In this article, we look at the flip side of the TerraForm Power (Pending:TERP) (see thesis here and here) Yieldco story - the sponsor. In this context it is worth revisiting our thesis about SunEdison (NYSE:SUNE) (see here).
The latest S-1 filing for TerraForm Power shows an offering of 23M shares at an estimated maximum price of $25 per share for a potential total offering size of $577M. However, the total Class A share count of 27.7M constitutes a value of $694M for TerraForm Power Inc.
TerraForm Power Inc., however, only has an economic interest of 27.5% in TerraForm Power LLC which implies a market cap of $2.5B for TerraPower LLC. Assuming the TerraForm Power IPO goes as planned, the enterprise value of TerraForm LLC is likely to be around $3.5B (Market Cap + Debt - Cash). Considering the way Yieldco stocks have been performing lately, TerraForm may perform well and it is entirely possible that the enterprise value may exceed $4B.
A $4B valuation, if it occurs, means that the market is valuing the 800MW of assets that SunEdison cobbled together at approximately $5 per watt. At current market rates, a blend of utility scale system and large scale DG system similar to the ones in SunEdison's portfolio should cost approximately $2 per watt.
Prior to the Yieldco, SunEdison could have sold these projects at about $3 per watt. Now, thanks to the Yieldco bubble, SunEdison can sell these projects at about a $2 premium in comparison to what it could have sold prior to the Yieldco.
While the revised SunEdison financials post the TerraForm IPO may not be available until earnings, we estimate that SunEdison will capture approximately $2 per installed watt in profits on its project portfolio with the Yieldco model. Since SunEdison is forecasting about 1GW of installations for the year, the Yieldco benefit would translate to approximately $2B in value capture.
It is unclear at this point how SunEdison will report its financials and how much of a tax bite the company may face. Assuming a conservative 30% tax hit, and applying a 15x multiple, would give it a bubble valuation of $21B in 2015.
At today's closing price of $23.44, SunEdison has a market cap of $6.28B. A $21B potential valuation implies that this stock could run a very long way in the next twelve months.
While the TERP S-1 leaves us with a bad taste of SunEdison's financial engineering shenanigans, it is tough to argue how well the company is positioned in the emerging solar industry. SunEdison would be a major beneficiary of the TERP IPO.
As we have written in the past, SunEdison's performance in the solar industry in the last 5 years has been phenomenal. From nearly a standing start, the company has become one of the preeminent project developers in the world. The company's asset light model has been a winner in times of industry oversupply, and the company is set to continue its winning ways by separating the project assets into TerraForm Power.
With TerraForm Power as a public company, SunEdison derives the following benefits:
- Has a captive and ready public company buyer for the projects it develops.
- Gets to sell the assets it develops at inflated prices to the yield hungry TerraForm Power investors.
- Transfers all long-term risks to TerraForm Power common stockholders.
- Improves its own balance sheet.
- Accelerates growth as a result of having a ready buyer to the projects it develops.
- Benefits from steady dividends from TerraForm Power operations starting with approximately 64.9% of total TerraForm Power distributions.
- Benefits from IDRs from TerraForm Power.
- Can buy and resell third party solar projects at a nice arbitrage enabled by the Yieldco.
SunEdison gets all the above benefits with virtually no downsides or disadvantages. However, some developments could diminish the upside for SunEdison. These include:
- TerraForm Power IPO gets delayed for market or other reasons. We find this unlikely with the IPO set to debut on Friday.
- The yield expectations of future Yieldco investors go up considerably from the current levels. Based on the performance of Yieldcos to date, it appears that this risk to SunEdison is not significant.
- The management of TerraForm Power gets fiercely independent and uses a conservative set of assumptions to negotiate lower value for SUNE projects. However, given the various conflicts of interests, we find such a development unlikely in the near term.
There are some long-term issues that investors need to be cognizant of:
- While it may not matter to short term and momentum investors, we believe that the TerraForm Power Yieldco model will unravel over time. However, given the likely time lag involved in getting to that stage, we fully expect that SunEdison will gradually reduce its role in TerraForm Power.
- We find at least one major assumption in the TerraForm Power S-1 to be materially misleading. There could be some legal consequences to SunEdison if there is a lawsuit and if the statement is found to be a willful misstatement.
- SunEdison's role in TerraForm Power has inherent conflicts of interest and is ripe for corporate governance risks.
We are not fans of the TerraForm Power IPO, but assuming the bubble valuation the Yieldcos hold, SunEdison could potentially go north of $70. With a most recent stock price of $23.44, this is a 3x run from its current levels.
Our Sentiment: Speculative Buy
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.