Sun Edison (NYSE:SUNE) is actively marketing the 470 MW portfolio of operating residential solar assets ("Portfolio Assets") of Vivint Solar (NYSE:VSLR) to potential third-party acquirers. As discussed in a prior article exploring the potential underestimate of cash needed by SUNE to close the VSLR acquisition, a sale of all or a substantial portion of the Portfolio Assets to a third party would be an important source of funds and would remove any doubt surrounding SUNE's ability to close the VSLR acquisition. It also would remove the immediate point of conflict in the legal dispute with Appaloosa ("Appaloosa Case") regarding the purchase of the Portfolio Assets by TerraForm Power (NASDAQ:TERP) under the Purchase Agreement. In addition to questions of corporate independence and the neglect of fiduciary responsibility by TERP, the Appaloosa Case raises the fundamental issue of what the Portfolio Assets are worth. So what are they worth?
Page 113 of the Definitive Proxy filed by VSLR includes a table entitled "Other Operating Metric made available to Vivint Solar's financial advisor prior to the execution of the Merger Agreement Amendment" that contains some information that may be of use in formulating an estimate of the worth of the Portfolio Assets. The table discloses the forecasted, undiscounted, levered (my emphasis) cash flows over a 30-year forecast period for the Portfolio Assets and the future residential assets to be installed and commissioned by VSLR during 2016 and 2017. In other words, these are the cash flows that would be available to an equity investor after the execution of a debt financing ("Portfolio Assets Project Debt") supported by the Portfolio Asset cash flows. The line entitled "Systems Installed in 2015 and Prior" contains the forecast of undiscounted, levered cash flows for the Portfolio Assets and I will focus only on that. Some of the assumptions underlying this calculation include:
- Undiscounted net cash flows expected from customers under long-term contracts (i.e. revenue from the system leases/PPAs)
- Plus estimated undiscounted value of any SRECs (solar renewable energy credits) over 10 years
- Less estimated cash distributions to fund investors (i.e. the tax equity)
- Less operating expenses including operations, maintenance (including replacement costs for inverters after 10 years) and administration costs (accounting, insurance, etc.)
- Less debt service costs (i.e. principal and interest payments)
- The panels are under warranty for the life of the underlying customer contracts (no specifics as to the warranty are disclosed, whether the module seller or a third-party is the counter party under the warranty)
- No assumptions regarding renewal rates or contract default assumptions were provided
What is not provided with these assumptions is any information regarding the principal amount, term, amortization and interest rate assumed in calculating the debt service costs for the Portfolio Assets Project Debt. These have a critical impact on the estimation of valuation for the portfolio assets, so it will be necessary to make some assumptions to arrive at a principal value for the Portfolio Assets Project Debt.
The National Renewable Energy Laboratory issued a white paper entitled "Credit Enhancements and Capital Markets to Fund Solar Deployment." On page V of this white paper is a table analyzing three debt securitizations completed by Solar City (NASDAQ:SCTY) on residential solar assets. The table indicates that the advance rate on the three securitizations increased over time from 62% to 73% as investors became more comfortable with the asset class, though the deal that achieved 73% appears to have had a subordinated tranche.
Simplistically, the advance rate is "saying" that for every $1 of net cash flow (after expenses but before debt service) 65% or 67.5% is servicing the debt and any cash flows after the debt service accrue to the benefit of the equity. Therefore, $1 of net cash flow divided by the advance rate equals the debt service coverage ratio. Here are the implied debt service coverage ratios for a few advance rate assumptions.
Debt Service Coverage Ratio
In comparison, the minimum debt service coverage ratio required by project lenders for larger wind and solar projects with creditworthy off-takers is typically closer to 1.3 times.
Here are the undiscounted equity cash flows for 20 years for the Portfolio Assets as disclosed in footnote 3 on page 113 of the definitive proxy. Please note that I excluded the cash flows for years 21 - 30 due to personal skepticism over the useful life of the modules and the likely obsolescence of the modules due to technical advances at the end of their contract life (look at the advances made over the last 20 years).
The undiscounted debt service cash flows will therefore equal the undiscounted equity cash flows divided by (1 minus the advance rate). The following are the estimated undiscounted debt service cash flows for an advance rate of 65%.
The valuation of the portfolio assets will equal the discounted value of the equity cash flows and the discounted value of the debt service cash flows. There are three variables in calculating these values: discount rate for the equity cash flows, advance rate for the debt service cash flows, and discount rate for the debt service cash flows. Here are the estimated present values at various discount rates.
|Discount Rate Equity CF||10%||12%||14%|
|Present Value Equity CF||$154.92||$136.39||$121.37|
|Discount Rate Debt Serv CF||5.0%||5.5%||6.0%|
|Advance Rates||PV Debt Service CF|
Recent equity research issued for SCTY and SUNE regarding the sale of portfolios of residential solar assets have discussed unlevered discount rates of 7.5%. Adding the 65% advance rate undiscounted debt service cash flows with the undiscounted equity cash flows from the tables above and using an unlevered discount rate of 7.5% yields a PV of $712.3 million. A worst case scenario in my opinion for the distressed sale of the portfolio assets to a third party would be an equity discount rate of 14%, an advance rate of 65%, and a debt rate of 6%, which would yield a PV for the portfolio assets of approximately $714 million. Very similar valuations. A more realistic scenario may be an equity discount rate of 12%, an advance rate of 65%, and a debt rate of 5.5%, which would yield a PV for the portfolio assets of approximately $753.5 million.
Conclusion: The portfolio assets have significant value even in a fire sale scenario. Management should use its best efforts to complete a sale to a third party so that it can lessen the severe balance sheet distress at SUNE and defuse the conflict with Appaloosa.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SUNE over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.