IPO Preview: TerraForm Power

| About: TerraForm Power, (TERP)

Summary

TERP is a 'drop-down' from a strong, established parent.

TERP’s initial portfolio will consist of solar projects total nameplate capacity of 807.7 MW.

TERP is another clean energy 'carve-out' from a strong parent.

Based in Beltsville, MD, TerraForm Power (Pending:TERP) scheduled a $401 million IPO on the Nasdaq with a market capitalization of $1.87 billion at a price range midpoint of $20 for Friday, July 18, 2014. The price range mid-point was recently increased to $24.

The full IPO calendar is available at IPOpremium

SEC Documents

Manager, Co-Managers: Goldman Sachs, Barclays, Citi, J.P. Morgan, Macquarie Capital

Joint Managers: Santander, FBR Capital Markets

End of lockup (180 days): Wednesday, January 14, 2015

End of 25-day quiet period: Tuesday, August 12, 2014

Summary

TERP is a 'drop-down' from a strong, established parent. See 'Sponsor' below.

The initial yield is projected at 4.5% annually. TERP believes it can grow the yield 15% per year over the next three years.

TERP's initial portfolio will consist of solar projects located in the United States and its unincorporated territories, Canada, the United Kingdom and Chile with total nameplate capacity of 807.7 MW.

All of these projects have long-term PPAs with creditworthy counterparties. The PPAs have a weighted average (based on MW) remaining life of 20 years as of March 31, 2014.

Valuation

Glossary

Valuation Ratios

Mrkt Cap (MM)

Price /Sls

Price /Erngs

Price /BkVlue

Price /TanBV

% offered in IPO

Annualizing Q1

TerraForm Power

$2,164

34.7

-72.1

2.5

2.7

19%

Valuation Ratios

Mrkt Cap

Price /Sls

Price /Erngs

Price /BkVlue

Price /TanBV

Div Yield

Compare

TerraForm Power

$2,164

34.7

-72.1

2.5

2.7

4.5%

SunEdison (NYSE:SUNE) parent

$6,200

2.8

-2.5

-17.4

-17.4

none

NextEra Energy Partners, LP (NYSE:NEP)*

$3,280

10.3

56.2

3.3

3.3

2.3%

*Projected yield for June '15 yr

Abengoa Yield plc (NASDAQ:ABY)*

$3,130

5.3

58.0

1.6

-0.6

2.6%

*Projected yield for June '15 yr

NRG Yield (NYSE:NYLD)*

$5,490

17.5

81.9

8.7

10.1

2.8%

Pattern Energy Group (NASDAQ:PEGI)*

$2,650

13.1

155.9

5.7

3.3

3.9%

*current yield

Click to enlarge

Definitions

CAFD: cash available for distribution
ROFO: right of first offer

The Sponsor
SunEdison $6.2 billion market cap. Institutions own 100% of the public shares.

The Sponsor is a solar industry leader based on its history of innovation in developing, financing and operating solar energy projects and its strong market share relative to other U.S. and global installers and integrators.

As of March 31, 2014, the Sponsor had a development pipeline of approximately 3.6 GW and solar power generation assets under management of approximately 1.9 GW, comprised of over 900 solar generation facilities across 12 countries.

These projects were managed by a dedicated team using three renewable energy operation centers globally. As of March 31, 2014, the Sponsor had approximately 2,200 employees. After completion of this offering, the Sponsor will own 100.0% of Terra LLC's outstanding Class B units and will hold all of the IDRs (incentive distribution rights).

Conclusion

TERP is another clean energy 'carve-out' from a strong parent. The projected yield of 4.5% at the price range mid-point of $20 is high compared to the sector. See 'valuation' below.

The recommendation is buy.

To put the conclusions and observations in context, the following is reorganized, edited and summarized from the full S-1 referenced above.

Business

TERP is a dividend growth-oriented company formed to own and operate contracted clean power generation assets acquired from SunEdison and unaffiliated third parties.

TERP's business objective is to acquire high-quality contracted cash flows, primarily from owning solar generation assets serving utility, commercial and residential customers.

Over time, TERP intends to acquire other clean power generation assets, including wind, natural gas, geothermal and hydro-electricity, as well as hybrid energy solutions that enables it to provide contracted power on a 24/7 basis.

TERP believes the renewable power generation segment is growing more rapidly than other power generation segments due in part to the emergence in various energy markets of "grid parity," which is the point at which renewable energy sources can generate electricity at a cost equal to or lower than prevailing electricity prices.

TERP expects retail electricity prices to continue to rise due to increasing fossil fuel commodity prices, required investments in generation plants and transmission and distribution infrastructure and increasing regulatory costs.

TERP believes it is well-positioned to capitalize on the growth in clean power electricity generation, both through project originations and transfers from its Sponsor, as well as through acquisitions from unaffiliated third parties.

TERP will benefit from the development pipeline, asset management experience and relationships of TERP's Sponsor, which as of March 31, 2014, had a 3.6 GW pipeline of development stage solar projects and approximately 1.9 GW of self-developed and third party developed solar power generation assets under management.

TERP's Sponsor will provide it with a dedicated management team that has significant experience in clean power generation. TERP believes it is well-positioned for substantial growth due to the high-quality, diversification and scale of its project portfolio, the long-term power purchase agreements, or "PPAs," TERP has with creditworthy counterparties, its dedicated management team and its Sponsor's project origination and asset management capabilities.

Initial portfolio

TERP's initial portfolio will consist of solar projects located in the United States and its unincorporated territories, Canada, the United Kingdom and Chile with total nameplate capacity of 807.7 MW.

All of these projects have long-term PPAs with creditworthy counterparties. The PPAs have a weighted average (based on MW) remaining life of 20 years as of March 31, 2014.

TERP intends to rapidly expand and diversify its initial project portfolio by acquiring utility-scale and distributed clean power generation assets located in the United States, Canada, the United Kingdom and Chile, each of which TERP expects will also have a long-term PPA with a creditworthy counterparty. Growth in TERP's project portfolio will be driven by its relationship with its Sponsor, including access to its project pipeline, and by its access to unaffiliated third party developers and owners of clean generation assets in its core markets.

Project Acquisitions

TERP's ability to execute its growth strategy is dependent on TERP's ability to acquire additional clean power generation assets from the Sponsor and unaffiliated third parties.

As of March 31, 2014, the Sponsor's pipeline (as defined below) was 3.6 GW.

TERP benefits from this pipeline because the Sponsor has granted TERP a right to acquire the Call Right Projects and a right of first offer with respect to the ROFO Projects pursuant to the Support Agreement.

SunEdison includes a solar energy system project in its "pipeline" when it has a signed or awarded PPA or other energy offtake agreement or has achieved each of the following three items: site control, an identified interconnection point with an estimate of the interconnection costs and an executed energy offtake agreement or the determination that there is a reasonable likelihood that an energy offtake agreement will be signed. There can be no assurance that SunEdison's pipeline will be converted into completed projects or that we will acquire these projects.

Cash Flow Available for Distribution

Immediately prior to the completion of this offering, TERP will enter into the Support Agreement with the Sponsor, which requires the Sponsor to offer TERP Call Right Projects from its development pipeline by the end of 2016 that have at least $175.0 million of Projected FTM CAFD.

Specifically, the Support Agreement requires the Sponsor to offer TERP:

-- after the completion of this offering and prior to the end of 2015, solar projects that have at least $75.0 million of Projected FTM CAFD; and

-- during calendar year 2016, solar projects that have at least $100.0 million of Projected FTM CAFD.

If the amount of Projected FTM CAFD of the projects TERP acquires under the Support Agreement after the completion of this offering and prior to the end of 2015 is less than $75.0 million, or the amount of Projected FTM CAFD of the projects TERP acquires under the Support Agreement during 2016 is less than $100.0 million, the Sponsor has agreed that it will continue to offer to us sufficient Call Right Projects until the total aggregate Projected FTM CAFD commitment has been satisfied.

The Call Right Projects that are specifically identified in the Support Agreement currently have a total nameplate capacity of 1.1 GW. TERP believes the currently identified Call Right Projects will be sufficient to satisfy a majority of the Projected FTM CAFD commitment for 2015 and between 15% and 40% of the Projected FTM CAFD commitments for 2016 (depending on the amount of project-level debt incurred by such projects).

The Support Agreement provides that the Sponsor is required to update the list of Call Right Projects with additional qualifying Call Right Projects from its pipeline on a quarterly basis until TERP has acquired Call Right Projects that have the specified minimum amount of Projected FTM CAFD for each of the periods covered by the Support Agreement.

In addition, the Support Agreement grants TERP a right of first offer with respect to the ROFO Projects. The Support Agreement does not identify the ROFO Projects since the Sponsor will not be obligated to sell any project that would constitute a ROFO Project.

As a result, TERP does not know when, if ever, any ROFO Projects or other assets will be offered to TERP.

Dividend Policy

TERP's intention is to cause Terra LLC to distribute a portion of the cash available for distribution generated by the project portfolio as distributions each quarter, after appropriate reserves for working capital needs and the prudent conduct of the business

TERP intends to pay regular quarterly cash dividends to holders of its Class A common stock. TERP's quarterly dividend will initially be set at $0.2257 per share of its Class A common stock, or $0.9028 per share on an annualized basis, which is 4.5% on an annualized basis.

TERP believes it can grow its dividend payout by 15% per year for the next three years.

TERP established its initial quarterly dividend level based upon a targeted payout ratio by Terra LLC of approximately 85% of projected annual cash available for distribution.

TERP expects to pay a quarterly dividend on or about the 75th day following the expiration of each fiscal quarter to holders of its Class A common stock of record on or about the 60th day following the last day of such fiscal quarter.

With respect to its first dividend payable on December 15, 2014 to holders of record on December 1, 2014, assuming a completion date of July 23, 2014, TERP intends to pay a pro-rated initial dividend of $0.1717 per share.

TERP intends to cause Terra LLC to distribute approximately 85% of its CAFD to its members, including to it as the sole holder of the Class A units, to its Sponsor as the sole holder of the Class B units and to Riverstone as the holder of Class B1 units, pro rata based on the number of units held, and, if applicable, to the holders of the IDRs (all of which will initially be held by its Sponsor).

However, during the Subordination Period described below, the Class B units held by its Sponsor are deemed "subordinated" because for a three-year period, the Class B units will not be entitled to receive any distributions from Terra LLC until the Class A units and Class B1 units have received quarterly distributions in an amount equal to $0.2257 per unit, or the "Minimum Quarterly Distribution," plus any arrearages in the payment of the Minimum Quarterly Distribution from prior quarters.

The practical effect of the subordination of the Class B units is to increase the likelihood that during the Subordination Period there will be sufficient CAFD to pay the Minimum Quarterly Distribution on the Class A units (and Class B1 units, if any).

Competition

TERP competes to acquire new projects with solar developers that retain solar power plant ownership, independent power producers, financial investors and certain utilities. TERP competes to supply energy to its potential customers with utilities and other providers of distributed generation.

TERP believes that it competes favorably with its competitors based on these factors in the regions TERP services. TERP competes with other solar developers, independent power producers and financial investors based on its lower cost of capital, development expertise, pipeline, global footprint and brand reputation.

To the extent TERP re-contracts projects upon termination of a PPA or sell electricity into the merchant power market, TERP competes with traditional utilities primarily based on low cost of capital, generation located at customer sites, operations and management expertise, price (including predictability of price), green attributes of power, the ease by which customers can switch to electricity generated by its solar energy systems and its open architecture approach to working within the industry, which facilitates collaboration and project acquisitions.

5% stockholders

SunEdison 99.4%

Use of proceeds

TERP expects to net $370 million from its IPO. Proceeds are allocated as follows:

TERP intends to use the net proceeds from this offering and the Private Placements to acquire newly-issued Class A units of Terra LLC, representing 23.1% of Terra LLC's outstanding membership units after this offering (calculated without regard to the IDRs). TerraForm Power will not retain any net proceeds from this offering or the Private Placements.

Disclaimer: This TERP IPO report is based on a reading and analysis of TERP's S-1 filing, which can be found here, and a separate, independent analysis by IPOdesktop.com. There are no unattributed direct quotes in this article.

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. The author has no business relationship with any company whose stock is mentioned in this article.