Regarding the downdraft in yieldco share prices, Jacobs offers that investor expectations aren’t aligned with the realities of the business model. “In 2014 and 2015, the growth expectations and how people were valuing them were much higher than they are now,” he says. “People were discussing 15% distribution growth rates. The market is now pricing them at a much lower distribution growth rate, which we think is undervaluing the growth over the long term.”
The Bearish Case
Yieldcos are somewhat related to master limited partnerships and real estate investment trusts in that they’re all publicly traded, yield-oriented vehicles that own project assets. That said, yieldcos don’t share the same entity tax status as the other two.
The comparison between yieldcos and MLPs is more apropos because they both deal with energy, albeit with MLPs being focused on fossil fuels and yieldcos primarily linked to clean energy. They have different operating structures—MLPs are partnerships requiring the dreaded K-1 tax form for investors, while most yieldcos are corporations requiring the more user-friendly 1099 tax form.
But critics have their beef with the yieldco structure. Some people knock renewable energy’s reliance on subsidies and tax credits. Others call yieldcos a product of financial engineering dreamed up by Wall Street firms looking for additional investment banking revenue. Still others contend that the drop-down acquisition model used by sponsors to sell assets to yieldcos is sort of a shell game that simply moves assets from here to there within related entities.
Ideally, yieldcos are meant to thrive in a virtuous cycle where the attractive dividend or dividend growth potential attracts investors and allows the yieldco entity to trade at a price that offers a cost-of-capital advantage to the sponsor. This enables the sponsor to develop energy projects at a faster pace than it could on its own, and if it drops down the projects into a yieldco vehicle, it gets relief for its balance sheet and can recapitalize a new project, which provides new revenue sources for the yieldco so it can keep generating income and support its distributions. As the yieldco’s dividend valuation increases, it can theoretically raise fresh capital from the public markets that lets the sponsor do more projects.
Some investors aren’t buying it. “The reason we’ve stayed away from yieldcos is it’s a vicious cycle where you’re caught in raising the valuation of the yieldco based on the dividend, which is kind of flawed,” says Alexander Oxenham, a partner at Hilton Capital Management and co-manager of the Direxion Hilton Tactical Income Fund.
“They should be valued based on their projected ability to earn cash flow above depreciation and capex expense,” he adds. “And that income stream should be valued as if it were a regular company, and not on the basis of a dividend. We worry the asset class was started and funded based on, ‘Hey, look how great these yields are, and this is where you should go for clients looking for growth and income.’”
Oxenham notes that during the past year cracks in that valuation model have curtailed the access to capital for yieldcos as investors have fled the space. “And this strategy is all about access to capital and less expensive capital for the sponsor,” he says. “And if that doesn’t work, the entire model is flawed.”
The Wait-N-See Case
Philip Blancato, CEO and president of Ladenburg Thalmann Asset Management, says he runs multiple dividend strategies and is interested in yieldcos but hasn’t yet pulled the trigger on them. “We’re watching them because for us it’s a matter of making sure the cash flow will be there,” he says. “For now, we think the renewable energy space is still too reliant on government subsidies. If the cash flow is there, I’ll be a buyer.”
For investors who believe in the green energy story and possess long-term horizons, yieldcos at their current levels might be worth taking a flyer on. But as shown during their brief existence, the dividend income churned out by yieldcos will likely come with stomach-churning volatility.