Macquarie Capital, known for its strong capital markets capabilities among others, is increasingly working with shops that are eyeing yieldco IPOs. Michael Allison, senior managing director of the bank’s renewables group talks to Managing Editor Nischinta Amarnath about his views on the potential for yieldcos coming to market, intrinsic challenges involved in securing tax equity investments and the scramble, among developers and investors, to avail of the federal investment and production tax credits by the end of 2016.
PFR: Investor appetite for yieldco paper remains largely unharnessed, and market observers are saying more yieldco IPOs could come into the market over the next few years. What is your take on that?
Allison: Yieldcos have been very successful for investors that have invested in the IPOs. Most have traded up significantly and have delivered or outperformed their growth targets – it’s been a very successful investment. In today’s low-interest rate environment, yield is important for a certain class of investors, and you can see that with the follow-on offerings of the public yieldcos. They have been very well received, typically four or five times oversubscribed for a follow-on offering, which is a very good sign. The initial wave of yieldco IPOs was for companies with strong parent companies and a significant development pipeline that could feed the growth in the dividends to shareholders that these companies promised at the time of listing. I believe the next group of companies that go public may be structured a little bit differently. For example companies such as 8Point3 Energy Partners, and Lightbeam Electric have slightly different business models than the companies that have gone before them. In my opinion, the market will still embrace these new business models that are coming to market in the next wave. In addition to 8point3 and Lightbeam, some other players are looking to file in the next six to 12 months. It’s been successful so far, and I think it’s going to continue to be successful. I think investors really like this product, the MLP market is analogous to the yieldco market and it’s been around for 25 years and has been very successful. I think the demand for yieldcos will continue to grow. There is going to be a lot of competition for assets, going forward.
PFR: What is the sense you are getting from prospective issuers in terms of other companies that might consider a yieldco IPO?
Allison: There are a number of other companies that are considering listing their asset portfolios through a yieldco IPO and it’s going to come down to how big the IPO portfolio is, how many assets they have been able to acquire and how much you can grow over time. Yieldcos are a function of growth and yield and the more demonstrable growth you have, the more the market believes that growth will happen, and the lower the yield you will trade at. I think all the companies in the current market that are looking at potential yieldco IPOs have got good assets, a strong development pipeline, and will be looking to acquire new assets over time. SunEdison has been public that they are going to do an emerging-markets vehicle which would be the first of its kind. The listed yieldcos today are predominantly invested in OECD countries, mainly the U.S., U.K. and Canada, so that’s going to be an interesting step for the market to assess projects and project risks in areas outside of the OECD countries. Are investors willing to take what many consider a low-risk product and introduce more potential risks for higher growth in areas such as China and India? I guess we will find out.
PFR: What types of roles is Macquarie Capital looking to take in transactions, going forward?
On the capital markets side, we’re involved with a number of companies that are looking to go public on the yieldco side. We have a strong equity capital market franchise and we’re very deep in the sector in terms of our merchant banking model and the development capital we provide. In terms of the development capital business, we continue to evaluate opportunities. It’s really about having the right development team and a strong risk management framework. We evaluate lots of deals and we’ve got to pick out opportunities that are right for the business, while maximizing the best possible outcomes for our clients.
PFR: What other areas should we watch out for in 2015 in terms of growth?
Allison: 2016 is all about the end of the PTC and ITC. So, you’ve got a number of companies that have prequalified equipment and are looking to obtain hedges or offtake contracts for their projects. These companies are likely to be moving to market, and the market is going to be very busy on the financing side. The timeline to build projects is quickly shrinking. I think there is going to be a real rush for the door over the next few months as firms try to get their financing lined up. The big bottleneck is likely going to be tax equity as there is a finite amount of tax capacity in the market. What I hear from the tax equity investors is that they don’t have enough resources to assess all the opportunities in front of them. So, the good sponsors will be able to utilize their relationships and get tax equity for their projects, the smaller players may get left out. The real growth over the next 18 months will be getting their projects done by the end ’16.
PFR: What are the challenges involved in raising tax equity? Are there going to be alternatives to that, going forward?
Allison: That’s a really great question. As we discussed, the bottleneck we see is lining up tax equity in order to secure construction financing to begin the construction phase of the project. Ironically, tax equity doesn’t fund till after the commercial operations date but project developers or owners need to get the tax equity commitment well in advance of the project’s COD, so that lenders who fund construction have a way for the debt to be repaid when the project begins operating. What we’re seeing and hearing from developers and sponsors, is a potential need to bridge the tax equity takeout, allowing the tax equity more time to assess the project, rather than having to do it upfront. This side of the market is going to develop over the next six months as the timing to bring all the parts of the capital stack together gets more and more critical.
Obtaining debt financing for a construction-ready project is typically straight-forward, given the robust debt markets and lenders’ appetite for doing well structured deals, but before a firm can draw on that debt, they need to have the tax equity signed off, and that can typically be a long process, in some cases up to six months from start to finish. In this situation, developers may have to delay the start of construction so they can secure the tax equity. There is talk in the market that certain investors could bridge the tax equity so that construction can commence and this would extend the timeline to bring a tax equity investor into the deal. I think there are a lot of sponsors and developers in the market thinking about how they can arrange the timelines of the different financiers in a more efficient way for all market participants.
PFR: A lot of renewables investors, especially in the solar space are rushing to buy or invest in projects mainly because the 30% ITC will decline to 10% at the start of 2017. Do you see investors who don’t do that, or sponsors who can’t raise financing or investments on time, explore other alternatives from 2017 onward?
Allison: There are still going to be projects developed in 2017. If you are a developer and have developed the project based on a 30% ITC and it goes to 10%, you will be leaving significant money on the table or the project will not be able to be developed. If you have projects today that can be done in 2015 or 2016, then these developers will try to get them completed as quickly as possible. On the flip side, if you’ve got projects where there is support for a 2017 COD date, the developers will tend to move on that timeline. The PTC going away or the ITC going away is not the stop point. Wind is, in some parts of the country, the cheapest source of energy. So, many developers are going to continue with business as usual. If there’s an extension, great. It’s a windfall gain for them. If not, they’re still looking to develop their projects without the PTC or a smaller ITC.
PFR: In the context of merchant wind, which zone do you think is most encouraging for wind projects? I am talking about markets like PJM or CAISO.
Allison: While we have spent significant time analyzing the merchant wind market, especially in Texas, we see two main areas of concern for us to provide development capital for these projects: One issue we face is that the hedge being provided really only protects the tax equity investor and does not typically protect the cash equity investor that much. Our clients are generally yieldcos or infrastructure funds or direct pension investors who are not really looking for that kind of exposure.
The other issue we’ve identified is that the hedge provider needs the developer to post a significant amount of collateral required to execute the hedge. This can add up to tens of millions of dollars. So, it is a significant amount of exposure and is often much greater than the collateral needed to be posted for the PPA security or the interconnection deposit. Sometimes, the hedge collateral needs to be posted before the start of construction and this really adds a huge amount of risk. Funding this security is not cheap which drags on returns.
PFR: Where do you see the debt market heading in the renewables space in 2015?
Allison: I think the debt markets continue to be robust. We’re seeing a lot of activity. If you have a well-developed deal, it doesn’t seem to be difficult at the moment to get debt. Macquarie recently closed financing for Freeport LNG project. We’ve seen success in our other projects as well, specifically development projects where there has been a need for holdco leverage. There’s a good amount of appetite to do deals that are well structured.
PFR: Do you see that changing structurally in any way over the next two years, or do you anticipate that it will remain the same?
Allison: I think it’s dependent on interest rates to a certain degree. Banks need to borrow. So, there is the cost of capital that they’re borrowing at versus where they are lending at. Banks are going to continue to try to make those margins. Senior lending in the project finance space to renewables companies and projects has been successful for the banks. So, I would imagine that it would be business as usual unless there’s a big market hiccup, which I don’t foresee.
PFR: Do you plan make any additions to your team in the year ahead? If so, what types of roles do you see opening up in your group?
Allison: We’ve got a very well-staffed group at the moment. My team in New York predominantly focuses on the financing side of transactions: capital markets, advisory and principal investing. The team in Austin, Texas leads our efforts in diligence and our in-house project development. The Austin team also supports our merchant banking efforts in the power sector and across renewables in Latin America and they have been very active. We may look to grow the development team as I see our development business as an area of differentiation. As we continue to grow, we will evaluate strategies to build out the team.