NRG's 18 months of experience provides lesson on 'yieldcos'

Business people don't get enough credit for their creativity.

One reason I enjoy writing about business is that I learn how companies address problems, such as regulatory inequities, investors failing to properly value assets or overcoming the high cost of capital.

NRG Energy, a power company with headquarters in Princeton, N.J., and Houston, says it faced all of those problems and solved them by pioneering the renewable energy yieldco, a standard corporate structure that holds stable assets to generate a high dividend yield for investors. Eighteen months after the company closed the first public offering of a renewable energy yieldco in July 2013 with NRG Yield, I spoke with Kirk Andrews, NRG's chief financial officer, about what he's learned.

One problem was that NRG's management felt investors didn't fully appreciate the value of the company's renewable energy assets that had long-term contracts and offered steady revenue that was immune to commodity prices, Andrews said. The typical NRG investor was interested in the company's role in the competitive power market, not the contracted-power market.

Companies can solve this problem with fossil fuel assets, such as pipelines, by placing them into master limited partnerships and attract investors by offering a high dividend yield. But Congress has rebuffed efforts to make renewable energy assets eligible for master limited partnerships, which also have huge tax advantages.

NRG also wanted to raise capital for new projects, but wanted to keep the cost as low as possible. Faced with these challenges, the company chose to place the low-risk contracted generation assets into a yieldco, a publicly traded corporation that could compete with a master limited partnership. The stock sale would also raise low-cost capital for NRG to develop new projects that could ultimately be sold to the yieldco.

"The first motivation was to highlight the value of our past successes," Andrews said. "The second motivation was creating a vehicle that had a more optimal cost of capital that would be the right home for our future successes."

The renewable assets with long-term contracts, or power purchase agreements, were placed into NRG Yield, where they would guarantee a steady revenue stream. Once a solar project with a 20- or 30-year lifespan is built and has a customer for the electricity, the asset's revenue is relatively low risk.

Many industrial consumers of electricity are signing power purchase agreements for renewable energy as a hedge against higher natural gas prices and for the tax credits.

A self-shielding vehicle

To mimic a master limited partnership's tax advantage, the NRG Yield portfolio also includes fossil fuel and thermal assets that generate taxable income and can benefit from renewable energy tax credits.

"By combining them, you create what is in essence a self-shielding vehicle." Although NRG Yield is a normal corporation, Andrews said it is "in some sense" a synthetic master limited partnership. "We have confidence that we are not a taxpayer for at least the next 10 years."

Since NRG Yield went public, almost a dozen yieldcos have entered the market, including pure-plays committed to just one form of electricity generation, such as Beltsville, Md.-based TerraForm Power. SunEdison spun off TerraForm with a $501.6 million initial public offering in July and the company is building a portfolio of solar projects.

Renewable energy yieldcos, though, must keep adding new, reliable assets to maintain the high yield paid to investors, as well as constantly balancing the tax credits produced by renewable energy with taxable income to maximize that benefit. Share prices could also suffer when interest rates go up and government debt begins providing higher yields, or suffer from gyrations of the larger stock market, according to University of Houston finance professor Praveen Kumar.

Dicey growth?

"If the new Congress decides not to extend some of the rather substantial subsidies that you get to invest in renewable energy generation, it's not going to be as attractive," Kumar added. "If that begins to happen, the growth is going to be dicey."

Andrews said NRG Yield addressed these challenges by letting investors know what assets NRG planned to offer to drop down to the yieldco in the future.

"We indicated our expectation that we were going to grow the dividend by 10 to 15 percent on a compounded annual growth rate over the next five years," he said. "Not only are we telling you that it is our aspiration to grow the dividend at this rate, but here is the means by which we are going to accomplish that."

In addition to having access to NRG's assets, NRG Yield can purchase third-party projects to grow earnings. Low commodity prices and the growing use of distributed power generation point to more power plants that have long-term contracts and therefore can go into yieldcos, Andrews added.

NRG Yield went public at $22 a share in 2013, and as of Jan. 8 was trading at $51.41 a share with a dividend yield of 3 percent. Standard & Poor's has given it a "fair" debt rating of BB&, partially because renewable energy yieldcos don't have a track record.

On Jan. 5, NRG Yield made its second acquisition of assets from NRG and paid $480 million in cash and assumed $737 million in debt for four wind farms and one natural gas facility.

The company said the acquisition would let it raise the estimate of cash available for distribution to shareholders in 2015 from $160 million to $195 million.

Yieldcos are an innovation that shows promise for both the company and investors. That's what I call creativity.