. NRG Yield’s initial profile is an aggregation of eleven renewable and conventional utility-scale (i.e., big) power plants and two distributed solar project portfolios (think lots of solar PV projects on commercial building rooftops). The NRG Yield public offering will let NRG sell off a portion of its ownership of these power-generating assets to the new NRG Yield shareholders, thereby raising additional capital to fund more solar.

Solar financing still too pricey

Substantial decreases in the cost of solar panels as well as the advancement of third-party financing has made solar pricing—paid as a financed monthly bill instead of tens of thousands of dollars upfront—more affordable than utility rates for hundreds of thousands of customers. While third-party financing has opened up the solar market, it has limits to its own growth. Solar panels might be cheap, and financing attractive for some individual residential customers (when compared to utility rates), but larger-scale financing for distributed solar projects is expensive, largely due to two major costs:

  • high cost of capital, comparable to credit card lending rates
  • very high upfront financial transactional costs

Bringing down costs in both categories by applying cheaper money (capital with lower required rates of return) and more standardized, mainstream financing vehicles that have lower transactional costs, is critical for moving the economic viability of solar from some customers to most customers.

The role of YieldCos

Over the past year, momentum has been growing for the use of master limited partnerships (MLPs) or real estate investment trusts (REITs) to fund renewable energy and encourage institutional investors to consider solar. Both MLPs and REITs are yield-oriented investments, where a high percent of earnings are passed to shareholders (called “unit holders” for an MLP). But some of the interest in MLPs and REITs has waned as industry pundits have espoused the trickiness of using these entity types while capturing tax benefits, which is a big part of financing solar these days. They also face governmental hurdles (MLPs require legislation while REITs require IRS rule clarifications or new legislation).

But MLPs and REITs aren’t the only games in town. Another type of yield-producing entity, the “YieldCo,” lets solar developers shift their renewable generation to a pure-play dividend-oriented company that’s not bound by the investment and income rules of MLPs or REITs and needs no new governmental actions. Sometimes the term “YieldCo” is used as a catch-all for these yield-oriented investments, and sometimes YieldCos are specifically meant to be only “C” corporations designed to pass through dividends.

A “C” corp. solar YieldCo can take tax benefits if it has a tax bill, and likely NRG Yield will do so by balancing its liability-heavier fossil-based assets with its benefits-heavier renewable assets. That mix might be tougher for YieldCos focused entirely on solar, so more financial engineering might be needed to bring them forth. Solar pure-play YieldCos will likely find it a bit easier when solar tax benefits get smaller in 2017 with the investment tax credit decrease from 30 percent to 10 percent. In addition, there might be an opportunity to mix older solar assets that’ve aged past their tax benefit period and now have tax liabilities with newer solar assets which have significant tax benefits.

Are YieldCo stocks an interesting buy?

Similar to how the exciting promise of solar securitization mixes with the discomfort of securities’ mental association with real estate securities and their contribution to the 2008 financial crisis, YieldCos are not without some concerns. For example, while YieldCo losses should be public with normal SEC reporting rules, you have to look at the prospectus to see if you’re getting a fair shake between the YieldCo’s management (in this case NRG) and you the potential shareholder. However, YieldCos formed from reliable, long-term, power-generating assets that have signed agreements with well-mixed, high-credit buyers (e.g., utilities) should be reasonably safe bets.

This YieldCo model enables individual and institutional investors pure-play access power generation cash flows, not possible when buying stock in solar developers (e.g., SolarCity) or vertically integrated solar companies (e.g., First Solar), where there is more to those businesses than cash flows from operating solar projects. Granted, crowdsourced funding also provides focused investment on solar asset cash flows, and we at RMI find this crowdsourcing compelling. In the near term, however, crowdfunding is unlikely to provide the scale of solar financing available through NRG Yield and follow-on YieldCos.

NRG Yield’s specifics

In total about 29 percent of NRG Yield’s generation is renewable (wind and solar). So indeed, NRG Yield is not a solar-only investment, and indeed is a notable contrast to Mosaic’s crowdsourced platform which does offer pure-play solar cash-flow-based returns. However, NRG Yield intends to use the proceeds from the IPO to fully fund the remaining 123 MW of the 250-MW California Valley Solar Ranch project.

The price for NRG Yield and its 1,324 MW of initial capacity sold for $431 million, a bit over announced expectations of $410 million. Industry experts expect dividend returns in the range of 5–7 percent, paid annually to shareholders. That’s quite an improvement over the 8–15 percent cost of capital that generally sits behind distributed solar financing.

YieldCos an important financing tool for solar’s economic competitiveness

YieldCos are designed to provide stable, long-term cash flows, similar to annuities, and be as easy as buying stocks or bonds. This means folks like you and us can buy in, which is a lot different than the normal private cabal of solar finance consisting of venture capital, private equity, and tax equity from big banks and insurance companies. Long-term contracted solar, insulated from commodity prices, is a great offering for yield-oriented investors and we think demand exists for much more. YieldCos also make solar cheaper in cents per kWh (the levelized cost of ownership), because the financing cost of capital is lower. In short, they’re likely a scalable and dependable (like a rock) solution of which we’re hoping to see more.

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August 14, 2013

The yield will reach 4.25 percent by the end of next year, according to Bloomberg projections (NYLD:US) based on company filings.