Another YieldCo Bites the Dust?
Sometimes Wall Street is too clever by half.
When it comes to YieldCos, for instance, you can’t help but admire investment bankers’ cynicism in coining a name for an asset class that promises the very thing income investors demand.
But for at least one company, the YieldCo designation—short for yield company—didn’t go far enough. Indeed, 8point3 Energy Partners LP’s (NSDQ: CAFD) ticker symbol is better known in the financial arena as the abbreviation for “cash available for distribution,” or all the money that’s supposed to fund those high and rising quarterly payouts. High fives all around to the company’s marketers for coming up with that one!
This particular YieldCo takes its pukey-cuteness even further with the name it selected for itself: 8point3 is a reference to the amount of time—about 8.3 minutes—that it takes for light to reach the Earth from the sun. That’s to hit you over the head with the fact that 8point3 is one of the largest solar-oriented YieldCos on the market, if you didn’t have to look up the origin of its name (we did).
Unfortunately for 8point3, no amount of cleverness could save it from a punishing business cycle. The YieldCo has been battered by two different macro factors that have crushed its unit price and called its very future into question.
Problems, Solutions … And More Problems
YieldCos were first created as another way to cash in on the master limited partnership (MLP) craze. Utilities and renewables companies were watching the energy sector successfully monetize stable, income-producing assets, such as pipelines, to create more growth capital while still getting a taste of these assets’ cash flows. Naturally, they wanted a piece of the action.
The problem is that while wind, solar, and other renewables projects generate similarly steady cash flows courtesy of ultra-long-term contracts, they aren’t eligible for the MLP structure.
Cue the lawyers and investment bankers! Of course, Wall Street found a way to create an investment vehicle that purported to give everyone what they wanted.
With the YieldCo structure, utilities and renewables companies could use their slow-growing assets as a cash machine, while income investors would have a security that eventually offers mouth-watering yields with the promise of strong future distribution growth.
Unfortunately, this concept suffered from poor timing. It was conceived toward the end of the energy boom, with most YieldCos debuting shortly before the cycle went bust. The same crash that took down MLPs also took down YieldCos.
Like MLPs, YieldCos depend on their ability to tap the equity market to help fund the purchase of accretive dropdowns from their sponsors. Typically, these types of deals are financed with an even mix of debt and equity.
But if the unit price on a high yielder falls far enough, then it becomes too expensive to issue new equity. That means deals will get funded entirely with debt—or they simply get left on the table.
While most MLPs rebounded sharply over the past year, some YieldCos are still trying to find a bottom. That’s not necessarily because of what’s happening at the YieldCo level. In general, the assets a YieldCo owns tend to be relatively low risk.
Instead, it’s all about what’s happening at the sponsor level. In good times, 8point3’s two sponsors—First Solar Inc. (NSDQ: FSLR) and SunPower Corp. (NSDQ: SPWR)—were a strong selling point. In theory, the backing of the country’s top solar-panel manufacturers would give 8point3 first dibs on a pipeline of accretive solar assets for decades to come.
But overcapacity in the solar sector has brought solar-panel prices to new lows, creating existential concerns for 8point3’s sponsors as they try to ride out the cycle.
For its part, First Solar is scrambling for capital to develop its next-generation solar panel. But because of 8point3’s low unit price—down more than 40% from its IPO less than two years ago—and its 8.5% yield, the YieldCo is effectively sidelined from acquiring more of First Solar’s contracted assets.
At current levels, the cost of capital is too high for 8point3 to do a secondary equity issuance. And with more than $700 million of non-amortizing debt coming due in 2020, right now the $957 million YieldCo simply can’t afford to borrow more.
A Message from 8point3’s Sponsors
With 8point3 no longer useful to First Solar in this environment, the sponsor announced earlier this month that it wants out. Since then, both sponsors have hired advisors to help pursue strategic alternatives with regard to their joint venture.
Given that any potential acquirer would be well aware of all three firms’ financial straits, it’s entirely possible that a deal won’t get done, and that both sponsors will still be around when the cycle finally turns. After all, potential suitors would probably drive a hard bargain since they know that First Solar is desperate to raise cash.
While SunPower could remain a joint owner of 8point3 alongside a new venture partner, the company is facing significant challenges of its own.
So both sponsors could end up being bought out by a firm that has its own pipeline of contracted renewables. Among the potential suitors cited by First Solar CEO Mark Widmar are infrastructure investors, as well as entities that already own stakes in the firm’s projects, such as utility giants like Southern Company (NYSE: SO).
Even with no future dropdowns from its current sponsors, 8point3 plans to grow its distribution by another 12% this year. And analysts calculate that the firm’s existing portfolio of projects would generate sufficient cash flows to grow the distribution another 12% in 2018.
Cash flows are projected to dip in 2019, then get a bump thereafter thanks to escalators in the firm’s power-purchase agreements.
So it’s possible that 8point3 could remain viable to income investors for a time, even as an orphan. But to adapt a line from the film “Annie Hall,” YieldCos are like sharks—they have to constantly move forward or they die.
And 8point3 has another major problem aside from a plateau in future distribution growth: the $700 million in non-amortizing debt that’s due in 2020.
At this point, it would make far more sense for the company to find a way to refinance that debt and put it at the project level, so future amortization is aligned with each project’s future cash flows, just like other YieldCos do. But for now, the whole sponsorship question has forced 8point3 to defer any decisions on this front.
A Very Special Situation
At Utility Forecaster, we’ve profited by taking advantage of similar situations in the past. Last year, for instance, we bought Columbia Pipeline Partners LP (CPPL) after its unit price crashed following the acquisition of its general partner, Columbia Pipeline Group (CPGX), by TransCanada Corp. (NYSE: TRP, TSX: TRP). Investors dumped CPPL due to its sudden orphan status and the resulting uncertainty about future distribution growth.
But we studied the Columbia empire’s structure and determined that it would make sense for TransCanada to eventually roll up CPPL since it owned a meaningful stake in the very same operating assets as CPGX. Meanwhile, we not only took advantage of the opportunity to buy CPPL near its all-time low, we also collected a still-growing distribution as we awaited its acquisition.
Our prescience paid off when CPPL was acquired at a nice premium, giving our subscribers a total return of 28.3% for a holding period of a little more than 10 months.
The situation with 8point3 is reminiscent of CPPL, but with a couple of key distinctions.
For one, CPPL carried very low leverage, while 8point3 is shouldering significant debt, with all of it coming due in just three years.
Equally important, we don’t know whether the joint-venture partners will prove successful in lining up another sponsor. While vulture investors such as Brookfield Asset Management (NYSE: BAM, TSX: BAM/A) wait for opportunities just like this, 8point3’s attractiveness depends in large part on whether there are acquirers with significant pipelines of contracted renewables who are looking for a vehicle to monetize them.
Right now, the pool of such candidates is relatively small. And the potential deal premium may not be enough to warrant the risk of holding the stock. Still, we’ll be monitoring this situation with interest, even though it’s a bit too risky for us.