Image source: First Solar.
Solar energy just got a big boost from Congress' ITC Tax Credit Extension and that means that solar very well could be an incredible opportunity for investors. Electricity generation is a $2 trillion market annually and solar energy accounts for less than 1% of that total, despite being the most abundant energy resource in the world.
One of the challenges is that companies have had a hard time making money in renewable energy. But First Solar (FSLR 1.14%) may have unlocked the key to value creation that will keep profits growing for years to come.
How project sales will work in the future
The growth in renewable energy hasn't been lost on utilities across the country. Southern Company (SO 2.49%), Dominion, and Berkshire Hathaway Energy have become active buyers of renewable projects, which provide long-term contracted cash flows and predictable returns at a time when growth in the traditional utility business is uncertain.
But instead of selling full projects to utilities, as companies like First Solar have done in the past, they're selling majority stakes and the tax benefits but keeping a minority stake and the long-term cash flows. The Desert Stateline project First Solar sold to Southern Company in the third quarter used a structure that sold tax equity and 51% of cash flows to the utility with First Solar keeping 49% of cash flows.
The advantage for First Solar is that it can generate enough cash from that majority sale to pay for all, or most, of the project, but it still gets to keep cash flows long term. Then it just needs to rinse and repeat to keep cash flows and profits growing.
Here's an example. Let's say a project is built that will cost $100 million to construct and will generate cash flow of $13.0 million per year for a 25-year contract. A utility investor is willing to pay $40 million for the tax benefits associated with the project and $60 million for 51% of the cash flows (generating a 10% return).
|
Cash Spent |
Net Cash Cost to First Solar | |
|---|---|---|
|
Project Construction |
$100 million |
$100 million |
|
Sale of Tax Equity Portion of Solar Asset |
($40 million) |
$60 million |
|
Sale of 51% of Cash Flows |
($60 million) |
$0 |
Calculations by the author.
Based on these numbers, First Solar would have zero net cost for owning 49% of the projects future cash flows of $6.35 million for the next 25 years.
This is just an example, but it approximates the way 51/49 project sales have occurred between multiple solar companies and utilities. And it's a good deal for both sides, as shown by the growing appetite for these structures from utilities.
How 51/49 project sales grow earnings
The great thing about keeping 49% of a project's cash flows for a low cost basis is that you can repeat the strategy over and over again. If First Solar had the capacity to do one project per year with the numbers I outlined in the example, it would have cash flow of $6.35 million per year after year 1, $12.7 million after year 2, and $31.7 million annually after year 5.
This is a great way to grow earnings with a very low cost basis and very little risk. And if First Solar keeps employing this sales strategy, it should be able to grow earnings for years to come.
