Best stock to invest in – How Much Could Another Yieldco Pay For 8point3?

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by Tom Konrad Ph.D., CFA

When SunPower (SPWR) and First Solar’s (FSLR) YieldCo, 8point3 Energy Partners (CAFD), went public two years ago, I used the
financial nerd joke in 8point3’s ticker symbol as a launching
point to explain what “cash available for
distribution,” or CAFD, means. 

In that article, I cautioned against the risks of using a
short-term cash flow measure for long-term investing decisions.
That risk is becoming more and more real for investors in 8point3
because the YieldCo is using
short-term, interest-only financing to fund its long-term
investments. 

All of 8point3’s debt matures in 2020, and refinancing that debt
will reduce its ability to pay dividends for two reasons. First,
interest rates are rising, which will lead to higher interest
payments. Second, if the YieldCo is unable to secure interest-only
debt, it will have to refinance with amortizing debt. The
principal payments from amortizing debt will further reduce
CAFD. 

First Solar and SunPower are also considering a sale of the
company. The better-capitalized YieldCo NextEra Energy Partners (NEP) has been mentioned as a possible
buyer. 


If another YieldCo were to buy 8point3, it would do so at a price
that allowed it to raise its own dividend. This is the same
yardstick YieldCos use when evaluating the effects of buying
renewable energy projects from their sponsors or third parties. If
a transaction will not increase a YieldCo’s CAFD per share
(preferably significantly), it will not do the transaction. This
rule applies to both individual projects and large transactions
like purchasing another YieldCo like 8point3.

A somewhat naive version of this rule would be that a YieldCo with
a low dividend should be able to purchase a YieldCo with a higher
dividend. Unfortunately, it’s more complicated than that. Here’s
why.

1. Declared dividends are not the same as a YieldCo’s ability to
pay dividends. Different YieldCos have different payout ratios
(the proportion of CAFD that they distribute as dividends).
Naturally, an acquirer will keep its own dividend policy when
acquiring another YieldCo, and so the value of the acquired
YieldCo will depend on its CAFD, not the proportion of CAFD it has
chosen to pay as dividends before the acquisition.

2. CAFD is what is called a non-GAAP measure, meaning that it is
not defined by generally accepted accounting principles (GAAP). As
such, different YieldCos do not use the same definition
of CAFD, and some are quite aggressive in how they define it.
This can lead to declared CAFD that is higher than the YieldCo’s
ability to pay dividends in the medium to long term. Naturally, a
buyer will want to use a conservative measure of CAFD that is more
indicative of the purchased YieldCo’s assets to support medium-
and long-term dividend increases.

3. 8point3’s debt is interest-only and does not include
principal payments. Most of this debt was issued when interest
rates were lower than they are today, and all is due by the end of
2020. No other YieldCo uses this capital structure; most limit
their interest-only debt to about one-third of total debt. A buyer
would want to refinance most of this with amortizing debt to match
its current capital structure. The increased principal and
interest payments will reduce CAFD significantly.

4. As I pointed out in my article two

years ago, CAFD exaggerates the value of projects that are likely
to have less value at the end of their existing power-purchase
agreements (PPAs). This will be dictated by the ability and cost
to develop competing projects in the future. Solar projects can be
built almost anywhere, and solar prices are falling rapidly. This
means that solar projects are likely to have very little value at
the end of their PPAs. Wind will be somewhat more valuable, while
hydropower and geothermal are likely to be the most valuable
renewable energy projects in the long term. 

8point3’s portfolio is entirely solar, meaning that using CAFD
exaggerates 8point3’s valuation compared to YieldCos that include
other types of assets. All other YieldCos contain non-solar
assets, and most have less than 50 percent solar in their
portfolios.

5. IDRs, or incentive distribution rights, redirect a portion of
a YieldCo’s dividend to its parent company. For an acquirer with
an IDR, any increase in per-share cash flow from a possible
acquisition of 8point3 would have to pay for the IDR as well as a
dividend increase to the buyer’s common shareholders. In the case
of NextEra Energy Partners, 25 percent of any increase in
distributions goes to its parent as an IDR payment, while 75
percent goes to the YieldCo’s shareholders.

Others have attempted to value 8point3 in a potential
buyout by NextEra Energy Partners, but I have yet to see an
analysis that takes most — if not all — of the above factors
into account. Below, I try to do just that, evaluating what the
other YieldCos (not just NextEra) might be willing to pay for
8point3 Energy Partners if they were to buy it. 

Comparable, sustainable CAFD

The meaning of “cash available for distribution” should be
clear. It’s cash that is available to be distributed to
shareholders. Actual definitions vary. 

One would expect that CAFD should include all cash produced by the
company’s operations, investments, and financing that is not
needed to maintain (but not replace) the company’s
investments. 

For investors’ purposes, these cash flows should not include
one-off payments and cash flows that are likely to reverse in
future periods. This is because investors are interested in a
company’s ability to both pay a dividend today and maintain that
dividend for the long term.

The more conservative a YieldCo’s definition of CAFD (i.e., the
lower the final number), the more confident investors can be that
expected future CAFD is a good measure of expected future ability
to pay dividends.

The definitions of CAFD that I find most realistic are the ones
used by Pattern Energy (PEGI) and NRG Yield (NYLD, NYLD-A). They start with the cash flow from
operations (CFO), a measure defined by GAAP and hence comparable
across YieldCos.

They also adjust for changes in operating assets and liabilities
(which should reverse in later periods), subtract operations and
maintenance capital expenditures (necessary to maintain
equipment), add distributions from minority investments, subtract
payments to the minority investors in its projects, and subtract
payments of principal made from operating cash flows. Note that
interest payments are considered an operational expense, and thus
are already subtracted when calculating CFO.

The one adjustment that does not fit my model is the addition of
one-time cash flows such as “network upgrade refunds.” Several
other YieldCos include these in their definitions of CAFD as well.
These refunds are likely to be one-off for any particular project,
and so they should be excluded from any attempt to estimate a
YieldCo’s ability to pay dividends in the medium to long term. In
order to be useful to investors, the current CAFD should only
include cash flows that are likely to repeat.

I attempted to build my own version of CAFD that would be
comparable across all YieldCos and only include sustainable cash
flows. I found that most YieldCos do not disclose sufficient
information to complete this calculation. 

The major barriers I found were different types of disclosure
around minority investments in affiliates. These affiliates own
the energy projects, and the YieldCo owns all or part of the
affiliates. The lack of consistent disclosure meant that I could
not be confident that my numbers were comparable across YieldCos.
A related barrier to comparability is company structure. Most
YieldCos have complex financial and legal structures, and these
structures vary from one YieldCo to the next.

Below, I outline the results of my survey of definitions for CAFD.

Table 1:
Comparison of how Yieldcos define Cash Available For
Distribution (CAFD) –
“Yes” indicates a relatively conservative definition of
CAFD
Yieldco
NRG Yield
Pattern Energy Group
NextEra Energy Partners
Atlantica Yield
8point3 Energy Partners
TransAlta Renewables
Ticker NYLD and NYLD-A PEGI NEP ABY CAFD Toronto: RNW
Simple definition of CAFD No Yes No Yes No Yes
Includes only cash payments from minority
investments
Yes Yes No* Yes No No
Conservative treatment of majority-owned
investments
No No No No No Yes
Excludes one-time cash flows No No Yes No No No
Overall
Average
Conserv-
ative

Average
Conserv-
ative

Aggressive
Conserv-
ative

*Note: NextEra Energy Partners has only one minority investment,
so the aggressive treatment of such investments has (so far) had
limited effect on reported CAFD.

More conservative definitions of GAAP

In my subjective analysis, I found that Pattern Energy,
Atlantica Yield, and TransAlta Renewables had the most
conservative CAFD definitions. Perhaps not coincidentally, all
three of these YieldCos report results using international
financial reporting standards (IFRS) instead of (or in addition
to) U.S. GAAP. 

IFRS is more of a principle-based system than GAAP, and so
places more emphasis on intent than GAAP. GAAP is a rules-based
system where the focus is more on the letter of the law. 

Neither GAAP nor IFRS define cash available for distribution.
GAAP gives a company nearly free rein to make up its own CAFD
definition. IFRS principles provide somewhat more guidance, and
seem to have resulted in more conservative definitions of CAFD.

The relatively conservative definitions of CAFD employed by
Pattern, Atlantica and TransAlta are all defined with
reference to cash flow measures. Pattern and Atlantica both treat
their minority stakes in affiliates (renewable energy
installations that the YieldCo does not own outright)
conservatively by limiting the CAFD impact of these investments to
actual cash received. 

TransAlta instead includes a proportionate share of adjusted
funds from operations (AFFO) for minority stakes in affiliates,
but also subtracts a proportionate share of AFFO for minority
interest in its affiliates when it has a majority stake. This is
conservative because TransAlta has more majority-owned than
minority-owned affiliates.

Treatment of minority/majority stakes in affiliates

The common factor in the two methods for dealing with minority
and majority stakes in affiliates is that the three YieldCos
discussed above treat the CAFD from their minority stakes in
affiliates as they do the CAFD associated with the minority stakes
of others when they have the majority share. In other words, they
apply the rules consistently. 

Hence TransAlta Renewables distributes the AFFO pro rata between
the owners of each affiliate, while Pattern and Atlantica
attribute only the cash payment to the minority investor,
regardless of whether that minority investor is the YieldCo or
some other party.

In contrast, the other three YieldCos seem to have chosen their
definition of CAFD to maximize the number they report, rather than
for internal consistency. NRG Yield, NextEra Energy Partners and
8point3 Energy Partners treat their own minority investments in
affiliates differently than they treat other investors’ minority
investments in their majority-owned affiliates.

When these YieldCos own 25 percent of a project (a minority
stake), they claim 25 percent of the project’s CAFD. When they own
75 percent of the project (a majority stake), they claim more than
75 percent of the project’s CAFD. These choices lead to a higher
value for CAFD than what it would have been if they treated both
types of ownership the same way.

Just how much this differential treatment of minority- and
majority-owned investment affects CAFD varies based on the
relative size of each YieldCo’s investments. 

8point3 did not respond to my request of a reconciliation of
CAFD to CFO, which I had hoped would have allowed me to
confidently isolate this effect. Lacking that information, my best
guess (based on the slide below) is that 8point3’s CAFD guidance
for 2017 would be reduced from a range of $91.5 million to $101.0
million, to a range of $86.8 million to $93.4 million. With 79
million shares outstanding, this is a difference of between 6 and
10 cents per share.  


Source: 8point3 Energy Partners Q2-2017 Earnings Presentation.

Reimbursement of network upgrade costs

Among the one-off cash flows many YieldCos include in CAFD, the
largest is usually refunds of network upgrade costs. These costs
are incurred when a new solar or wind farm is built in order to
ensure that the grid can handle the additional power production.
The YieldCo can only be reimbursed for these costs once, and hence
they are non-recurring. 

8point3 Energy Partners expects to receive $13.2 million in
network upgrade refunds in 2017. Since the YieldCo is making far
fewer purchases of solar projects in 2017 than it was in 2016, we
can expect network upgrade refunds to fall dramatically next
year. 

If we remove these one-off refunds from 8point3’s 2017 CAFD
guidance, it is reduced to $73.6 million to $80.2 million, or
$0.93 to $1.02 per share. This is below 8point3’s current annual
dividend ($1.09 per share).

Refinancing 8point3’s debt

Elsewhere, I have attempted to calculate the effects of
refinancing 8point3’s debt before it is due in 2020. My estimates
range from a best-case scenario where all the debt is refinanced
with interest-only debt at current interest rates, to one where
two-thirds of debt is replaced by amortizing debt. 

Today’s higher interest rates would reduce annual CAFD by $11 million in
the most optimistic case. Replacing two-thirds of 8point3’s debt
with amortizing debt would reduce annual CAFD by approximately $20
million to $25 million. I use $20 million in the calculations
below.

8point3’s sustainable CAFD

Putting these adjustments together, we find that, based on the
company’s 2017 guidance, its sustainable annual CAFD after
replacing two-thirds of its debt with amortizing debt would be $54
million to $60 million, or $0.68 to $0.76 per share.

What another Yieldco should pay for 8point3

Most YieldCos have a target payout ratio (the percentage of CAFD
paid to shareholders) of 80 percent to 90 percent. The residual
value of solar farms after the end of their PPAs will be lower
than most other types of renewable generation, as explained in the
beginning of this article. For that reason, I assume that another
YieldCo would only want to buy 8point3 if the purchase would both
allow it to increase its dividend, while maintaining an 80 percent
or lower payout ratio. 

If the YieldCo were to pay for 8point3’s shares with shares of
its own, it would then be paying at most 75 percent of 8point3’s
per share CAFD, or $0.51 to $0.57 on each of the 8point3 shares.
This amount would have to be further reduced for NextEra Energy
Partners, which pays 25 percent of any dividend increases to its
parent in the form of incentive distribution rights.

Table 2: The most
other Yieldcos could pay for 8point3 Energy Partners and
still increase their dividends.
Yieldco
Current Yield
Could Pay For Each 8point3 Share
NRG Yield 6.2% $9
Pattern Energy Group 7.0% $8
NextEra Energy Partners 3.8% $13
Atlantica Yield 7.1%* $8
TransAlta Renewables 5.7% $10

* Expected yield after last issues related to Abengoa bankruptcy
are resolved.

Perhaps First Solar and SunPower will find a buyer for 8point3
with easier access to capital than the other YieldCos, all of
which have been at least somewhat undervalued since the popping of
the YieldCo bubble in the second half of 2015. The only exception
to this rule is NextEra Energy Partners, which has recently been
approaching a point where it can issue new shares to fund
accretive acquisitions.

An investor expecting NextEra’s stock to rise further should buy
it. Barring that, investors hoping for another YieldCo to buy
8point3 above $13 will be disappointed. 8point3’s current share
price of almost $15 seems due more to investors chasing yield than
a careful valuation of the company in a buyout.

Why does 8point3 continue to raise its dividend unsustainably?
Most likely, it hopes the high yield will drive up the share
price. While this has succeeded to a limited extent, it is not
close to a level (over $20) where 8point3 might be able to issue
new shares and grow its way out of its current problems.

The final victim of the YieldCo bust?

Another possibility is that 8point3 and its sponsors don’t have
a strategy at all. Before the YieldCo bust, it seemed to many that
YieldCos could keep issuing new shares to buy more projects at
increasingly higher prices. 

Rising dividends, rising share price and rapid growth worked
together in a virtuous cycle. If a YieldCo raised its dividend a
little faster than it should have, the only consequence was an
opportunity to sell more shares at high prices and use the
proceeds to paper over past mistakes.

Then share prices stopped rising. The weakest YieldCo sponsors,
SunEdison and Abengoa, had been relying too heavily on cheap
capital from their YieldCos and other sources. They both fell into
bankruptcy. 

SunEdison’s YieldCos, TerraForm Power and TerraForm Global are
in the final stages of being sold to Brookfield Asset Management
and Brookfield Renewable Partners at one-third and one-half of
their IPO prices, respectively. Atlantica Yield is in the final
stages of establishing itself as an independent company, but it
also is down a third from its IPO.

First Solar and SunPower never relied heavily on 8point3, but the
solar market is in a downturn, and all solar manufacturers are
being squeezed. Neither can afford to support 8point3 if it is
unable to stand on its own. Like TerraForm Global, 8point3 went
public just months before the YieldCo bust and never had a chance
to issue new shares at higher prices.  

I think it’s unlikely that 8point3 will share TerraForm Global’s
fate and be sold off to the only bidder at a third of its IPO
price ($7 a share). Its sponsors are far less desperate than the
bankrupt SunEdison. Using the same formula as in the table above,
Brookfield Renewable Energy Partners could buy 8point3 for as much
as $8 a share, but I doubt First Solar and SunPower would find
that offer attractive.

More likely, the sponsors will simply fail to find a buyer at a
price that satisfies them. In a few months to a couple of years,
8point3 will cut its dividend. The resulting stock price collapse
may allow its sponsors to take the YieldCo private, selling off
its assets piecemeal to fund the buyback of public shares.

The bottom line

Most of the above numbers are estimates. The most striking thing
about the disclosures surrounding CAFD at most YieldCos is just
how difficult it is to decipher the accounting underlying those
numbers. 

The bottom line is that 8point3’s cash distribution outlook does
not “look right.” It’s easy to get lost in the accounting, so in
April I built a chart comparing these YieldCos’ basic
profitability and efficiency metrics in 2016.

best-stock-to-invest-in

For other YieldCos, adjusted EBITDA (orange bars) ranges from 60
percent to 85 percent of sales. For 8point3 (CAFD), adjusted
EBITDA was 125 percent of sales in 2016.  

For other YieldCos, CAFD (yellow bars) ranges from 15 percent to
38 percent of sales. For 8point3, CAFD was 120 percent of sales in
2016.

How can a company offer more cash for distribution than it is
taking in sales? I asked. The folks on 8point3’s investor
relations team told me that it is because revenue from
minority-owned projects is not included in total revenue. With
this adjustment, 8point3’s 2016 CAFD falls to 92 percent of sales
plus distributions from minority-owned projects. This is more than
double the unadjusted CAFD/sales for other YieldCos.

I keep coming back to this from different angles. Each time, I
reach a similar conclusion: 8point3’s CAFD is less reliable than
that of other YieldCos.

***

Disclosure: Long PEGI, ABY, RNW.TO, NYLD/A, TERP, GLBL, BEP,
FSLR. Short CAFD.

Tom Konrad Ph.D., CFA is the editor of AltEnergyStocks.com and
an investment analyst specializing in environmentally
responsible dividend income investing.  He manages the
Green
Global Equity Income Portfolio, a private fund focused on green
dividend income stocks. 

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