With the recent excitement about the YieldCos from SunPower, First Solar and SunEdison, it would seem that the YieldCo capital structure is a market winner for large project portfolios from vertically integrated companies.
But the YieldCo structure doesn't work every time, as evinced by Sol-Wind's withdrawal of its $100 million IPO registration of earlier this month, as reported by Renaissance Capital. Last month we covered Sol-Wind's IPO filing for its modestly sized YieldCo.
The movement toward a master limited partnership (MLP) structure is what made this deal unique. The MLP structure creates the potential to open up a new source of cheap capital for solar and wind projects. It puts renewables on more equal footing with oil and gas when it comes to some of the U.S. tax code.
Bigger is definitely better when it comes to YieldCos
GTM's sources close to the deal suggest that the deal was pulled "due to, among other things, the amount of cash available for distribution (CAFD), which was too little -- the figure was around $26 million per year. That was a test of the bottom of the market. The YieldCos that have been successful have had more like $50 million CAFD, with the market really looking for figures like $80 million to $100 million. Those are hard numbers to hit, especially if the bulk of the proposed assets are in U.S. solar, where a lot of the economics are in tax benefits, not cash. If you look at the YieldCos to date, they tend to include non-solar and non-U.S. assets to help drive CAFD." CAFD is a non-GAAP metric of a YieldCo's "ability to generate cash to service its dividends."
The SunEdison TerraForm Power YieldCo has a 2015 CAFD guidance of $214 million.
The website The Deal reports, "It appears as though the market did not have enough confidence in an unknown sponsor, according to...industry sources. The management team was light on well-known industry names, which may have added to investor caution." The Deal's sources added that Sol-Wind's general partner, 40 North, a New York-based hedge fund, has "deep financial pockets and likely will just wait for the market to get 'frothy' and then brush off its IPO papers and try again."
The article quoted a source as saying that while forming a YieldCo has become easier, "bigger is definitely better in the equity capital markets."
Details on the postponed Sol-Wind YieldCo IPO with an MLP flavor
Here are the recently reported details of the Sol-Wind YieldCo structure that could not make it through the IPO window this month.
Sol-Wind is an aggregation of 184 megawatts of mostly solar assets (with some wind) in the U.S., Puerto Rico and Canada. The firm was looking to raise $100 million in the IPO, with UBS Investment Bank and Citigroup leading the transaction. Backers include hedge fund 40 North. The CEO of the YieldCo is Scott Tonn, the former chief of solar distributor SunWize Technologies. Last year, Sol-Wind had income of $4.9 million on revenue of $22.1 million, according to the S-1 filing. The company estimated 2015 revenue of $41.8 million.
As Louis Berger of Washington Square Capital Management wrote in a GTM article, "YieldCos are similar in concept to a master limited partnership in the oil and gas sector or a real estate investment trust in the real estate sector. All three investments are designed to provide a dependable stream of cash flow to investors. Whereas MLPs use oil or gas pipeline income and REITs use commercial real estate lease income, YieldCos use completed renewable energy projects with long-term power-purchase agreements in place to deliver dividends to investors."
Here's the crucial tidbit from Sol-Wind's S-1 document:
- "We believe we will have a competitive advantage in sourcing acquisition and investment opportunities because of our master limited partnership ("MLP") structure. We believe our structure allows us to utilize low-cost capital in the form of tax equity without affecting our ability to maintain an attractive level of distributions. We intend to leverage these advantages in executing on acquisition and investment opportunities, which will ultimately enable us to grow our distributions."
As GTM Senior Editor Stephen Lacey reported, master limited partnerships are publicly traded entities that are allowed to act like traditional corporations, but are not required to pay corporate income taxes. Instead, after raising capital for projects through the public markets, MLPs pass income down to shareholders, who pay personal income taxes. MLPs have been limited to fossil fuel companies, mostly those developing pipelines.
David K. Burton of law firm Akin Gump did some analysis, excerpted here with permission from the author:
- The Sol-Wind structure is like an upside-down YieldCo. In the YieldCo structure, the public entity is a corporation that owns a partnership; in the Sol-Wind structure, the public entity is a partnership that owns a corporation. One drawback of the Sol-Wind structure is that the public investors will receive an IRS Schedule K-1 from the MLP, which causes tax filing complexity not present in the YieldCo structure (where the public holds corporate stock).
- Sol-Wind’s structure is an MLP that meets the exception in I.R.C. § 7704 to be publicly traded, yet taxed as a partnership.
- Because Sol-Wind’s underlying assets are renewable energy projects that do not generate “qualifying income” for purposes of I.R.C. § 7704(d), the structure includes a blocker corporation (a blocker corporation is a limited liability company organized in Delaware that makes an election to be taxed as a corporation) between the MLP and the assets. As a result, the venture will owe corporate tax. However, according to the disclosure in the S-1, Sol-Wind does not “expect [its] corporate subsidiaries to generate a significant amount of taxable income for at least the next 30 years.” Thus, on a present-value basis, the use of the corporate blocker to meet the rules of I.R.C. § 7704(d) results in only a de minimis tax cost. The tax cost is minimal because Sol-Wind has bought and will buy renewable energy projects that qualify for accelerated depreciation and tax credits, and these tax benefits should more than offset the taxable income of the corporation. The tax attributes that are not used in the current year to zero out the blocker corporation’s tax liability can be carried forward 20 years.
- It is not entirely clear from the S-1 how Sol-Wind can both monetize the tax benefits in tax equity transactions and still not owe any corporate-level tax for 30 years. Presumably, it will monetize less than all of the tax benefits in the tax equity transactions to enable the corporate blocker to shelter its income for the next 30 years.
- The Sol-Wind structure is similar to the MLP structure used by private equity fund managers that went public (e.g., KKR). These MLPs also had underlying assets that generated non-qualifying income under I.R.C. § 7704(d) and, therefore, had to have a blocker corporation between their business operations and the MLP. The blocker structure used by Sol-Wind and the private equity fund manager MLPs are different from the classic structure used for oil and gas MLPs. Oil and gas MLPs do not need to interpose a corporation between the MLP and the underlying business operations, because oil and gas assets generate “qualifying income” under I.R.C. § 7704(d). Thus, the corporate tax is avoided completely.
- If the MLP Parity Act is enacted, then Sol-Wind’s solar and wind projects would be deemed to generate “qualifying income,” and Sol-Wind could qualify as an MLP without the use of the corporate blocker. In other words, passage of the MLP Parity Act means that Sol-Wind (and other MLPs owning renewable energy assets) could use the classic MLP structure and thereby avoid the extra corporate level tax, as is the case for oil and gas MLPs.
As we've reported, allowing renewables to have MLP status gives solar and wind the same tax benefits for project development that oil and gas companies have long enjoyed. There have been concerns that MLPs will be used as a bargaining chip for ending the federal Production Tax Credit or Investment Tax Credits, or that MLPs will create "path dependency" on large, centralized projects.
Senators Chris Coons (D-DE) and Lisa Murkowski (R-AK) introduced the 600-word Master Limited Partnerships Parity Act last year (S.795) with a bipartisan group of co-sponsors. It would enable renewable energy and efficiency companies to take advantage of the same tax benefits on projects that fossil fuel companies have. The bill might only succeed as part of a broader tax package -- potentially bringing with it new calls for eliminating the PTC through tax reform.