On the surface, yieldcos should be among the safest stocks on the market. They own renewable energy projects with long-term contracts to sell electricity to utilities over the course of decades, creating a very predictable stream of cash flows.
With that in mind, how can TerraForm Power (NASDAQ:TERP) and TerraForm Global (NASDAQ: GLBL) lose 80% of their value in less than a year? And what can investors learn from it?
Not all yieldcos are created equal
The first thing to understand is that yieldcos can be structured and financed in very different ways. 8point3 Energy Partners (NASDAQ:CAFD) has chosen to finance its projects with a combination of equity and corporate-level debt. It isn't taking debt onto specific projects (although it could in the future), which is a more conservative approach to financing.
Assets within the portfolio can also be very different. NRG Yield (NYSE:CWEN) owns solar, wind, and a few fossil fuel plants. As wholesale electricity prices have fallen, the natural gas assets have made less money than anticipated, and wind assets have also underperformed, the stock has declined.
Where TerraForm Power went wrong was using a heavy amount of leverage at both the corporate and project level to buy projects from parent SunEdison. That has led to financing problems, which I'll cover below.
TerraForm Global bought projects in India that weren't even completed, putting project-level financing on the assets. When SunEdison went bankrupt and failed to complete the projects as planned, the company was in trouble. And now those structural decisions are coming back to haunt the company.
Not all debt is equal
I've already mentioned that yieldcos use some combination of corporate- and project-level debt. And the difference between the two is really important. If a company uses just corporate debt, investors can see what overall cash flows look like, where they're trending, and how debt costs compare to those cash flows. Excess above the cost of debt and what the company keeps for future growth should be returned to shareholders in the form of a dividend.
Project-level debt can be much more complicated. There can be covenants related to the health of a parent company, production from the assets, reporting of financial statements, cash reserves for a project, or any number of other requirements creditors want. And often stock investors don't know the minute details of these contracts.
This is exactly what has gotten TerraForm Power and TerraForm Global in trouble this year. According to Moody's, TerraForm Power faces potential default on 10 project-level loans because of different clauses, and TerraForm Global faces the same problems with five loans. And it's that project-level debt that could end up costing them millions in reserves, triggering higher interest rates, or even pulling them into bankruptcy.
Safety is key in yieldcos
A company like 8point3 Energy Partners or NRG Energy may not provide the growth or excitement the TerraForms did for a while, but they're also a lot safer for investors because they're not as highly leveraged, and 8point3 Energy Partners has avoided project-level debt.
After what we've seen in the past six months in renewable energy, safety matters.