In the second part of this exclusive interview, Nick Knapp, president of CohnReznick Capital, discusses opportunities in restructuring, M&A market dynamics and how the firm competes for advisory mandates with PFR reporter Fotios Tsarouhis.
PFR: In what ways is CohnReznick Capital’s business expected to change in the years ahead?
We have certain capabilities here. One of our managing directors, Jeff Manning, has a special situations focus. He has 30 years of distressed and restructuring experience, and he’s been focused on this work for the past few years at CohnReznick Capital. The initiative now is to really focus this expertise on the power and renewables industry. We have a couple of mandates we’re working on now in that regard. There’s going to be heightened activity over the next few of years and we really want to be in the middle of that.
PFR: Can you offer any additional details on the nature of those transactions?
A big area within the renewables sector is the underperforming wind farms, and we’ve been doing a lot of those secondary sales on behalf of tax equity investors. We’ll package up 10 to 15 different Class A positions and we’ll create a structure where we can carve out the cash in these positions and the sellers maintain the tax economics and we’ve been selling those positions.
Those are largely underperforming wind farms that are now in a position where tax equity is sweeping 100% of the cash, so it’s a little different than their initial profile. Most of that was unlevered activity. There’s a pocket of this activity that has senior leverage on it, and those are the distressed positions. We have the capability and the experience with these underperforming wind farms, but when you have a senior lender in there it’s a different position, and adding our restructuring capability positions us well. So there’s a couple of those right now in addition to a couple of landfill gas project restructurings we’re working on.
PFR: Moving on to M&A, we have seen transactions such as EverPower where development platforms have been split up from operational assets. Is this something you expect to see more of?
That was the story of last year and it continues to be the story of this year—the story of market consolidation with [independent power producers] and utilities. It’s a strong market, so that’s going to continue until every reputable development platform is under one of these large strategic players. That will cause a shift in the overall market dynamic and how financial sponsors can play, especially infrastructure funds, because the project inventory is going to be really sparse. The handful of smart, proven infrastructure funds will continue to be highly successful, but the rest of that market will need to evolve and adapt quickly to hit their investment volume goals. It was already heavily competitive and this is going to exacerbate that. Generally speaking, just about every energy player is heavily focused on renewables, including the oil and gas universe. The international names, the U.S. names—it’s all about finding a platform. They’re not looking at buying projects. They’re saying: “The first deal we do is going to be a large platform and then we’re going to build it from there.”
Historically, getting value for a development pipeline and a platform really didn’t happen much, and that’s different now. It’s because these guys have big aspirations, they’ve made public announcements, they have to find a way to get to the scale they have stated within their organizations’ primary goals. And you can’t do that, in this market, project by project. It’s just too competitive. So it’s a good balance for them. Financials typically can’t make these investments in non-project-related activity, there’s just too much risk for them given their mandate with their public investors and [limited partners]. And so it’s the perfect area for strategics, and because there’s a lot of them it creates a competitive dynamic where they’re paying meaningful value for the proven platforms.
PFR: From what you’re saying, it doesn’t seem that there’s any way that small projects and smaller portfolios can make up for a lot of these bigger development-stage portfolios that were on the market. How are potential investors valuing development-stage assets?
To your point, there’s not a lot left in regard to large proven development platforms, so I think that that will be the next step. As the larger names are off the market, the next step’s going to be the smaller names. There’s got to be a scale that makes sense and it’s certainly a very different type of deal but if there’s a 15-person team they’re still a player that can add meaningful value for strategics. As long as there’s a meaningful track record of commercializing projects, I think it’s going to be attractive to some of these strategics that need a U.S. presence.
PFR: Are we dealing with the same types of buyers now as in the past?
It’s definitely a new wave of activity that includes Innogy—RWE’s subsidiary, Ørsted, Engie, Enbridge, Shell, BP, Total and a growing utility interest both on the unregulated side and with build-transfers on the regulated side. It’s a long list of major energy names that weren’t really penetrating renewables historically. It is an anticipated trend as we have hit a mature point in the industry and it helps with a few years of horizon on tax credit policy to mitigate the historical uncertainty we have faced.
PFR: How do the investor bases differ for development-stage and operational assets?
That’s another area of heightened activity. In terms of operating portfolios, it’s a different buyer universe for that. That can and should be more of a financial investor play. But I think it’s also part of being at a mature point in the market where, just like any mature industry, there is going to be more trading volume in the secondary market, and we’re seeing a ton of that, and that’s going to continue. So it’s either 50% sell-downs of operating portfolios, the full sale, or just capital stack optimization with refinancing or creating vehicles to get these portfolios sitting with the best cost of capital. Over the past three years we have seen the secondary market continue to provide more trading volume with each year. I believe this will be proven true again in 2018 based on the market activity we are seeing.
PFR: Do you see some of the same international players continuing to invest at the same level they had been before? Canadian pension funds, for example?
For the operating opportunities it is the financials. It’s primarily infrastructure funds, it’s [real estate investment trusts], it’s the U.S. and international pensions. And it’s come a long way. The market has been evolving in terms of the project risk profile. The revenue contracts have come in a lot. To come by a busbar 20-year power purchase agreement is very tough these days. So it took a bit of time for all these companies to get comfortable with the fact that the contracted profile is much shorter, so they have to take merchant risk in the U.S.
Additionally, there’s getting comfortable around basis risk when moving away from busbar PPAs. Over the last two years, they have adapted their underwriting requirements for a certain [internal rate of return] during the contracted period, while at the same time decreasing the size of desired risk premiums within their hurdle rates. What I’m curious about is that you haven’t seen too much direct investing from pensions, and I think that some of these operating portfolios at scale provide a meaningful way for them to go in and make a direct investment instead of going through an affiliate sponsor or fund manager. It’s a great way for them to put some money to work but where there’s less of a development story and the related uncertainty.
PFR: How savvy are foreign buyers regarding U.S. tax equity structures? Is this a major hurdle? Has it changed over time?
Yeah, it’s a big hurdle. It’s not like you have a fixed rule set. Annually, there’s a new set of hurdles and uncertainty to work around, whether that’s tariff-related or tax reform-related, so it takes time. From our experience, really, it takes years for these investors to get there. The benefit is that a lot of these names have been on the fringes for years getting educated and getting their risk policy down, and that’s why I think we’ve started to see meaningful traction now. It’s not their first rodeo, they’ve been looking at a lot of deals and talking a lot to their committees and have really refined what works and doesn’t work for them.
But if you’re new, yeah, if it’s a competitive process, it’s pretty challenging. But from our perspective, if you are willing to roll the sleeves up and focus, the reward is clearly there and makes the learning curve efforts worthwhile.
PFR: What is the secret to running an effective sales process, both in general as for a portfolio of development-stage assets? What is the battle for the mandate like?
It’s always going to be competitive. For us, what we try to do is to get involved prior to [a request for proposals] and to put meaningful time into the analysis and into the strategic decision. Between [two of our major clients], we were their adviser for years on the financing side and as they considered strategic plays to bring in a partner or to sell, we were right in the middle of that discussion and really helped them through it. That’s where we see our growth, working with our client base and expanding on the fact that we can provide the full-service investment banking package. What we pride ourselves on is our execution capability, meaning we know the ins and outs from an underwriting standpoint on the risk of the projects, risk of the companies, we know all of the structuring required, and how to optimize the performance of the assets. Also, because we live in this space, we have the same or better deep investor relationships as our competitors.
Out of about 35 people in New York and San Francisco, with one person, Jeff Manning, in Baltimore, about 34 are focused renewable energy bankers.
PFR: What differentiates a boutique from bulge bracket firms and other large banks?
When we see a bulge bracket as a lead adviser there’s a difference, because they don’t have the same focus on renewables and typically the required fees are different for a boutique versus a bulge bracket. For us, if we have a big mandate we’re going to staff it with our best guys and have no restriction on the resources we can deploy, and really manage everything, from creating a great story and a great marketing package to taking the time to really spoon-feed the investors in terms of everything they need for their credit package and everything they need to take to their committee. We really spend the time with them to develop that and go above and beyond what other advisers would do, which is typically leaving it with the potential investors to figure out. Any question they have or analysis they would like to see, we’re going to deliver. Additionally, CRC does not have a learning curve, which allows for us to add value from day one and be extremely efficient with our clients’ time. We often see bulge brackets have some level of learning curve as they often have a deal team that is not focused in the U.S. renewables market. This clearly is not a blanket statement, as there are a couple banks we consider strong in renewables and that we often co-advise with. Lastly, we’re proud to run disciplined processes with immediate and successful outreach to the suitable investor universe every time for a client.
Check back next week for the third and final instalment of this Q&A.