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The curious world of Solar Yieldcos

posted May 26, 2016, 8:07 AM by Nate Shanklin

February 17, 2016

2015 was not the year of the Yieldco. 2016 is not looking to be much better for the funding structure that one stood to be the unlimited fountain of capital for the renewable energy business.

There was a time when altruism was a pretty significant factor in renewable investment.  Pioneering companies delving into investment in renewables would have to convince their boards that “Going green was good for business”. Whether or not that was true, it was hard to make an argument based solely on economics. At the start of the 2000’s, electricity from renewables could be upwards of 10 times as expensive as power from the grid. But, like many industries, efficiencies and competition began to bring system prices down. Year by year, the cost of renewables, and specifically solar became more and more reasonable. By 2014 a convergence occurred, the levelized cost of energy (LCOE) fell to the point that it matched and even fell under grid produced power (data from

The LCOE for renewables falling under the average commercial rates for electricity meant that renewables were now viable nation wide, and billions of dollars of projects were for the taking.

While the opportunity was undeniable, there was a problem. No one, not even the biggest solar houses had access to enough funds to make all of these projects a reality.

Traditionally, capital raises depended upon structures developed in the commercial real estate markets such as real estate investment trusts (REIT) or similar. The problem with these structures was and is first and foremost they pay taxes twice.  They pay corporate taxes from their revenues and then their members are taxed as if the dividends were regular income (not capital gains). Beyond this primary issue, their private issuance, can limit their exposure to capital markets, slowing investment. A more efficient model was sought.

And so came the invention of the Yieldco.  A Yieldco, is simply a public company whose assets are long term income generating projects. The parent company owns at least 50% of the Yieldco stock, gaining initial revenue from the IPO. The Yieldco then pays out roughly 80-90% of its net income out as a dividend, thus supporting the stock price and infusing the parent company with project development capital. A Yieldco benefits from the fact that by claiming depreciation and operating expenses and then throttling its dividend payments they can typically avoid paying taxes, making it a seemingly highly efficient structure.  Per Bloomberg, in 2014, 15 Yieldcos went through IPOs netting $12 billion in initial revenue.  While the rise of the Yieldco seemed all but assured by late 2014, mitigating factors began to mount quickly in the following months.

When the markets opened up in 2014 the major players never dreamed that keeping their Yieldcos filled with projects would be like feeding a monster.  Since projects are continually retired, projects must be regularly fed in the front end of the Yieldco, but additionally, since this structure pays out so much of its free cash flow, projects must be added nearly exponentially to stop the price of the stock from falling due to a tumbling P/E ratio.feed the beast 16-Feb-2016 19-07-25_Page_1.jpg

This is where the first big issue came to fall against Yieldcos.  As development exploded, the major developers began to notice that they were bumping into each other like never before.  Given that the middle swath of the United States is not a hotbed for solar, the traditional East and West coast markets became swarmed with development reps from the various publicly traded firms.  For many, it has proven nearly impossible to fill their pipelines sufficiently.

Another major issue to affect Yieldco performance is that of leveraging, or rather the cost of the capital used to leverage these companies.  The solar industry is dependant on incredibly cheap money. There is still only a small margin between solar and traditional grid prices, and small changes in the long term debt rates will erase that difference. Essentially, solar systems pay out like mortgages, in set increments. if the cost of capital to borrow rises above the IRR of the projects, the Yieldco will nearly immediately be underwater. In the past month, Janet Yellen, Chairman of the Federal reserve has stated the Fed’s intention to raise long term interest rates. While there is current doubt as to the realization of this hike, uncertainty never speaks well to stock prices.TERP Interactive Stock Chart _ Yahoo! Inc.jpg

Without a high stock price, Yieldcos are finding it nearly impossible to attract the equity to allow for the leveraging and create development capital as they were originally designed to do.  

In what has become the largest and most public saga in the solar industry, the fickle nature of finance and the endless thirst for projects generated through their Yieldco, Sunedison is presently headed towards a bankruptcy within the next 12 months.  While not the only culprit to their current state of peril, Terraform Power Sunedison’s Yieldco surely cannot be held blameless.  The draining nature of the dividend payments has meant that Sunedison has had to add more and more projects to their pipeline.  Developing their present portfolio of 2.9 gigawatts will easily surpass their current on cash holdings of $695M.  All this and the Terraform monster cannot be contained as its stock price continues to dwindle.  To make matters worse, a current $500M lawsuit against Sunedison proposed that the company used funds from the Yieldco to make up the losses of Sunedison in the form of inappropriately small dividend in this past quarter. Rather than being the tree that feeds the parent, Terraform has become a gluttonous fund draining leach to Sunedison. Like a scene from a western, the hedge funds have been buying stock and circling like vultures as a takeover becomes ever more likely.feed the beast 16-Feb-2016 19-07-25_Page_2.jpg

While Yieldcos have their own list of problems, their recent troubles are by no means completely their own.  Seemingly irrationally as the price of oil and fossil fuel stocks have come down, they have drug solar Yieldcos down with them.  In operation, oil and solar do not really touch. as Solar goes towards electric grid production, the vast majority of oil goes to support transportation.  So why does this connection exist? In a word, diversification.  Portfolio managers are continually seeking diversity. When they arrived on the scene, the Yieldcos represented a strong and credit worthy alternative to the fossil fuel stocks while staying in the energy sector.   By fund purchasing shares of the Yieldcos for their energy portfolios, they inadvertently tied the Yieldcos at least partially to the price of oil because as these funds move in value they tend to drag everything with them.

Given all this, where does the future of solar finance point? There are several directions that seem plausible and no one single path may be the answer.  Funds such as NRG’s may continue to diversify further with fossil fuels and thus mitigate some of their non systemic risk. Alternatively, private equity funds have started to make compelling argument for their value in the market as their relatively efficient acquisitions have proven a solid outlet for current project portfolios.  In the end, if long term interest rates do not see a significant uptick, which at this juncture, seem unlikely, solar will continue to find a way, with or without the beast that we call Yieldcos.