When SunPower (SPWR) and First Solar’s (FSLR) YieldCo, 8point3 Energy Partners (CAFD), went public two years ago, I used the financial nerd joke in 8point3’s ticker symbol as a launching point to explain what “cash available for distribution,” or CAFD, means. In that article, I cautioned against the risks of using a short-term cash flow measure for long-term investing decisions. That risk is becoming more and more real for investors in 8point3 because the YieldCo is using short-term, interest-only financing to fund its long-term investments. All of 8point3’s debt matures in 2020, and refinancing that debt will reduce its ability to pay dividends for two reasons. First, interest rates are rising, which will lead to higher interest payments. Second, if the YieldCo is unable to secure interest-only debt, it will have to refinance with amortizing debt. The principal payments from amortizing debt will further reduce CAFD.
First Solar and SunPower are also considering a sale of the company. The better-capitalized YieldCo NextEra Energy Partners (NEP) has been mentioned as a possible buyer.
If another YieldCo were to buy 8point3, it would do so at a price that allowed it to raise its own dividend. This is the same yardstick YieldCos use when evaluating the effects of buying renewable energy projects from their sponsors or third parties. If a transaction will not increase a YieldCo’s CAFD per share (preferably significantly), it will not do the transaction. This rule applies to both individual projects and large transactions like purchasing another YieldCo like 8point3. A somewhat naive version of this rule would be that a YieldCo with a low dividend should be able to purchase a YieldCo with a higher dividend. Unfortunately, it’s more complicated than that. Here’s why.
1. Declared dividends are not the same as a YieldCo’s ability to pay dividends. Different YieldCos have different payout ratios (the proportion of CAFD that they distribute as dividends). Naturally, an acquirer will keep its own dividend policy when acquiring another YieldCo, and so the value of the acquired YieldCo will depend on its CAFD, not the proportion of CAFD it has chosen to pay as dividends before the acquisition.
2. CAFD is what is called a non-GAAP measure, meaning that it is not defined by generally accepted accounting principles (GAAP). As such, different YieldCos do not use the same definition of CAFD, and some are quite aggressive in how they define it. This can lead to declared CAFD that is higher than the YieldCo’s ability to pay dividends in the medium to long term. Naturally, a buyer will want to use a conservative measure of CAFD that is more indicative of the purchased YieldCo’s assets to support medium- and long-term dividend increases.
3. 8point3’s debt is interest-only and does not include principal payments. Most of this debt was issued when interest rates were lower than they are today, and all is due by the end of 2020. No other YieldCo uses this capital structure; most limit their interest-only debt to about one-third of total debt. A buyer would want to refinance most of this with amortizing debt to match its current capital structure. The increased principal and interest payments will reduce CAFD significantly.
4. As I pointed out in my article two years ago, CAFD exaggerates the value of projects that are likely to have less value at the end of their existing power-purchase agreements (PPAs). This will be dictated by the ability and cost to develop competing projects in the future. Solar projects can be built almost anywhere, and solar prices are falling rapidly. This means that solar projects are likely to have very little value at the end of their PPAs. Wind will be somewhat more valuable, while hydropower and geothermal are likely to be the most valuable renewable energy projects in the long term.
8point3’s portfolio is entirely solar, meaning that using CAFD exaggerates 8point3’s valuation compared to YieldCos that include other types of assets. All other YieldCos contain non-solar assets, and most have less than 50 percent solar in their portfolios.
5. IDRs, or incentive distribution rights, redirect a portion of a YieldCo’s dividend to its parent company. For an acquirer with an IDR, any increase in per-share cash flow from a possible acquisition of 8point3 would have to pay for the IDR as well as a dividend increase to the buyer’s common shareholders. In the case of NextEra Energy Partners, 25 percent of any increase in distributions goes to its parent as an IDR payment, while 75 percent goes to the YieldCo’s shareholders.
Others have attempted to value 8point3 in a potential buyout by NextEra Energy Partners, but I have yet to see an analysis that takes most — if not all — of the above factors into account. Below, I try to do just that, evaluating what the other YieldCos (not just NextEra) might be willing to pay for 8point3 Energy Partners if they were to buy it.