Terraform Power: Focusing On The Potential Benefits Of Vivint's Solar Lease Portfolio

| About: TerraForm Power, (TERP)

Summary

Ever since SunEdison and Terraform Power agreed to their initial acquisition of Vivint Solar in July 2015, the prevailing argument has been that the move was a terrible deal.

After a December renegotiation resulted in Terraform saving only about $.06/watt on its purchase price, David Tepper filed a lawsuit to prevent the company from completing its portion of the transaction.

Since the lawsuit was filed, the narrative has focused on how much SunEdison might be able to receive from a third party for the 458MW of assets.

I believe that Tepper will not win his suit, and that the market is potentially missing substantial value in its analysis of the completed MWs.

Ever since SunEdison (SUNE) and Terraform Power (NASDAQ:TERP) agreed to their initial acquisition of Vivint Solar (NYSE:VSLR) in July 2015, the prevailing argument has been that the move was a terrible deal. A December renegotiation of the purchase price did not result in enough savings to change the market's mind, but SUNE management has been steadfast in their efforts to close the deal.

This has led Appaloosa hedge fund manager David Tepper on a crusade to prevent TERP from completing its portion of the deal - the purchase of approximately 470MW of completed residential solar assets for $799 million. Tepper accused SUNE management of self-dealing and of forcing what he considers poor-quality assets onto TERP. The lawsuit is currently being heard by a Delaware court.

Pending the outcome of the lawsuit, fellow contributor Morningsidepark (MSP) has put together an excellent series of articles on the situation, including an article looking at potential third-party valuations of Vivint's assets, and an excellent piece explaining why the companies might be better off terminating the deal altogether.

I was particularly interested in MSP's valuation of the completed solar assets, as I had a hard time figuring out how to value the projected stream of cash flows that Vivint shared on page 113 of its definitive proxy statement. MSP did a great job showing a range of values, and concluded that in a negative scenario, the MW completed by the end of 2015 would be worth about $714 million, while using more normalized equity and debt rates might yield a valuation close to $754 million.

It's important to note that these valuations are estimates by MSP, based on the less-than-ideal pieces of information we currently have from Vivint. He's also trying to be conservative, given that the goal was to figure out how low third parties might go when bidding for the assets. I am going to take a different approach by presenting five reasons why I believe TERP shareholders would benefit from the purchase of these assets.

5 reasons that Vivint's assets are worth the purchase price

  1. MSP's analysis compares the expected cash flows from pre-2016 installations only, not the entire 470MW that would be purchased for $799 million. On page 111 of the proxy, Vivint noted that it expects 2015 installations to total 229MW, down from previous estimates. Adding this total to its previous installs yields only 457.4MW installed through 2015. Thus, the expected cash flows and net present values should be increased by about 2.8%, or about $20 million.
  2. Residential solar assets are more likely to deliver projected cash flows than most analysts believe today. Negative net metering decisions in multiple states such as Nevada have rightfully generated concerns about the long-term viability of the solar lease contracts. However, it's important to note that every state aside from Nevada has chosen to grandfather existing systems. Even the Nevada PUC was forced to update its plan after the intense backlash from existing solar customers.
  3. MSP gives zero value to Vivint's projected cash flows for the past 20 years. While I agree with him that those projected cash flows are almost certainly too high, I, for one, do believe that solar installers will be able to get most of their customers to renew. It's simply a matter of at what price.

    Vivint currently projects about $665 million in cash flows from years 21-30, an NPV of $35 million if we assume a 12% discount rate. It's important to note that there is no longer any debt attached to these cash flows, as it has been paid off during the initial 20-year lease.

    Based on data I've seen from Solar City (NASDAQ:SCTY) and Sunrun (NASDAQ:RUN), it seems that installers are projecting 90% renewal rates at an average price per kWh somewhere in the $.17-.20 range. This is based on the assumption that utility rates will continue to increase at 2-3% over the next 20 years. I would argue that the assumption is incorrect, due to continued advancements in renewable technology and battery tech. Instead, I chose to assume that utility prices will fall 30-40% from current levels to $.08/kWh. Using this assumption, I calculate total cash flows of $150 million over years 21-30, given that they sell energy at $.07/kWh. Considering the customer is getting a deal for their energy, there is little-to-no reason for them not to renew. This adds another $10 million in NPV to the assets.
  4. Inverter replacement costs are likely overstated. Like other solar installers, Vivint assumes that all its inverters will need to be replaced at the end of their warranty periods, i.e., in 10-20 years. The company also assumes that inverter prices drop by 2%/year. I believe these are both conservative figures. Inverter manufacturers likely expect their products to last well past the warranty period, and as such, replacements will likely happen later than projected.

    The inverter replacements will also be cheaper than projected. Vivint's current assumption is likely that the current cost to replace the inverter is about $.15-.17/W (this is what SCTY is using). Using a 2% decrease in cost per year means the inverter would cost about $.13/W in 10 years and $.10/W in 20 years. However, the cost is coming down much more quickly. At its recent Analyst Day, Enphase (NASDAQ:ENPH) laid out a plan to reduce the cost to $.10/W within 2 years.

    $.10/W comes out to an estimated replacement cost of $47 million on 470MW. Vivint was likely projecting something between $50 million and $60 million. With current trends, it may only end up costing $25 million.
  5. 470MW represents close to 70k customers. Purchasing the solar assets also gives TERP the opportunity to continue marketing additional products and services to 70k different customers. Vivint paid an average of around $.50/W to acquire these customers, well over $200 million.

    As society makes the switch to electric cars and continues the trend towards a more distributed energy grid, TERP will be in a position to increase the size of its installations, install batteries, and sell many more products or services. I believe these baked-in customer acquisition costs may be an extremely large benefit of the transaction, which is not currently being priced in by the market.

Summary

I believe TERP will do well on its purchase of Vivint's completed installations if the company is not prevented from buying them by a court decision. Given that TERP is currently trading under $9/share, while its net asset value is close to $18/share, I believe the shares are a solid buy either way.

The company will be announcing its dividend soon. I would not be surprised to see TERP increasing it past the current $1.40/share annually.

Disclosure: I am/we are long SUNE, TERP.

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.

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