Two weeks ago, First Solar (FSLR) and Sun Power (SPWR) announced a plan to jointly form a YieldCo. A YieldCo is a publically traded company that owns and operates a renewable power array and generates a predictable cash flow.
Investors love these types of companies. A YieldCo allows the parent company to separate out the volatile construction and R&D activity from the stable operation of a renewable power farm. YieldCos allow investors to participate in renewable energy without all the risk associated with it. YieldCos typically pay out dividends equal to 80% to 90% of their stabilized cash flows, after debt payments, over contract durations that typically last 15 to 25 years.
Last time I checked, there were about eight publically traded yield companies in the United States. While the details of the Fist Solar/Sun Power YieldCo were sketchy, it is believed both companies will initially contribute 400 megawatts (MW) of solar generation to the company, with the possibility of ultimately contributing over five giga watts (GW) of capacity. The companies chose to partner up because they can both contribute a wider range of geographically diverse sets of assets than they could alone. In addition, the YieldCo could benefit from Sun Power's strength in rooftop installations, which tend to generate better returns.
Last July, when SunEdison (SUNE) brought YieldCo TerraForm Power (TERP) public, the company ultimately raised $500 million. Sun Edison manages more than 900 solar plants, with a total power output of over 1.9 GW. In investor presentations, TerraForm has outlined plans to generate as much as 4.9 GW of power. Just recently, the company acquired 521 MW of wind generation.
Wind now accounts for about 30% of TerraForm's power generation. The company added wind generation because it helps to stabilize the company's cash flow. Wind generation is most productive in the first and third quarters of the year, while solar is the most productive in the second and fourth quarters. Furthermore, by diversifying the company's portfolio, it reduces its risk to government policy action such as the expiration of solar tax credits.
In just six months, TerraForm has increased the size of its renewable power portfolio by 87%. While primarily a North America power producer, the company plans to operate in additional countries such as the U.K. and Chile.
YieldCos aggressively acquire additional power generation capacity in order to grow the dividend. TerraForm has plans to grow its distributions to shareholders from $0.25 a share to as much as $0.80 a share by the end of 2018.
But YieldCos can be risky. They are dependent on low interest rates and high electric and natural gas prices. As the price of natural gas drops, it often becomes less expensive to generate electricity by using natural gas. If that happens, the demand for renewable energy could drop.
Most of the public YieldCos yield between 3% and 5%, which can make them attractive to investors who are looking to collect dividends. But it's important to remember that YieldCos are an engineered product from Wall Street's financial geniuses. They are substantially different from Master Limited Partnerships (MLPs).
MLPs have a formal tax designation, while YieldCos do not. YieldCos are structured to resemble a MLP, but they are simply C-corporations that use the 10-year tax shield of accelerated depreciation to pay dividends. Since these projects are capital-intensive projects, they throw off substantial depreciation, which is used to great effect.
Later this week I will take a look at the solar companies.