Sunedison: Sunny Days Ahead
By: James Serena
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Global solar power generation on average grew by over 50% per year between 2004 and 2014, and now makes up over 1% of all electricity produced globally. Moreover, solar power made up half of the generating capacity of new power plants installed in the US in the first quarter of 2015. This rapid adoption has been driven by improvements in panel efficiency, government subsidies, and innovative financing arrangements for consumers.
Utility-scale solar projects are finally cost competitive with power generated from other renewable and conventional sources. A 2014 Lazard study found the unsubsidized levelized cost of energy (LCOE) for utility-scale solar ranged from $72/MWh to $86/MWh, ignoring certain social and environmental externalities. In contrast, electricity generated from more conventional means, such as coal and nuclear power, had LCOEs ranging from $66/ MWh-$151/MWh and $92/MWh-$132/MWh respectively. The decreasing cost of generating solar power is creating enormous opportunities for solar power developers.
Like most forms of power generation, solar power plants require large up-front capital investment. While solar panels can last over 25 years, in many cases capital costs are not recovered for 15 years.
SunEdison
SunEdison (SUNE), the world’s largest renewables development company, primarily focuses on utility-scale solar power projects - projects which consist of thousands of solar panels. In order to continue its extraordinary growth, SUNE is dependent on external financing. To raise the money necessary to build and sustain its projects, SUNE has developed a complicated organizational structure with multiple subsidiaries, three of which are public companies.
SUNE targets projects with three key entities: SunEdison Semiconductor Limited (SEMI) manufactures silicon wafers, development companies (DevCos) purchase these wafers to create new “shovel ready” projects, and these projects are sold to private construction entities called “warehouse credit facilities”.
These warehouses are ring-fenced, meaning that they are legally separate from the parent company while still being under its control. In the case of utilities, ring-fencing is designed to protect consumers from a bankruptcy of the parent company and is commonplace in utility scale project development. Having this bankruptcy remoteness allows the warehouses to raise money from institutional investors at reasonable rates to finance the development of large projects, with those investments secured specifically for that project.
Once the project is completed, SUNE has the option of keeping the solar project in the warehouses to earn a stream of cash flows or selling these projects to a third party or one of its “YieldCos”. A YieldCo is a high dividend payout, yield-oriented company that takes the cash generated from electricity sales and distributes the majority of the free cash flow back to investors, supported by low cash tax rates due to government incentives.
SUNE is the majority shareholder in its YieldCos, TerraForm Power (TERP) and TerraForm Power Global (GLBL). Therefore, SUNE still benefits from the cash flow of the projects it “drops down” into the YieldCos. The TerraForm YieldCos also have “Incentive Distribution Rights” (IDRs), which allow SUNE to earn a larger percentage of the distributable cash as the YieldCo achieves certain distribution targets. These IDRs are designed to incentivize SUNE to sell projects to its YieldCos on mutually attractive terms rather than selling to third parties. IDRs create a win-win situation for SUNE and its YieldCos’ investors as transactions would support distribution per share growth for both.
Cloudy Days
In the last 12 months, SUNE’s shares have dropped over 90%. This aggressive decline stemmed from a liquidity crisis; SUNE was forced to restructure and take on more expensive debt to avoid potential default. Before the crisis, SUNE had three key ways of raising money: traditional debt financing through the DevCo, warehouses, or YieldCos; traditional equity raises primarily done through the YieldCos; and selling projects either to YieldCos or a third party.
In a credit crunch, traditional debt financing becomes prohibitively expensive. Lenders are now charging SUNE around 11% interest to pay off loans that used to be priced at 3%–5%.
Issuing equity is also no longer feasible due to the dilutive effects from SUNE and its YieldCos’ heavily discounted stock prices. Furthermore, when Greenlight Capital took a seat on SUNE’s board of directors in early 2016, it made SUNE agree not to issue any additional equity without the approval of nearly all of its board members over the next two years.
A Deeper Dive Into YieldCos
As publicly traded companies, YieldCos are valued by investors based on specific multiples. YieldCos trade on a Price / Cash-Available-for-Distribution multiple (P / CAFD). CAFD is a yield-focused metric that shows how much cash the YieldCos have, after expenses are accounted for, to be distributed back to shareholders in the form of a dividend. When P / CAFD multiples are high, YieldCos are able to pay more for solar projects and still have the resulting cash flow from the projects be accretive to share price. The issue recently is that US interest rates have increased and global commodity markets have fallen. TERP’s share price and P / CAFD multiple have crumbled, resulting in TERP being unable pay SUNE the higher prices that it used to for solar projects. As a result of TERP’s low multiples, SUNE has kept a number of projects in its warehouses, preventing SUNE from selling projects to generate cash and manage its overbearing debt load.
Relinquishing Control
Currently, TERP’s shares are significantly undervalued because investors fear that SUNE will declare bankruptcy. SUNE holds a 90% voting ownership of TERP through a set of Class B common shares that gives SUNE ten votes per share. Concerns about potential conflicts of interest between public shareholders and SUNE, who is not only the controlling shareholder of TERP but also a company with challenged liquidity, have led the markets to punish TERP. However, if SUNE were to exchange its Class B shares for the standard, one-vote Class A shares, it would give up its controlling interest in TERP. While giving up control of a subsidiary seems to be a radical move, there is precedent; recently, Abengoa reduced its ownership in its holding company, Abengoa Yield, to insulate the YieldCo from Abengoa’s potential bankruptcy. There are a number of mutually beneficial advantages to a similar transaction between SUNE and TERP:
1) Eliminating investor fears of conflicts of interest that could arise from SUNE’s potential bankruptcy would cause TERP shares to climb;
2) Higher share prices will lead to higher CAFD multiples, indicating that TERP would be able to buy the projects currently held in SUNE’s warehouses at higher prices and still have them be accretive;
3) With a higher TERP share price, SUNE would be able to sell more TERP shares in order to raise money to manage its debt.
While TERP currently trades at 6.6x P / CAFD, the industry median is 13.2x, exactly double that of TERP’s multiple. After Abengoa Yield separated itself from its parent company, its P / CAFD multiple shot up to 10.6x, implying that a similar multiple could be achieved by TERP post-transaction. Even if this strategy only results in a multiple 25% below the industry median, that jump represents a 50% increase in TERP’s current share price. As TERP’s P / CAFD multiple increases, TERP will be willing to pay higher prices for SUNE’s projects and SUNE will be able to raise capital through both project drop downs and sale of existing TERP shares.
Risk Control
While the proposed transaction has benefits to SUNE, these benefits are only realized if investors drive TERP’s share price upwards. It is possible that the YieldCo market continues in a downward spiral and SUNE sees little benefit to spinning off TERP. In order to limit SUNE’s downside, SUNE should take the following actions:
1) Reset the IDRs, giving SUNE a larger claim on future benefits of TERP;
2) Control, to an extent, the project drop downs into TERP, ensuring SUNE can still sell its projects to the YieldCo
These two actions should be taken as insurance for the strategic benefits associated with the deal failing to materialize. With these incentives, SUNE will be able to relinquish its ownership of TERP while maintaining the benefits of project drop downs at above street prices. As SUNE is currently facing a liquidity crisis, having a system that allows it to raise money through selling TERP shares at higher prices or selling projects will allow SUNE to have a cash infusion without paying high interest rates or sacrificing a part of its business. SUNE should have a contractual agreement with TERP to drop down projects meeting certain criteria, which will be carefully structured to ensure that SUNE does not have undue influence over TERP. Ironically, the best way for SUNE to grow is to release ownership of its largest subsidiary.
Moving forward under this proposal will allow SUNE to maintain its position as the leading renewable development company. SUNE will position itself for growth and continue to make a meaningful impact on the global focus to combat climate change.