Yieldcos: Spinoffs Seek Tax and Other Advantages for Renewable Projects
Government support is providing powerful tailwinds for renewable energy projects. Despite some public relations problems, the Obama administration’s clear policies still favor renewables over any type of hydro-carbons — even domestically produced oil and gas. Until recently, investors wishing to invest in wind and solar projects have had relatively few vehicles to gain exposure to renewable power generation infrastructure assets. In addition, investors generally prefer ‘pure plays’. Pure plays on renewable energy generation offer the opportunity to invest in the growth of renewables… without exposure to the slower-growing, traditional fossil fuel generation assets along with it.
Renewable Generation Projects Are Seeking Creative Financing Vehicles
Demand For Financing Fuels Yieldcos
Renewable energy projects have, for their part, been seeking additional sources of financing — especially as forecasts suggest growing demand for renewable capacity over the next decade. As a consequence, companies have been exploring creative financing vehicles. For a variety of legal reasons, renewable projects have mostly been unable to structure themselves as real estate investment trusts (REITs) or master limited partnerships (MLPs), although various groups are pushing for regulatory accommodations. In the meantime, an alternate vehicle has emerged: the “yieldco.” Yieldcos are not able to offer all of the tax advantages of REITs and MLPs, but the benefits they do offer may make them attractive enough to play a significant role in the buildout of renewable infrastructure.
Desirable Assets + Dividends = Higher Price Earnings Multiples
A company forms a yieldco by spinning off an entity which owns its renewable assets (usually wind farms or fields of solar collectors), as well as the streams of revenue from the contracts for their output. These desirable assets, when spun off into a separate investment vehicle, often command a higher multiple than their parent company. This is because the parent companies are usually traditional electric utilities that have been required to invest in renewables in order to meet requirements to produce a percentage of their electricity via the use of renewables. The parent utility can maintain its own pipeline of renewable projects, with their yieldco having the first option to buy those renewable assets as they are completed.
The separate yieldco offers investors a liquid, publicly-traded entity with predictable cash flow and prospects for capital appreciation. The utility receives the cash from investors to use toward future projects, and the yieldco gains access to the funding that such a liquid market generates. The yieldco stock’s relatively high valuation can be even higher if the yieldco is able to carry forward its depreciation to shelter earnings from taxation.
Additionally, yieldcos are able to diversify risk by holding assets across various technologies and in varied geographical regions.
The tax advantages of this structure may not be as robust as those of real estate investment trusts (REITs) or master limited partnerships (MLPs), but they are still significant. Most renewable energy projects don’t generate taxable income for years after their operation begins, since depreciation exceeds revenue. Excess depreciation can be carried forward for up to 20 years. Without current-year earnings or profits, cash distributions are considered nontaxable returns of capital to shareholders.
These characteristics — high valuation, dividend yield, risk diversification, liquid trading, access to growth through future acquisition of assets, and tax advantages from depreciation — make yieldcos an interesting option for investors seeking exposure to renewables. Earlier this year, NRG Energy Inc., created a yieldco (NRG Yield Inc.) with a portfolio of its solar, wind, and gas assets which has risen some 60 percent from its offering price in July. Other similar deals this year — for example, TransAlta Renewables and Pattern Energy — have also had positive results. Barring regulatory changes or the emergence of other vehicles, it looks like yieldcos will increase their presence in the investment world.