- SunEdison's new spin-off, TerraForm, offers an interesting case study for the industry.
- This new business model makes perfect sense to solar companies.
- Modeling the effect of such spin-offs by other solar companies reveals serious valuation distortions.
Tearing Down SunEdison's Spin-Off
Last week, SunEdison (NYSE:SUNE) filed an S-1, officially announcing its long-awaited spin-off of its solar project business. The solar project business, also known as a downstream business, is SunEdison's business unit that owns and operates its solar projects. A solar project is basically an array of solar modules that generates electricity throughout the day, which is then sold to a customer.
That customer can be a utility company, a commercial customer, or a residential customer. Solar module manufacturers that operate in the downstream had announced plans to spin off their downstream businesses as well. Completing such spin-offs can float a lot of value to the parent company investors.
In this article, I will go through the details of SunEdison's spin-off, try to valuate it, and finally I will show the effects a spin-off could have on three Chinese solar companies. So let's dive in:
TerraForm, the name SunEdison's management gave its spin-off, will be traded on the NASDAQ Global Select Market, under the symbol TERP.
The purpose of the spin-off is to own and operate solar projects that the parent company SunEdison builds. The business process between the two entities will look something like this:
- SunEdison completes a solar project, including a signed PPA (power purchase agreement) which spans about 20 years.
- SunEdison offers the project to TerraForm for purchase.
- TerraForm raises the required capital through debt/equity.
- TerraForm purchases the project and operates it for its life span.
- TerraForm pays dividends of which SunEdison will get a certain share, and the rest will go to investors in TerraForm.
The "YieldCo," as some refer to this business structure, is meant to provide immediate cash to the parent company in exchange for finished projects, carry the debt burden these projects carry, and pay recurring and growing dividends to the parent company.
TerraForm Initial Portfolio
The new company's initial portfolio will consist of a few projects that SunEdison has contributed plus several other projects that will be acquired by TerraForm (or have already been acquired by SunEdison). Here's the list of the initial portfolio:
Source: TerraForm S-1
TerraForm will own projects located in the U.S., Canada, U.K., or Chile. After the IPO of TerraForm, a certain agreement between SunEdison to TerraForm will be effective, immediately. That agreement is the "Support Agreement."
Under the support agreement, SunEdison is obliged to offer TerraForm certain solar projects that SunEdison has identified as eligible to be handed down to TerraForm. The agreement says that by the end of 2015, SunEdison will offer TerraForm projects that will generate $75M of cash available for distribution (CAFD), in the first 12 months after each project starts generating electricity.
By the end of 2016, SunEdison will be mandated to offer additional projects that will generate an additional $100M of CAFD, in the first 12 months after each project starts generating electricity. That means that by the end of 2016, TerraForm will have a project base that will generate $175M in CAFD. What exactly is CAFD? It is the amount of profits TerraForm can legally distribute as dividends.
SunEdison has identified more than 900 MW of projects (called Call Right projects) to offer to TerraForm under the support agreement. Here's the complete list:
Source: TerraForm S-1
Any other project that SunEdison chooses to put up for sale (in the eligible geographies), will be first offered to TerraForm. So, summing it all up quickly, gets us to the following:
- TerraForm will own 523.8 MW immediately after the offering.
- By the end of 2016, TerraForm will own approximately 1,458 MW of projects.
How Much Money Will All of these Projects Actually Make?
TerraForm kindly provided their estimates for operations for the 12 months ending in December 31, 2015. Here it is:
Source: TerraForm S-1
We know that TerraForm will have about 523.8 MW after its IPO. We also know (by the expected acquisition date on the call right projects) that by the end of 2015, it is expected to own about 355.9 additional MW.
I adjusted those additional 355.9 MW to reflect their annualized electricity generation capability. For example, if a 100-MW project is acquired at the middle of the year, it will contribute about 50 MW of annual production capacity. It's a rough estimation given the seasons of the year, but for the purpose of this work, it'll do.
The annualized figure of those 355.9 MW is 215 MW. That means that in 2015, TerraForm will sell electricity produced from 523.8 + 215 = 738.8 MW. According to the expected operating revenues figure for 2015 ($162M), each MW is expected to bring $219,274 in revenues.
What Will TerraForm Look Like in 2016−2017?
Running the same model, using $219,274/MW in revenues, I reached the conclusion that by the end of 2016, TerraForm will own an additional 577.86 MW. The additional capacity will have an adjusted production capacity of 435 MW. So, in 2016, TerraForm will sell electricity produced from about 1,315 MW.
Assuming TerraForm will increase its installed base by 15% in 2017 (to suit the company's goal of increasing dividends by 15%/year), in 2017, the new downstream unit will sell electricity produced by 1,676 MW.
Using about the same expected net margin reflected in the S-1, 15%, I reached the following revenues and net income figures for 2016 and 2017:
Net Cash from Operations
Net cash from operations figures are calculated according to the expected operational model TerraForm presented in the S-1. The large difference is largely due to depreciation.
Ok, We Got It! How Much Is It Worth?
After modeling the TerraForm operational structure for the next three years, at how much might it be valued? TerraForm shares will offer a dividend that will supposedly grow by 15%/year. We don't know the offering pricing but we do know that the company plans on distributing about 85% of its CAFD each year. I'll assume investors in TerraForm will get 50% of the dividend (and the rest will go to SunEdison).
The only comparable dividend YieldCo I had in mind to compare to is NRG Yield Inc. (NYSE:NYLD), which currently offers a dividend yield of around 3%. Let's run the numbers real quick and see what a dividend yield of 3% means to TerraForm's market cap:
Mkt Cap (3% div yield)
In an interview with SunEdison's CFO, it was said that TerraForm could be valued at $800M−$1B:
SunEdison's TerraForm could be valued at between $800 million and $1 billion based on cash flow, SunEdison Chief Financial Officer Brian Wuebbels told Reuters in an interview last November.
Those numbers make sense given our model shown in this article.
What Does It Mean to Chinese Solar Companies?
"The whole is greater than the sum of its parts." Aristotle.
Here's the interesting part. The Chinese companies that are heavily involved in the downstream solar business are so beaten up, their entire market cap is less than what a potential spin-off of their own might be worth.
I would like to point out that TerraForm's market cap implies about $1.8M−$1.9M in market cap for each MW. Before we value the Chinese top three companies' downstream businesses, take note that the Chinese business is almost 1.5−2 times more profitable than TerraForm's business. JinkoSolar (NYSE:JKS), for example, reported that it's seeing 30% in net margins on electricity sales in China.
In my valuation, I didn't factor the profitability difference just to further underline the distorted valuation Chinese companies currently hold.
Downstream Projects Size in MW
Low Market Cap ($1.8M/MW)
High Market Cap ($1.9M/MW)
Trina Solar (NYSE:TSL) YieldCo
Yingli Green Energy (NYSE:YGE) YieldCo
Expected downstream business size (in MW) is based upon my estimates and current management comments. Other than JinkoSolar, some of the other companies are engaged in selling complete projects, thus the actual size of their business by the end of 2015 might be lower. I modeled 80% of Yingli and Trina's downstream business to be owned by the companies by the end of 2015 and the rest to be sold to third parties.
The results that are presented in the table above are astounding. Even if you completely value the solar module manufacturing at zero (the three Chinese companies are among the biggest manufacturers in the world), these companies are building a business that could be valued at 2−2.5 times their current market cap.
The upcoming IPO of TerraForm will give investors a hard cold anchor to use when trying to value the solar company's downstream business. Given that the Chinese downstream businesses are more profitable, and they might take on themselves some of the large debt levels these companies carry, at some point in the future, the true value of the downstream business will float and investors will be rewarded. Stay tuned for more solar research!
This article was first published on SolarStockIdeas.