Canadian Solar (NASDAQ: CSIQ) is launching a yieldco. A year ago that kind of news would have sent a stock through the roof. Today it's met with skepticism by the market.

What's strange is that Canadian Solar would even pursue a yieldco in a market that seems overwhelmed with yieldco choices. It may show some desperation on the part of a company that can't seem to figure out what its long-term strategy is going to be.  

Why solar companies want to have yieldcos
The reason solar companies want to be part of yieldcos comes down to the fact that they need to monetize projects they build somehow. It's not profitable just to build and sell solar panels, so companies like Canadian Solar have gotten into the solar plant building business, which expands margins and creates a captive demand for panels.

The one big issue solar companies have becoming system developers is figuring out what to do when the project is completed. There are really three options:

  • Sell the project outright.
  • Drop the project down to a yieldco to retain some ownership interest.
  • Hold the project on your balance sheet.

For solar companies like Canadian Solar, holding projects on the balance sheet long-term isn't really feasible because it can't exploit tax benefits and doesn't have the necessary low-cost capital. Selling projects outright is nice, but it generates far less long term value than holding a piece of ownership and that's why solar companies are trying to own more of what they build. But therein lies the problem.

Yieldcos becoming less attractive
Yieldcos allow for a public vehicle to buy projects and allow partial ownership for a company like Canadian Solar, but they have been hammered lately on the public markets. The result is rising costs for the equity from yieldcos, which are now yielding over 5% from dividends alone.

TerraForm Power (NASDAQ: TERP) and NRG Yield (NYSE: NYLD) were among the first yieldcos on the market have been the poster children for the downfall of yieldcos. They promised growing dividends to investors, but they rely on issuing new equity as a source of capital so maintaining a high stock price is central to their investment thesis. Once the stocks started to fall and yields rose, their ability to buy projects was cut off and the growth thesis fell apart. 

TERP Chart

TERP data by YCharts

Since both NRG Energy and SunEdison were counting on these yieldcos to be sources of new financing for growth they helped drag down their parent companies as well. For Canadian Solar, the high yields in today's yieldco market means a yieldco offering would have to come with a high dividend -- reducing Canadian Solar's initial yieldco IPO price -- and makes growth through selling shares more difficult.

The rock and the hard place
If Canadian Solar had launched a yieldco earlier this year -- or even a year ago -- it wouldn't be dealing with the same challenge it is today. Yieldcos really only face this high cost of equity problem when they sell shares to the public, so for yieldcos that have done that, they don't necessarily need to again to buy projects near term.

But going public in a high-dividend-yield environment is problematic because you're selling new shares at that higher cost of capital. That negatively affects everything the yieldco does in the future and can strap its ability to buy projects and grow.

The alternative is that Canadian solar just sell projects to other yieldcos or utilities, but again as the cost of capital has risen over the last few months, the price they're willing to pay for projects has gone down.

This dynamic puts Canadian Solar in a tough position trying to find ways to finance projects now and in the future. And I don't see an easy answer to the conundrum today.

Travis Hoium has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.