Why use a yield co to raise capital for solar projects?

This blog post extracts some interesting parts related to the benefits and challenges of using a yield co to raise capital for solar projects based on an article titled "New Horizons In Solar Financing" published on Law360 on 15 May 2014 by Freedman and McFayden - partners at Shearman and Sterling LLP. They noted that alongside public debt markets and crowdfunding, yield co can be helpful in financing solar projects.

What is a yield co?

Historically, developers raised equity at a parent level, requiring investors to optimally value an entire pipeline of projects in various stages of development and even (in some cases) non-development businesses. Recently, developers have shown growing interest in an alternative.

A yield co is a special purpose vehicle created to hold a portfolio of de-risked operating assets and monetize a portion of its value through the sale of equity on a public exchange.

The yield co distributes some or all of the projects’ revenues as dividends. The parent company may use the cash raised from the initial sale of shares and from ongoing dividends to develop additional assets to sell to the yield co or for general corporate purposes.

Any cash retained by the yield co may be used for operations and maintenance and to acquire additional projects.

Projects may be acquired from the parent or an affiliate, which may also be involved in managing the company, or from third parties.

The company may be established around a portfolio of identified projects, or it may be established as a blind pool of capital, with management exercising discretion to acquire projects opportunistically.

Benefits

First, in a yield co, the tax attributes of renewable generation can offset the tax obligations of other projects in the portfolio. In order for the yield co to utilize all of its tax benefits, some of the projects in the portfolio must have net profits resulting in tax liabilities, either because they are conventional generation assets or because they are older renewables projects that have already exhausted their tax benefits. The yield co’s ability to shelter its own tax obligations eliminates the need to access a potentially constrained pool of tax equity investors.

Second, a yield co may allow a parent to finance its corporate operations (and potentially its further project development activities) more cheaply than selling equity at the corporate level, if investors have not appropriately valued the assets’ potential as part of the parent or if investors will pay a premium for the high, stable yields of operating assets in isolation.

Third, selling assets into a yield co may provide certain tax benefits — the parent company can realize the tax value of net operating losses from retained operations immediately rather than over the several years of project cash flows; and the yield co’s investors enjoy the benefits of tax-free distributions (as return of basis — for as long as the yield co does not generate earnings and profits) and a tax shield resulting from incremental depreciation.

Challenges

Several challenges must be addressed in order to effectively use a yield co to monetize solar projects.

First, the yield co must have a large enough portfolio to justify the expense of a public offering.

Second, it must continue to acquire new projects to maintain its favorable tax position and to generate the growth that investors seek.

Third, affiliated entities (such as developer-managers) may incur high costs to protect against potential conflicts of interest when they want to sell assets to the yield co, a risk highlighted by ratings agency reports in connection with the NRG Yield offering.

Fourth, the portfolio must be carefully selected and marketed to match the risk appetite of the target investors, and the market’s lack of familiarity with either the technology or the applicable regulatory regimes can lead to underpriced or failed offerings. For example, in 2013 ,when AES Corp. withdrew its IPO of Silver Ridge Power, a solar yield co, reports attributed the offering’s failure to investor uncertainty about the applicable international regulatory regimes.


http://www.shearman.com/~/media/Files/NewsInsights/Publications/2014/05/New-Horizons-In-Solar-Financing-Freedman-McFadyen-Lamb-051614.pdf