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Moody’s Report Provides Clarity. Invenergy Private Warehouse Will Provide Greater Clarity. Up to 4.5 billion in Purchases Possible. Yesterday’s Moody’s report for Terraform Power should help shape TERP’s financial decisions next year. Although Moody’s reaffirmed the corporate rating at Ba3, the outlook was cut from positive to stable and Moody’s said a rating upgrade is unlikely anytime soon. Terraform most certainly would like to obtain an investment grade rating. TERP has a better credit profile than many MLP’s that are investment grade, yet the nascent yieldco business model will need a lot more time to mature in Moody’s opinion. The most interesting line of the report was “TPO’s rating could be downgraded if there is a change in financial policy causing the company to target materially higher levels of leverage with a consolidated Debt/EBITDA greater than 6.5-7x.” Source: (BMP) Moody’s affirms TerraForm Power Operating’s Ba3 rating; ch anges rating outlook to stable from positive What this line implies is that TERP can go up to 6.5 to 7x leverage and not put in jeopardy the Ba3 rating. Because there is no clear path to an investment grade rating anytime soon and TERP can lever up some more without jeopardizing the Ba3 rating, TERP can and should move to higher leverage ratios. And the way to do this is project level debt with no or little unsecured offerings. Moody’s disagrees with the way TERP calculates debt to ebitda and calculates the number a little higher than TERP yet there still is ample room for TERP to issue project level debt. TERP in the July financing update shows a proforma 2016 view 2.952 billion in debt and 567 in ebitda creating a 5.2 debt/ebitda metric. TERP can comfortably take that number up to 6.2 without creating a ratings downgrade. That would allow 3 billion more in debt. How are they going to do that? With project level finance and the Invenergy Warehouse should pave the way. The Invenergy Warehouse With a high stock price, TERP management got aggressive with the Invenergy purchase. Paying 7.1% unlevered yield was steep and quite frankly sloppy. It was yet another example of sloppy aggressive purchasing by Sunedison and/or Terraform this year. The good news is that the Invenergy assets have a AA counterparty and a 19 year PPA so the contract there is about as strong as you are going to get. Abengoa, the most troubled renewable developer of all, recently priced 19 year amortizing bonds backed by a couple 50 megawatt solar(thermal) plants in Spain at 3.75% coupon. The bonds were rated BBB. Yields are lower in Europe but still that is attractive spread financing. Solarcity’s asset backed loans have investment grade ratings and priced sub 5%. For many renewable projects, if the project has a base debt service coverage ratio up close to 1.5 and a good counterparty, the ratings agencies have assigned investment grade ratings to the project finance bonds. Even recently, the NRG Alta bonds which dropped to 1.09 debt service kept an investment grade rating since S&P assumed normal wind patterns would resume and bring the debt service coverage back up to a 1.4 range. It is kind of ironic that the rating agencies will assign investment grade ratings to project finance with debt service coverage around 1.4 or so but TERP has a pro forma ebitda to interest expense over 3 with a more diverse set of projects than specific project financing yet has high yield ratings. This is strange and it leads to disconnects in the market. The insurance and pension funds buying project debt at 5% or so yields really ought to just buy the unsecured debt of yieldcos but they are probably restricted due to the need to invest in investment grade securities. So what will the Invenergy warehouse price at? BBB investment grade utility bonds are about 5% for 20 years and project finance although mostly amortizing has been pricing in that range. Since there likely will be a TERP call option associated, 6% debt may be an appropriate number for 70% of the proceeds. And then perhaps a 9% or so equity return for the remaining 30%. That would get to a cost of capital just below 7% and the unlevered yield of 7.1% covers the warehouse with TERP not having to put up cash (though there is a decent chance TERP is going to buying some of the equity portion of this warehouse). We don’t know what the debt on the Invenergy warehouse will price at but if it does price in line with other project finance debt, it sets a strong precedent for TERP going forward in the project finance market. 4.5 billion in purchases in 2016? It is highly unlikely but I will lay out a scenario that is not too far fetched. Since there is no chance of TERP becoming investment grade anytime soon and Moody’s stated TERP could lever up to 6.5 to 7x without creating a downgrade that is exactly what TERP should do if project finance permits. 8.5% unlevered yields on projects are out there for purchase. The Sunedison First Reserve and Goldman warehouses seem to have cost of capital somewhere around 8.5% so much better to have TERP calling projects from those warehouses at 8.5% than projects staying in the warehouses (JP Morgan warehouse seems to be much better than those two). If SUNE projects are 10% IRR projects than still 17-18% gross margins for SUNE on 8.5% unlevered calls by TERP from project warehouses. But if TERP is going to acquire 8.5% unlevered projects it needs a cost of capital close to 7.5%. That isn’t going to happen with 50/50 unsecured debt/equity these days. If TERP were to package existing projects and/or built call right projects into project finance bonds, there is a good chance a 5.5% debt rate could be had, at least for amortizing bonds. If 5.5% project debt can be used for 65% of projects, then the 35% equity portion needs to be at 11.2% to generate a 7.5% WACC. If TERP were to acquire 4.5 billion of projects with 65% project debt/ 35% equity all at 8.5% unlevered yields, debt would rise to almost 6 billion. 382 of unlevered CAFD would be added. Debt service would be .055 x 3 billion so 165 million. Probably makes sense to assume about 10 million of extra expense to cover backfilling amortizing portion of debt with higher cost debt and perhaps to cover extra various fees. 382 million of unlevered CAFD minus 165 million of interest and 10 million extra expense leaves 207 million levered CAFD(assuming no taxes here which perhaps there should be an assumption for some). 207 divided by 1.5 billion of equity issuance is 13.8% equity yield, certainly accretive. Levered CAFD of 207 million would actually be growth of about 60% on the 320 million of pro forma CAFD that TERP is projecting for 2016. 320 million plus 207 million leads to 527 million of CAFD. Assuming 1.5 billion of equity comes at a $20 stock price (8.75% 2016 dividend) that is 75 million more shares to add to the 140 million outstanding. 527 million CAFD * .85 is 448 million CAFD to distribute. Even with IDR’s, a 15% dividend increase from $1.75 would be possible for 2017. Do I think that scenario is going to play out? No, I don’t. But I do think the private project finance numbers out there do support something more than a dead in the water TERP in 2016. TERP needs to move into the project finance market in a big way. And some less than ideal equity issuances may make sense to give investors confidence dividend growth is still alive. With added confidence that TERP can grow its dividend in difficult times, the dividend yield should move lower and allow for more even debt to equity funding in future years. One may question with a movement to project finance in the renewables space vs. corporate level finance why Sunedison would even try to feed a yieldco vs. creating its own project finance vehicles to keep ownership. A yieldco was supposed to allow corporate level finance in addition to project level finance so finance could be attacked from all angles at reasonable rates. Although not ideal, TERP still has better funding characteristics than SUNE. No projects are going to be 100% debt financed and even with suppressed yieldco equity prices, I do believe a yieldco has a better chance of consistently raising even small amounts of equity at reasonable prices vs. Sunedison. Plus, there may be a need to do small unsecured corporate level debt issuances and that is still better done at TERP than SUNE. In addition, it is very possible the yieldco market does improve with maturity and yieldcos can once again finance at the corporate level with attractive rates. Besides, TERP has a call right list so Sunedison has to offer projects to TERP. TERP paying even a little lower than what others will pay still makes sense for Sunedison due to IDR’s and residual ownership value. However, Sunedison won’t sell projects from the warehouses much lower to TERP than to the private market so TERP needs to quickly establish project finance initiatives. Management of TERP and SUNE has touted their creative finance ability in the past and it is time for TERP management to do just that in a difficult 2016. Playing dead and hoping the market improves to once again issue significant amounts of corporate equity and unsecured debt is not good enough management and equity owners deserve better. I am long SUNE and short covered calls. The firm I work for is long GLBL and TERP. Scalper1 News
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