Falling yieldcos may push US utilities into mergers

UNITED STATES: The growth-driven yieldco model is on the wane in the US, creating opportunities for smaller utilities to invest in operating renewables and reduce their carbon emissions.

Moving in… Utilities are buying stakes in or acquiring 100% of completed wind projects (pic: Duke Energy)

New money is moving into the wind-energy sector to fill the void left when slumping share prices forced publicly traded yieldcos to back off in their efforts to acquire new projects to add to their operating portfolios.

"Last year our dance card was filled with yieldcos. This year it is filled with infrastructure and utility investors,"Tom Carbone, president of Texas-based developer Tri Global Energy, told last month's Infocast Wind Power Finance and Investment Summit.

Over the past three years the renewable-energy sector saw a surge in use of the yieldco structure, particularly in the US, driven by businesses selling off some of their existing fleet to release capital. Yieldcos are designed to hold operating plants with long-term power contracts, which generate reliable cash flows that can be paid out to investors as dividends.

Overly aggressive

But last summer, yieldcos began to face difficulties in the equity markets as investors pulled back. The share selloff was partly triggered by concerns about overly aggressive growth expectations for what was supposed to be a safe, income-oriented investment vehicle. By late September, stock prices for the sector had bottomed out at a level 54% below their market peak. Yieldcos stopped issuing new shares to fund project acquisitions, taking them out of a market in which they had become the dominant player.

"In the second half of last year there was a marked downturn in interest in acquiring assets. First off, obviously, the public yieldcos were not in the market. But also, all the wannabe yieldcos that were trying to bulk up their asset base disappeared," said Ted Brandt, CEO of Marathon Capital.

The situation is starting to change, however, as other alternative sources of capital step in. Although it is still early in the year, he is seeing public investor-owned utilities starting to muscle in. "I think you are going to see massive amounts of mergers and acquisitions over the next year," he predicted.

An early 2016 mover was Montana-Dakota Utilities, which purchased the 107.5MW Thunder Spirit Wind project in North Dakota from utility Allete Clean Energy, adding it to the two much smaller wind facilities in its operating portfolio.

In addition to purchasing projects outright, utilities are forming joint ventures with developers. Last September, for example, North Carolina's Duke Energy acquired a 50% stake in the 211MW Mesquite Creek Wind project in Texas.

Utility-driven acquisitions are only going to increase as pressure mounts to cut carbon emissions and bring online new renewable generation, agreed a number of speakers at the wind industry's financial gathering for North America. Carbon is also a driver for many of the power-focused investment funds that are starting to play a bigger role in the market.

Seeking carbon neutrality

"A fundamental trend in the market at a macro level is that institutional and individual investors are increasingly looking to have investments that are carbon-neutral or lead to carbon-reductions," said Susan Nickey, managing director at Hannon Armstrong, a provider of debt and equity financing to the renewable-energy sector. "The funds are being driven in that direction. They are looking for these kind of investments."

Infrastructure-oriented funds have billions of dollars in available capital and a lot of pent-up demand after being outbid by yieldcos for projects over the last 12-18 months. JP Morgan Asset Management acquired 333MW of wind assets from SunEdison in December. Blackrock, a US-based multinational investment-management firm snapped up UK developer Renewable Energy Generation in December and committed last year to taking a 50% stake in 894MW of US wind projects developed by EDF Renewable Energy. Some of the funds are looking for the long-term contracted cash flows these projects provide, while others are willing to take higher risks for higher returns, investing in projects still under development. Some buy entire development companies - I Squared Capital, for instance, acquired Chicago-based Lincoln Clean Energy in January.

While many funds are active on a global scale, much of their attention is likely to be focused on the US in coming years. US yieldcos were harder hit by the downturn than the more conservative European models, leaving a gap for alternative capital sources. December's five-year extension of key US tax incentives also gives investors confidence in the market's growth potential.

"A lot of people that were sitting on the sidelines are coming in because they have that runway to make investments over an extended period of time," said Tim Kemper, a partner at financial advisory firm CohnReznick.

A future for yieldcos

Yieldcos are not being discounted as viable buyers in the future as they work through issues and regain investor trust. "It seems where some of them are trading right now, they may have the ability to do secondary share offerings in 2016 for acquisition purposes," said Kemper.