A number of hedge funds are circling TerraForm Power (TERP), and before long, one could conceivably buy the controlling B shares and incentive distribution rights in it that SunEdison owns. In other words, a hedge fund soon could control the company's destiny. And here's what investors can expect to see if that happens.
Assets will be put on the block
One thing that's almost guaranteed is that some or all of TerraForm Power's assets would be put up for sale. If an acquirer could get reasonable value for some parts of its power-generating portfolio, assuming they buy the company at a low enough price, a quick payday could unlock a lot of value. It could also bring debt down to a more reasonable level, something that will be important long term.
The question is, who would buy solar and wind assets today? The answer may come from the very recovery that would occur in a TerraForm Power sale. The yieldco market has collapsed in the past year, largely because SunEdison and TerraForm Power fell apart. But if the yieldco regains some stability, it will help shares of other yieldcos, which need more assets to grow their own dividends.
Utilities could be interesting buyers as well. At the right price, they would be interested in acquiring electricity-generating assets with long-term contracted cash flows. And they're less affected by the market's whims than yieldcos, which need to issue new equity to grow.
Returning TerraForm Power to growth
If the acquisition of TerraForm Power isn't just a liquidation job, we could see a new owner put the company back on a growth path. The point of a yieldco is to buy renewable energy projects with newly issued debt and equity. But to do that, its cost of capital must be low enough for it to buy those projects accretively. If TerraForm Power's borrowing costs go down and the dividend yield falls under new ownership, it could actually return to growth.
Should that happen, a new owner may see new value in the incentive distribution rights (IDRs), assuming they come with any purchase of SunEdison's stake in the company. IDRs are payments made to their holders based on an increasing dividend. Shareholders get some of the increase, and IDR holders get a portion as well. If TerraForm Power returns to dividend growth, those would be valuable assets.
Repackage and sell again
Since hedge funds aren't known for being long-term investors, at least on the scale of decades that renewable energy assets will perform, it's possible they'll simply reorganize TerraForm Power and sell it again. That may be a way to make a quick buck, too.
One of the biggest reasons TerraForm Power's shares fell as much as they did is because the market lost faith in SunEdison, and therefore TerraForm Power. But if the assets, which are generating cash flow each quarter, don't have that same overhang, we could see a sharp recovery in shares. For example, if the stock continues to pay a $1.40 annual dividend under new ownership and the dividend yield falls from 10.8% to a more reasonable 5.4%, the stock would double. And a new owner may still be interested at that price.
A solar developer like Canadian Solar (CSIQ -3.40%) would be a logical choice. The company has had its eye on the yieldco market for some time, but didn't launch its own yieldco because of the dislocation in the market over the past year. It could take a stake in the company's B shares to get a controlling position.
A utility could also be interested in the company at the right price. We've seen NRG Energy, NextEra Energy, and others launch yieldcos to develop a renewable energy arm; buying one ready made is another solution. But they might want to leave the work of restructuring it to hedge funds more adept at dealing with bankruptcy courts.
Hedge funds could be good for TerraForm Power
In this case, I think hedge funds like Brookfield Asset Management, Appaloosa Management, and Greenlight Capital could bring valuable funding and expertise to TerraForm Power. That's not always the case, but they seem willing to ensure the company's survival and buy it out of the arms of SunEdison. And that's the best that investors can hope for at the moment.