This interview was conducted with a Power Investment Banker specializing in the Renewable Energy space.
Renewables are hot right now – is there a difference between which renewables are doing better between solar, wind, hydro, biofuels and geothermal? Why is that?
The renewables space has been around for a long time. For example, some hydro plants have been around for nearly 100 years. Other relatively newer technologies, such as wind and solar, have also been around since the 70’s-80’s. So the industry itself has been around for some time, but it’s really only been in the past 15-20 years that it has really picked up.
Regarding which fuel type is doing ‘better’, it truly depends on a company’s strategy. More mainstream fuels are the hydro, wind and solar facilities, in that order. The biofuel and geothermal facilities are more of a niche fuel type. This difference can be attributed to the technology backing the mainstream facilities. The advancements over the decades have brought about the ability to develop ‘utility-scale’ sized facilities (aka are large enough for a utility company to sign a contract with). Having the size allows for developers to sign a Power Purchase Agreement (“PPA”) with a utility company, or other offtaker, for an agreed upon time (can last decades depending on the fuel type). This gives developers and operators certainty of cash flow streams in the future as opposed to being paid through a regional power pool which is at the mercy of the market dynamics.
Due to the nascent nature of the biofuel and geothermal industries, the scale hasn’t quite reached the same level as the above mentioned facilities, making it riskier and more difficult to develop.
A big story lately has been cost pertaining to renewable power becoming competitive with and even cheaper than traditional sources of electricity without subsidies – what are some forces that have led to this?
The growth in the industry has been largely driven due to advancements in technology (better wind turbines, more efficient solar panels, etc.) and regulatory regimes making it economically feasible for companies to continue investing in these assets. Advancements in technology for wind and solar have been in leaps and bounds over the past couple decades and has even led to the development of new industries (such as offshore wind). Government subsidies are still a large part of the renewables space in general. Though technology is making it cheaper, it will still take time before renewables are able to be ‘cheaper’ than traditional sources on a stand-alone basis.
In an example renewable asset such as a wind farm, what are some key figures and metrics that a corporate finance professional would need to know (MW, PPA etc)?
When looking at a renewable asset, it really depends on the corporation that is looking at it. Typical metrics would include:
- $ per MW
- Provides an idea of the amount of total capital being paid for a unit of capacity (these change depending on the fuel type)
- Provides an investor a multiple that can be compared globally as it excludes any effect of taxation and capital structure manipulation
- Free Cash Flow Yield
- Due to the long-term contracted nature of the assets, investors will be very interested as to how much of a dividend/distribution that they can pay themselves over the useful life of the asset
- Internal Rate of Return
- Many private investors (financial sponsors in particular) will look at assets on a returns basis to determine whether the project will hurdle internal return thresholds
- Public investors may also have an internal return threshold or have a stated level that they have told investors
Although, if a publicly traded company is looking at an asset they might take the above into consideration, but in the end, need to look at other metrics such as accretion/dilution to shareholders on a several bases.
That said, renewables have historically required some form of subsidy to become commercially viable – what were some government incentives (tax breaks, grants) that pushed projects over the line in terms of economic hurdles?
Governments have been able to spur growth in the renewables space through several channels. They typically come in two forms: (i) subsidies/breaks during the construction phase, or (ii) subsidies/breaks during the operating period.
During the construction phase, governments can provide tax breaks to developers when purchasing parts that will be used in the construction of the facility. During the operating phase, governments can step-in to help by allowing further tax breaks or by entering into PPA’s with operators to provide a certain level of cash flow stream.
These subsidies have led to the creation of several tactics used by corporations to take advantage of these subsidies/breaks. One example is the use of Tax Equity financing by developers, which is a very complicated and detailed financing system that takes advantage of a renewable developers tax attributes.
What returns are renewables investors looking for in a politically stable jurisdiction such as Canada? What about frontier regions like in Latin America?
Returns that investors are looking for really depend on which point in the business cycle the industry is in. As you mentioned, renewables are a hot space right now and there is a lot of appetite for these assets. This has led to investors bidding down returns. As an example, a wind facility could be bought at a levered after-tax IRR of ~9.0% – 11.0% (unlevered after-tax IRR of ~7.0% – 9.0%). Someone might look at these returns and think they’re very low, which they are, but with certainty of cash flows for the majority of an assets useful life an investor can have visibility on revenues and create cost synergies or use financial engineering to juice up their returns.
A similar process would be used in other jurisdictions as well. Lately, the renewables space has started to bud in areas such as China, Latin America, and India. Typical investors will look to these new geographies in hopes of grabbing higher yield (to offset any potential geo-political risk) and add geographic portfolio diversification. With their know-how, they can again use synergies and capital structure manipulation to help with the returns.
Traditional power companies tap into the capital markets quite frequently at the corporate level. For renewables companies, is there investor appetite?
There is always appetite for power companies as they can provide investors with yield and growth. Many provide dividends/distributions to investors and are highly focused on long-term cash flows to fund this. This will appeal to dividend investors as they can get additional upside in conjunction with their quarterly dividend.
Several companies also make use of an OpCo/HoldCo structure where they can fund at both the corporate and project level. Largely, the funding at the OpCo level is bank based (credit facilities, revolvers, term loans) as they are being used to finance a project, but can also consist of bond financings that would be broadly distributed to institutional investors. Bond financings are welcome by investors as they have clarity into future cash flows and how they can be used to service the bond’s obligations.
What are some large recent equity raises? Do renewables look at alternative sources of capital such as preferreds, convertibles and hybrids? When and why?
In the last couple of years, there is no relatively large (>$1 billion) renewable company equity raise to point out. Most of the equity raises done in the Canadian market are done from time-to-time to fund continuing construction activities, M&A transactions (whether asset, portfolio or corporate), or for general corporate purposes.
What are some large recent debt raises? Is renewable debt limited to bonds?
The majority of debt used by renewable companies is comprised of bank facilities either at the OpCo or HoldCo level to fund growth initiatives. These are typically used during the construction phase for an asset and are paid down during the term of the PPA. Rarely, however, some renewable facilities will use bond financing in addition to what is provided by the bank (ex. North West Redwater Partnership). Due to the large upfront capital needs to build these facilities, companies can be very price sensitive as a basis point can represent a very large amount of money.
What are some reasons behind renewables M&A that we are seeing beyond standard M&A (less financial reporting, administrative synergies) – what are some renewable M&A synergies?
Similar to other resource based industries, the M&A that occurs is more project focused as opposed to corporate. Beyond strategic reasons for purchasing an asset, portfolio, or platform, an investor may look to add to their portfolio if they are able to create synergies below the revenue line.
As mentioned, the majority of assets are under long-term contracts and hence there is no room to create revenue synergies. What an investor will look to do is to create cost synergies by cutting corporate costs, applying in-house knowledge in operating an asset, or can tuck-in the asset to an already existing portfolio management platform.
Who are the main players in renewables in Canada and globally?
The renewables space is interesting since it has a real global presence. Many of the largest investors in renewables in Canada are from abroad. These could include large utilities from the U.S. (NextEra, Duke), Europe (EDF, Engie, EDP) or Asia (China Three Gorges, State Power Investment Corp.), as well as financial sponsors from around the world. Of course, we have the home team players as well that include names such as Enbridge, Northland Power, TransAlta, and Algonquin.
Many of these companies see the renewable and power space as an offshoot to other industries such as pipelines, utility distribution and transmission.
Who are some private equity funds and other industry players that have a strong renewables franchise?
The large household private equity names (KKR, Blackstone, Carlyle, etc.) will all have funds that target renewable investments. Though the majority of private equity investments into the renewable space will come from firms that have a specific infrastructure mandate (Arclight, Riverstone, Alinda, IFM). As mentioned, the renewables space is very global and many of the funds are based in internationally with offices all over the world to find deals. There are also several pension funds (CPPIB, OTPP, APG, PGGM) and sovereign wealth funds (ADIA, Mubadala, QIA) that look to the renewables space to be able to match up long-term outflows to pensioners with long-term inflows from the assets.
Although it is a rapidly changing space, what are some current developments in the renewables space in terms of technology or regulation?
Technology continues to advance and provide more ‘bang-for-your-buck’ as developers can purchase larger parts for less. The real developments, however, are attributable to the regulatory regimes that the assets are built in. for example, with the appointment of Donald Trump as POTUS, and his pro-coal views, some investors are worried that many subsidies/breaks may be taken away from the renewables space. There is already the phasing out of the ITC/PTC program, pushing developers to get projects out the door so they can are eligible for these grants. Any additional moves could be detrimental to investors views and willingness to invest in assets.
This however is offset by the view that renewable space has become such a large part of the power generation profile, that anything that would hurt the industry could hurt end-electricity users.
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