Q&A, Marathon Capital – Part III
Although interest rates are expected to start climbing, the relatively low cost of capital is keeping buyers hungry for assets. “If you are an owner of assets and you’ve owned those assets for a period of time and you’re not a strategic, long-term, 25-year owner, it’s been a good marketplace for you to sell and move those assets and take your gains off the table,” according to Gregg Elesh, principal and chief information officer at Marathon Capital. “Today, you clearly have some market demand and you want to be responsive to that,” says Terry Grant, managing director at Marathon Capital, of potential sellers. PFR Managing Editor sat down with Elesh, Grant, Ted Brandt, principal and chief executive officer and Wendy Carlson, managing director to get the team’s perspective on buying and selling assets in today’s market.
PFR: Are there any other trends you’re seeing out there in renewable or non-renewable asset sales?
Elesh: One point that’s kind of obvious, the industry has been talking about it since the beginning of the year and even last year, is that even though cost of capital may be creeping up a bit as interest rates start to move, cost of capital has been pretty low. If you are an owner of assets and you’ve owned those assets for a period of time and you’re not a strategic, long-term, 25-year owner, it’s been a good marketplace for you to sell and move those assets and take your gains off the table. We’ve seen a continuation of that, as one of the factors behind the asset trades.
There’s certainly a bit of talk out there that these increasing yields in the marketplace are going to put a bit of a damper on that. That’s given some people an incentive to move assets this year, whereas maybe a year ago they would have said to hold on to them for a few more years.
Carlson: On the non-renewables side, for a long time there haven’t been the price signals that have really spurred people to do traditional gas development. Now, as people are looking forward with planned coal-fired plant retirements and with a little bit of load growth, there is more activity in certain areas of gas development and we’re seeing a lot of projects under construction or planning to go into construction in the next couple of years to be ready for that 2016-2018 period when the price signals should be there to make the gap in investment work. That’s particularly in markets where there are planned coal-fired retirements because that’s certainly helping to drive those tighter reserve margin forecasts.
Also, it’s the IPPs and the utility affiliates that are pursuing most of the gas-fired development. There are some smaller developers working in certain areas but the bulk of the development work is by the IPPs and the utilities. It’s in liquid markets, or the markets where there are the coal-fired retirements for the most part. We expect to see a lot of activity in those areas –people looking for the construction and term financing and looking for those assets to change hands, from the developers to the long-term owners, as the development continues to advance.
PFR: What would your advice be to a potential seller of a renewable asset or a non-renewable asset?
Grant: Sell high (laughter). This is sort of simple, but as a starting point we like to ask: What are your transaction goals? Are you exiting? Are you looking for a development or investment partner? Are you willing to stay in? How much more development risk are you willing to tolerate? Are you looking for something other than money? Are you looking for strategy or strategic lift in something that gives you better positioning?
We’ll often see ownership and entrepreneurs who aren’t always aligned. So, it’s pretty important to get that sorted quickly when you’re going to the market. The first thing we’re generally saying is timing and calendar. Timing is really, really important. Firstly, most buyers come out of the gate in January looking to make their plan for the year. So you’ll see a lot of focus in late December, early January, with people looking for what deals are in the market, which strategies? Is this going to be a busy year or not? What are going to be the bellwether deals? We also see that effect right after the summertime. People come back in September and looking to get things either wrapped up or play catch-up before year-end.
Today, you clearly have some market demand and you want to be responsive to that. That sense of timing in the big picture is important, but you’ve also got to address your own timing. Is the asset ready for the market? Is it time to monetize the asset? Has it been de-risked or not? If not, what role should the seller play in the further development of the asset or the business model? To what extent are they willing to rely on cash consideration upfront versus cash over time?
The idea of where we are in the year and where the asset is in its lifecycle and where the individual investor is in their lifecycle and the company and the business’s lifecycle, are all really important. That sets you up for a very clear transactional direction. Once you’ve got that done, drill into the actual execution side of the equation. I always like to be really clear about setting up a process to be on the offensive. In other words, manage the negotiation and the disclosure from the beginning with a ‘no surprises’ approach. You want to put it all out there. It’s Marathon Capital’s job as the advisor to make sure that bidders are aware of what they’re walking into because all things will be found in time. What you want to do is match the best buyer to the circumstance and the asset you’re selling.
If I think back, if you look at the solar business, the maturation of transactions and in the very beginning, we were dealing with very high-level EPC contract issues. We were starting with contracts with structures that came out of the wind business and they had to do with warranties and performance guarantees that were reflective of a different technology. We’ve seen EPC contracts mature in the bidding process in the last several years. We’ve seen the O&M strategies evolve in terms of how assets are staffed and how people view operating risks. How attentive do you have to be to a set of solar assets? What level of monitoring is required?
We’ve seen contract structures with a curtailment from the California utilities becoming an important issue to structure around. We’ve seen aggressive design response to the time-of-use tariffs in the California market and particularly where people have created a great value by building the DC footprint in a way to maximize the tariffs given that you have a constant of fixed AC interconnection. We’ve watched that evolution and we’ve seen a lot more of that in the later years than we did in the early years of the industry.
Degradation is another great point. In the beginning we were dealing with the rating agencies looking at the wind experience and looking at default rates and performance rates. There was a conservative view of degradation that was financeable and we’ve now seen manufacturers tighten up their product specifications and actually put those product sheets in front of the independent engineers, which drives for a tighter financing standard and therefore greater output because of lower degradation expectations.
Degradation goes beyond the financing. It gets into the equity return. We’re seeing developers looking at overbuilding the resource to take into account degradation in the early years of the asset life given the importance of those cash flows. And whether or not you have an escalating PPA or not, it can influence the asset present value.
We’ve witnessed all of this in our practice. We’ve got relatively senior people on the ground. We’ve all been in the energy business for a long time. We’ve seen structures evolve and, particularly in solar, we’ve seen a market that’s been evolving through an early consolidation period. We’ve been able to take that latest trend in deals and bring that to the seller of an asset and position them relative to the market expectations so that we can put the best foot forward.
I’ve drilled down specifically in solar because it’s something that I see a lot. Regarding the non-renewable assets, it’s not been as much of a one-way trend. We’ve seen a lot of the issues recycle, having to do with being clear about transaction expectations and understanding the balance between buyers and sellers in any given market. Know who has done the last transactions and who was left at the table without an asset and who needs to get the next deal done.
PFR: What would your advice be to a buyer of a renewable or non-renewable asset?
Grant: I always say to bidders ‘Be the best bidder you can be. Emphasize your strength.’ Buyers come to us and say ‘Where is this deal going to clear? What do I have to do?’
You can never play favorites in a process, but what you can say to a buyer is ‘Let’s look at how you are differentiated relative to your business plan, your cost of capital, your business goals, your alliances, your business interests to make sure you’re emphasizing and differentiating your bid in an optimal way.’ That way you can carry a consistent tone to buyers because we have the unfortunate circumstance of seeing many buyers in multiple processes and there can only be one winner in any given process. It’s important for us to be consistent and treat the market in a fair and uniform manner.
The other quip I like to offer is to have a high ‘do-say’ ratio. Build a pattern of doing what you say you’re doing, being as thorough as you can be in the due diligence, being explicit and very direct in your intentions and the Letter of Intent. Ensure that all of the conversations show a firm, but a very direct and knowledgeable point of view. Being taken seriously is an important way to differentiate yourself and nothing does that better than a high ‘do-say’ ratio, where you have a consistent, focused tone in the negotiations.
Elesh: As someone who has taken a lot of these transactions out to the marketplace, what the seller wants at the end of the day is certainty. Certainty around execution, certainty that pricing holds up, particularly in an auction process. Nobody likes the bid high, and then change dramatically in the second round because you haven’t done any work.
As a buyer, doing the work upfront, spending the time, demonstrating why you can have pricing, timing, approval and execution certainty is always a serious discussion with our clients. When we get down to it, and we have proposals from a number of parties, along with price, we look very hard at the options and our clients ask who’s going to be able to execute here and why? Who’s done the work upfront? Who’s got the right team? Who’s got the track record to execute? In a lot of instances, they’re asking about companies that we’ve already transacted with, which gives us a leg-up in those conversations. I think that’s what sellers are looking for.
Believe it or not, we’ve had clients take lower bids in order to have certainty of timing and execution and that’s mattered to them.
Check back next week for the Marathon team’s take on asset-based project finance and M&A in Latin America in the final installment of this Q&A.