Yieldco Asset Management (Global)
Yieldcos and contractual assets
A yield company (yieldco) is an entity formed to own operating assets, such as solar or wind power, and to raise funds by issuing shares to investors. Cash flows from these operating assets are then used to distribute dividends (cash payments) to shareholders over time. By separating operating assets from riskier activities such as project development, yieldcos can attract investors who are looking for more stable, predictable returns (e.g. from power purchase agreements).
Like securitisation, the bundling of renewable energy assets under a yieldco (possibly with other contractual agreements) reduces risks (e.g. payment defaults) associated with individual assets. This can help to attract new investors, including those who may lack the interest, capacity or channels to place capital into individual renewable energy projects.
Bundling, alongside projected long-term dividend growth (how often and how much the dividend is raised over time) also allows yieldcos to raise capital at attractive terms. For example, capital raised through some of the first yieldcos in the United States was used to pay off expensive debt and to finance new projects at rates lower than those that were available through tax equity finance, which could exceed 8% (Urdanick, 2014).
Yieldcos have (re)emerged in recent years (after the failure of SunEdison in the United States) as an attractive option for utilities and renewable energy asset owners to move operational capacity from their balance sheets to finance new projects (Deign, 2020).
In a typical arrangement, a renewable energy company creates a separate entity (the yieldco) and transfers its operating assets, typically at a premium to their costs. To buy those assets, the yieldco raises equity by issuing shares to investors with the promise of predicable, low-risk returns (dividends).
In return, the parent company uses the sale to finance new assets. Once operational, those assets can then be sold to the yieldco, effectively creating a sort of revolving credit facility, which can be cheaper than through project financing (OECD, 2020).
To increase the overall distribution of free cash flow to shareholders (thereby making investment more appealing), yieldcos generally use a tax-efficient (pass-through) structure in which income is taxable at the investor level. Yieldcos also generally offset taxable revenues with asset depreciation expenses, whereby acquiring new assets helps to maintain high annual depreciation expenses.
Naturally, cash flows depend on the productivity of the renewable energy assets and their contractual agreements (e.g. if they are fixed price and have inflation-indexed revenue profiles). Dividend yields (annual cash payments relative to the share value) also depend on the yieldco’s ability to manage and acquire new operative assets.
This ability to manage and in particular acquire (or even develop) new assets is a central element to the yieldco structure, as it affects the yieldco’s capacity to maintain or grow its underlying value (e.g. accounting for asset depreciation) and subsequently maintain a high stock price (i.e. the investor’s underlying investment). A high stock price in turn allows the yieldco to finance new acquisitions by issuing new shares with limited dilution to the existing shares.
This so called “virtuous cycle” (Konrad, 2021) can of course become a risk if not well managed. The more yieldco share price rises, the more underlying growth in dividend needs to be to maintain (or increased) for the yield to remain stable or grow. While short-term ups and downs may be manageable, maintaining this virtuous cycle with high growth in both the yield and dividends can mean taking on big risks.
Lessons learned
Global experience with yieldcos over the last decade has shown that as with any capital-intensive and fast-growing industry, there is a risk that the company grows too quickly, affecting its ability to manage its debt and pay its shareholders (IRENA, 2016). Yet, if operative assets (or a portfolio of different grade assets) are of good quality, are diverse and produce distributable cash flow (once capital expenditures to maintain the assets are taken into account), then this cycle can continue, helping to attract new investors and increase flows of finance to renewable energy projects.
A number of good practices in the design and operation of a yieldco can allow it to grow and meet investor expectations. Importantly, a manageable growth strategy is critical to avoid volatility in the yield valuation, which was a factor in the SunEdison crash (Mitidieri, 2020). As with structured finance, diversity of assets can also address potential associated risks. For instance, a portfolio of renewable energy asset types and locations can help manage issues like hydrological risks from droughts or periods of low electricity output from wind and solar farms.
In India, the opportunity for yieldcos as a way to manage operative assets while raising capital for new projects is not unprecedented. In 2014, the Securities and Exchange Board of India (SEBI) issued regulation for Infrastructure Investment Trusts, which allow companies to unlock tied up capital by transferring operating and revenue-generating infrastructure assets to a newly created trust (UNESCAP, 2017). Similar to the yieldco structure, these trusts (e.g. the Greencoat Capital renewable investment trust in the United Kingdom) create investment opportunities for certain investor classes looking to avoid risks associated with project development. Though, the SEBI rules for these trusts have a stronger requirement than yieldcos, as the capital raised has to be used to repay at least 50% of the debt.
To date, these infrastructure trusts in India have had limited number of applications for renewables, but their experiences from the overall growing use of investment trusts in India may provide useful insights for using the yieldco model for renewable energy projects. This could help to attract new capital, for instance from institutional investors. Recent developments by Powergrid and NHAI, two prominent public sector entities in the renewable energy space planning to monetise assets through Infrastructure Investment Trusts, may also help build momentum in the market (Jai, 2021; Ray, 2021).
Key findings of an OECD 2020 empirical investigation* found that around USD 150 billion of institutional investment in green infrastructure (not exclusively renewable energy assets) globally was already held through yieldcos, highlighting the important role of these securitised products. Further information on the emergence of yieldcos in institutional investor activity can be found in the OECD 2015 report on Mapping Channels to Mobilise Institutional Investment in Sustainable Energy. Additional information will also be included in the OECD 2021 Progress Update on De-risking Institutional Investment in Green Infrastructure (June 2021).
* Note: the report focuses on real economy investments, which in consequence exclude most corporate stock holdings as well as corporate bonds.