Our Favorite Vulture Investor

One of our favorite deep-value investors happens to be the largest renewable energy company in the world. And until recently, it wanted nothing to do with solar.

As environmentalists push renewables with a quasi-religious fervor, it’s easy for some to dispense with economic considerations, at least until debts come due. 

That’s why we love the incredibly shrewd management team running Brookfield Renewable Partners LP (NYSE: BEP, TSX: BEP-U), the publicly traded renewables portfolio of Canadian alternative asset giant Brookfield Asset Management Inc. (NYSE: BAM, TSX: BAM/A).

With so much capital flowing into solar, Brookfield refused to buy into the hype. Instead, the company was content to manage a portfolio consisting mostly of hydropower assets, a deeply unfashionable choice amid the latest green revolution.

Indeed, as Brookfield Renewable’s CEO Sachin Shah acknowledged back in October 2015, “ … if you talk to most people today … and you say we’re the largest renewable company in the world … and we’ve delivered 16% annual returns over 15 years, and we own no solar, most people would step back and not understand how that could possibly happen.”

But Brookfield is an opportunistic investor. And it knew that eventually the cycle would turn.

In late 2015, Shah noted, “We’ve been very patient on solar … in five years, I think we’ll have a meaningful solar business attached to this portfolio.”

Where the Sun Doesn’t Shine

The company had been avoiding solar for two reasons.

First, Brookfield didn’t like the fact that solar’s economics were predicated on government subsidies because when policies inevitably change that can destroy value.

Second, the firm saw other investors piling into solar, pushing valuations to unsustainable levels.

Brookfield doesn’t play like that. Instead, the disciplined management team doesn’t buy until others are panicking, and it can pick up top assets for pennies on the dollar. Earlier we characterized Brookfield as a deep-value investor, but in some ways it’s really more of a distressed-assets investor.

As Sachin observed at the time, “ … we think that we’re entering what I call the first inning of a dislocation in the solar market, with owners who have acquired assets at multiples that are too high with unstable capital structures.”

“And we think,” he continued, “there may be an opportunity in the next two to three years to acquire meaningful solar … ”

Toward the end of April 2016, a little more than six months later, SunEdison Inc., the former renewable energy giant and “magic money machine,” declared bankruptcy. With $11.5 billion in assets, SunEdison had the dubious distinction of being the biggest bankruptcy of 2016. And Brookfield began licking its chops.

Picking Through the Remains

SunEdison’s once-burgeoning renewables empire included two YieldCo subsidiaries, TerraForm Power Inc. (NSDQ: TERP) and TerraForm Global Inc. (NSDQ: GLBL).

If you’re not familiar with YieldCos, they’re a relatively new asset class created by utilities and renewables companies (and their investment bankers) to monetize stable assets under long-term contracts. In other words, their hope was to achieve something similar to what master limited partnerships (MLPs) did for the energy sector.

In this scenario, the parent company sells assets that generate predictable cash flows to subsidiaries that operate as yield-oriented investment vehicles. The parent can then use the proceeds from each sale to invest in new growth, while also still getting a taste of its former assets through an ownership stake in its subsidiary.

But a YieldCo is only as good as its sponsor’s potential pipeline of future asset dropdowns. And with SunEdison in the midst of a reorganization, the future of its two YieldCo subsidiaries was suddenly very much in doubt.

In late June, Brookfield Asset Management revealed it had acquired a 12% stake in TerraForm Power, with an option to more than double its stake at a later point.

More negotiations ensued over the next six months, with other potential acquirers circling, before culminating in two deals this week.

In the first deal, Brookfield Renewable and its deep-pocketed parent plan to acquire TerraForm Global for $787 million in cash and the assumption of $455 million in net debt.

In the second deal, Brookfield agreed to up its stake in TerraForm Power to 51%.

As the subsidiary of Brookfield Asset Management, Brookfield Renewable’s upfront cash outlay in these deals is expected to be around $500 million.

Divvy up the Goodies

For its part, the Brookfield empire will have secured control of about 3,600 megawatts of contracted renewables (60% wind, 40% solar) situated around the world. And Brookfield Renewable will have a sizable piece of that.

Meanwhile, Brookfield Asset Management has also gained another valuable piece of currency that will enable it to continue monetizing the renewables that it’s acquired, including the more than 900 megawatts of assets it will receive from the acquisition of TerraForm Power’s sister YieldCo, TerraForm Global.

But before that can happen, Brookfield will first work toward helping TerraForm Power reduce leverage, boost cash flows, and restore its dividend.

To that end, Brookfield Asset Management will provide TerraForm Power with a $500 million line of credit to facilitate growth-oriented acquisitions, as well as the right of first offer on 3,500 megawatts of wind and solar plants.

For Brookfield Renewable, the big question is whether it will continue to push into wind and solar now that TerraForm is part of the Brookfield empire.

Complicating this assessment is the fact that Brookfield’s Sachin Shah really wears two hats—one as CEO of BEP, the other as the managing partner in charge of Brookfield Asset Management’s overall renewables segment. So we can’t really deduce anything from the fact that he led the analyst call following the deal’s announcement.

Right now, it looks like BEP will remain a largely hydro-oriented vehicle, while TERP will become the firm’s wind-and-solar vehicle. But capital is ultimately finite, so it never hurts to have two potential funding vehicles for renewables.

Of course, it’s always possible that in the long run Brookfield chooses to merge these two entities, but clearly they see value in having a publicly traded wind-and-solar operator that’s separate from their hydro play.  

Although TERP could soon become a very promising yield vehicle, income investors who want to get paid right now are better served by BEP’s 6.5% yield.