SunEdison is expanding beyond solar with a $2 billion wind acquisition. Source: SunEdison.
SunEdison (SUNE +0.00%) has become a market darling since launching the yieldco TerraForm Power (TERP +0.00%) and going on a renewable energy buying spree around the world. The latest buy was a 930 MW wind portfolio of assets from Invenergy that TerraForm acquired for $2 billion, expanding the company's wind business even further.
The goal is to add assets and cash flow to the yieldco, which will eventually make its way bad to SunEdison through dividends and payouts from incentive distribution rights. But are SunEdison and TerraForm playing with fire in paying billions for these renewable assets?
Source: SunEdison.
What renewable energy returns really look like
If you look at SunEdison's press release on Monday, the returns of the wind projects are framed to look very attractive. Unlevered cash available for distribution is $141 million over the first 10 years, and levered cash on cash yield is 8.4% (this is basically just the inverse of payback time). The average contract life for the projects is also 19 years, which is fairly long for this type of acquisition.
Adding $141 million in cash available for distribution may sound like a lot, but the $2 billion price tag is steep for that kind of return. Remember that the cash flow from projects has to cover the depreciating value of a wind turbine over time as well as pay for debt that will be used to acquire the assets, so the return for shareholders may not be as attractive as it seems. What investors need to ask is what the wind turbines being acquired will be worth after the 19-year contracts are over?
Depending on how you answer that, the total internal rate of return (IRR) for this investment isn't very impressive. Below, I've built a table calculating the IRR of these assets using the annual unlevered cash available for distribution (the best cash flow figure we have available) and varying asset value assumptions at year 19. If the assets hold value over time, the returns increase to as high as 7.05%. This could be goosed to the 8.4% quoted by SunEdison by adding debt.
|
$0 Value at Year 19 |
50% Value at Year 19 |
Full Value at Year 19 | |
|---|---|---|---|
|
Initial Value |
$2 billion |
$2 billion |
$2 billion |
|
Annual Cash Flow |
$141 million |
$141 million |
$141 million |
|
Final Value |
$0 |
$1 billion |
$2 billion |
|
Internal Rate of Return |
3.1% |
5.5% |
7.05% |
Calculations by the author.
The problems start to show up if the wind turbines aren't very valuable in 19 years. Then the cash flow generated would barely pay for the $2 billion purchase price, providing a measly 3.1% return over that timeframe.
The IRR isn't even as high at TerraForm Power's 5.9% interest rate on debt in Q1 2015. And with rates rising, that rate will likely rise before the power purchase contracts expire. Unless TerraForm Power can re-up contracts for equal or greater electricity prices well beyond the current contracts, the company may not even earn its cost of capital back.
In the meantime, TerraForm Power will be paying out as much cash as it can in distributions to shareholders and SunEdison instead of paying down debt, where the risk in the business lies. This strategy could pay off in spades if interest rates stay at record lows for 20 years, but what happens to the business if rates rise 2%, 3%, or 4% by the time debt matures in the next decade? Stack on top of that the variable interest rates TerraForm Power uses, and the interest rate risk is extremely high.
Yieldcos are more than just advertised cash flow
Even a yieldco has to earn enough money from projects to pay for construction or acquisition costs as well as the principal cost of debt. But SunEdison and TerraForm Power don't seem to be worried about those costs in acquisition calculations, which could come back to bite investors long term.
Yieldcos are the market's hottest financing vehicles, but aggressive assumptions could bring them down if companies aren't careful. This deal and many others by SunEdison just don't look like the kind of profitable projects I would want to invest in right now, especially when you look at TerraForm Power's $2 billion in debt last quarter, which will grow now that this acquisition is being added to the mix.
