The Yieldcos Stumble
The yieldco was created as a renewable energy investment analogue to the master limited partnerships. Internal Revenue Code Section 7704 states that at least 90% of an MLP’s income must come from qualified sources, and Section 613 further requires qualifying energy sources to be depletable resources or their derivatives such as crude oil, petroleum products, natural gas and coal. Renewable energy isn’t considered to be a qualifying energy source (something the proposed Master Limited Partnerships Parity Act seeks to rectify), therefore the yieldco structure was formed as a pseudo-MLP.
Like MLPs, yieldcos are meant to provide a predictable tax-deferred yield in exchange for cheap equity capital. They differ from MLPs in that they are not automatically exempted from the corporate income tax, but accelerated depreciation provisions of the tax code and other tax breaks offered to renewable power producers mean that they are able to report net losses for five years at least, while using cash flow to pay investors.
Yieldco distributions are treated as dividends under U.S. tax law to the extent they are paid out of current or accumulated earnings. If dividends are paid out in excess of current and accumulated earnings for a taxable year, the excess cash payments would be treated as a return of capital for federal income tax purposes. This reduces the adjusted tax basis of the shares, and any balance in excess of the adjusted basis is treated as a capital gain taxable only upon sale.
The yieldco era began to heat up in July 2013 when NRG Energy (NYSE: NRGY) spun off subsidiary holding solar generating assets into NRG Yield (NYSE: NYLD). Then TransAlta Renewables (TSE: RNW) listed on the Toronto Stock Exchange in August 2013, and Pattern Energy Group (NASDAQ: PEGI, TSE: PEG) listed simultaneously on the NASDAQ and Toronto Stock Exchange the next month.
In 2014 several more olar PV yieldcos launched. TerraForm Power (NASDAQ: TERP) was spun off from SunEdison (NYSE: SUNE). Abengoa Yield (NASDAQ: ABY) was formed by Abengoa (NASDAQ: ABGB). This year First Solar (NASDAQ: FSLR) and SunPower (NASDAQ: SPWR) jointly launched 8point3 Energy Partners (NASDAQ: CAFD).
How have these new yieldcos fared to date? Here are some metrics from several of the newer yieldcos sorted in order of descending enterprise value:
- EV = Enterprise value in millions as of Nov. 16
- EBITDA = Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in millions
- Debt/EBITDA = Net debt at the end of Q3 divided by TTM EBITDA
- FCF = Levered free cash flow for TTM in billions
- Total Return = Total share price return, adjusted for dividends, since IPO
- Yield = Annualized yield based on the most recent quarterly distribution
As you can see, each of these yieldcos other than TransAlta Renewables has suffered a double-digit loss since its IPO. Debt for each of these offerings is quite high relative to a comparable midstream MLP. Perhaps not coincidentally, TransAlta has the lowest debt ratio among these yieldcos, and was also one of only two to generate positive FCF over the past 12 months. TerraForm Power, with the largest negative FCF in the group, has also performed the worst.
Perhaps due to a combination of the meltdown in the energy sector and a lack of track record for these new investment vehicles, the market hasn’t been kind to these offerings. Another concern may be the looming expiration in 2016 of the production and investment tax credits for renewable projects. Loss of the tax credit could stymie the continued growth required to maintain the tax shield on the distributions.
So, despite the fact that we are big fans here of renewable energy, we continue to advise to steer clear of the yieldcos at least until the dust settles. In any case, it should be clear that these should be considered very aggressive speculations suitable only for those with the highest risk tolerance.