Published by North American Windpower on October 27, 2015
Written by Nick Knapp, Managing Director, CohnReznick Cap Markets, and John Richardson, Associate, CohnReznick Cap Markets
We are reaching the peak of a seller’s market for the cash portion of tax equity membership interest in operating U.S. renewable energy assets. CohnReznick Capital Markets Securities has advised tax equity partners with aging and historically underperforming power assets on ways to optimize proceeds from these assets. With yield-hungry passive investors hoping to monetize their cashflow interests, this is a complex and accretive transaction with a number of important tax and return considerations.
The Original Tax Equity Model
Since the earliest days of renewable energy financing, most investors focused primarily on originating tax equity investments. They had reasonable confidence that their ultimate exit from partnerships would be achieved when their managing member partners exercised the standard call options upon flip. As these earlier investments matured, many initial wind resource assessments had missed the mark. This, compounded with early mechanical and curtailment issues, impacted the performance of certain wind farms.
The early transaction structures favored an unlevered yield-based partnership flip with 100% of cash going to the managing member until the earlier of an agreed-upon date or return of capital. After this, 100% of the cash went to the tax equity member until an agreed-upon yield was obtained.
As a result of these early structures and performance issues, there are a significant number of wind assets that have already monetized a majority of their tax losses and production tax credits, but still have a material gap to bridge to their target yield. Accordingly, they are projected to continue to allocate 100% of their cashflows to the tax equity investors for the foreseeable future. This leaves many tax equity investors with a cash equity interest in projects that stray from the original investment thesis.
A year ago, this was an illiquid position. But a new market has developed for this cash interest that allows tax equity investors to sell the cash interests and redeploy their capital in new wind project financings.
The New Tax Equity Market
In this new market, some investors view the opportunity as a simple way to chase yields with a passive interest in the cash sweeping tax equity interest in underperforming projects. Others have a more complex strategy to acquire this equity interest with the end goal of gaining management control from the managing member and then utilize their operating expertise to optimize the performance of the assets. It is a deep and complex market, especially due to the merchant exposure that most of these assets face. This further limits some investors, such as YieldCos, from investing in them.
For tax equity, the decision to sell depends not only on the valuation, but also on the potential generally accepted accounting principles (GAAP) loss they may face as a result of the transaction. The potential for a GAAP loss on their equity exposure is a key constraint for entities holding these interests. They are public companies managing a very delicate income profile. With the right mix of aged assets, this GAAP loss can be nominal or even avoided all together. Selling these positions also allows for the embedded future losses and potential future impairment to be managed in a controlled environment.Today, we are at the peak of a sellers’ market. Required yields are low, but they will increase in a rising-rate environment. Certain power and infrastructure funds with a reasonably low cost of capital have improved their ability to take on merchant exposure due to the yield protection offered with this investment. Many of the traditional power utilities and strategic investors that have recently entered the wind space are also hungry for these cashflows. In addition, a few notable start-up funds, backed by industry pioneers, are now focusing on this investment proposition.For sellers, we know a few things about these relatively new market trades. First, the cost of capital does move much lower from here. Second, the buyer population has developed to create a competitive market for aged assets with a heavy merchant component. Last, the potential loss on a transaction can be effectively managed and mitigated with the appropriate mix of aged assets and production performance.
For interested sellers of these structured equity cashflows, now is the time to trade. There is an educated buyer population on this transaction, and we do not envision material pricing improvement from here.
This is Part I in a two-part series of articles. Part II will examine the motivations for selling, with a focus on the structuring and return profile of a sale.
Nick Knapp is managing director and John Richardson is an associate at CohnReznick Capital Markets Securities LLC.