TerraForm: Life Without SunEdison

| About: TerraForm Power, (TERP)

Summary

SunEdison, which is facing bankruptcy concerns, has been a benevolent controlling shareholder and sponsor of TerraForm Power.

Without SunEdison, dividend cash flow coverage will shrink but should still be sufficient to cover the current $0.35 quarterly dividend.

There will be less margin for error indicating there is increased risk of a dividend cut. Also dividend growth is unlikely for some time.

There is unlikely to be a significant adjustment to TerraForm Power’s financial statements from the delayed security filings.

Background

TerraForm Power, Inc. (NASDAQ:TERP) was formed by SunEdison, Inc. (SUNE) to hold solar and wind power farms primarily in the U.S. SunEdison is a manufacturer of renewable energy power equipment and uses TerraForm Power as a source of sales revenue. On July 18, 2014, TerraForm Power was taken public. TerraForm Power is classified by investors as a yieldco. There were three sets of shareholders as shown below. Cash flow is the economic interest in the profits of the consolidated TerraForm Power.

Public Shareholders

SunEdison

Riverstone

Stock Class

A

B

B1

2/25/15 Voting Rights

9.1%

91.0%

0.9%

2/25/15 % Cash Flow

45.0%

50.1%

4.7%

Current Cash Flow

57.0%

43.0%

0.0%

Click to enlarge

TerraForm Power has a sister company, TerraForm Global, Inc. (NASDAQ:GLBL). This company has similar assets, ownership and management but its assets are almost entirely outside of the U.S.

The revenues of TerraForm Power are currently 52% from solar and 48% from wind power. Currently, 77% of revenues are from the U.S. with the remainder in stable foreign countries, the U.K., Canada and Chile. Total Megawatts will be 2,750 when the last 98 mw piece of the Invenergy acquisition closes in April. Revenues are easy to forecast as they are almost all under long term power purchase agreements primarily with utilities. These agreements mostly range from 10-20 years. The counterparties are mostly corporations with investment grade bonds. Recurring cash operating expenses are quite low in relation to revenues. In the first nine months of 2015, they totaled 34.5% of revenues. TerraForm Power has increased its dividend each of the last four quarters from $0.27 in 4Q 2014 to $0.325 in 1Q 2015, to $0.335 in 2Q 2015 and $0.35 in 3Q 2015.

TerraForm Power is currently primarily managed by SunEdison. The CEO of TerraForm Power, Brian Wuebbels, is also the CFO of SunEdison. SunEdison handles, and is reimbursed for, the repairs and maintenance of the solar and wind farms and a significant portion of the G&A expense. In the first nine months of 2015, 43.0% of TerraForm Power's operating expenses were performed by SunEdison and reimbursed by TerraForm Power. Brian Wuebbels became the CEO in November during a management shake-up. At that time the prior CEO and CFO were let go and three directors resigned due to a disagreement over the direction of the business. The new management and board wanted to purchase more assets from SunEdison. Surprisingly in the past, more than half of TerraForm Power's assets were acquired from unrelated third parties.

SunEdison has been a benevolent sponsor of TerraForm Power but it has run into financial difficulties. They have been benevolent due to financial support discussed below and allowing TerraForm Power to purchase the majority of its assets from third parties. SunEdison is currently heavily leveraged with a negative net worth and has had four years of large losses. Its stock and bonds are currently trading at a level indicating investors expect a bankruptcy filing. On March 16, 2016, SunEdison announced a delay in filing its Form 10-K. This delay is principally due to the additional scope of work required from the identification by SunEdison's management of material weaknesses in its internal controls. A Wall Street Journal article on March 28th indicated SunEdison has materially overstated its liquidity. Since SunEdison prepares TerraForm Power's filing, TerraForm Power's 10-K was also postponed. SunEdison faces a default on some of its debt if the 10-K is not filed by March 31, 2016. It did have $3.5 billion of cash on September 30, 2015, so any bankruptcy is up to the banks.

Life Without SunEdison

The following will likely change if SunEdison goes into bankruptcy.

SunEdison has provided financial support to TerraForm Power. This support is projected to total $46 million in 2016. This support likely goes away.

TerraForm Power may be able to choose what to buy without input or commitment to SunEdison. However, surprisingly, the majority of power assets acquired to date have not been from SunEdison, so this isn't as big a change as it looks.

While most yieldcos have declined in price over the past year, TerraForm Power and its sister TerraForm Global have declined more, probably due to their association with SunEdison. What happens to SunEdison will not affect revenues which are very transparent and under long term contracts mostly with utilities. It will affect expenses as discussed in #1 and #4.

TerraForm Power will need to hire new staff to take over the functions currently handled by SunEdison. It is likely a lot of those people will be former SunEdison employees. Not sharing expenses may lead to higher costs.

The accounting issues of SunEdison will be less likely to occur as TerraForm Power is a much simpler entity to report on.

Management is going to become more independent even without a SunEdison bankruptcy. CEO Brian Wuebbels will relinquish his CFO duties at SunEdison on April 4, 2016. He will remain CEO of sister TerraForm Global.

Growth is going to slow for now. Acquiring new assets requires about an equal amount of equity and debt. The low stock price of TerraForm Power makes issuing new equity economically unfeasible, and new equity from SunEdison is currently off the table. Independence from SunEdison may help but the stock will need to be significantly higher than it is now for future growth.

The creditors of SunEdison cannot go after TerraForm Power for their claims as TerraForm Power has not guaranteed any of those obligations of SunEdison. Vivint a solar company that backed out of a deal to sell its self to SunEdison is suing SunEdison over the deal. However, they are not suing TerraForm Power.

Risks

Yieldcos have very stable revenues but there are still have a number of risks with TerraForm Power as detailed below.

A big risk is a counterparty default. This is mitigated by the financial strength of most of TerraForm Power's customers. Most are utilities who are investment grade bond issuers. There is one customer in Chile which is a mine which represents about 3% of revenues. If this mine were to close it may be difficult to replace it.

Another big risk right now is how clean the books are in light of the delay of the 10-K filing. I do not expect there to be a significant effect on TerraForm Power though anything is possible. TerraForm Power's revenues are very transparent and all of its customers are listed. Cash operating expenses are only about a third of revenues, so if they are off by 10% it wouldn't have that much impact. Peers NYLD and NEP have cash operating expenses ratios to revenues similar to TerraForm Power. Their ratios were 36.3% and 21.0% in 2015, compared to 34.5% from TerraForm Power. The issue with SUNE appears to be liquidity. TerraForm Power showed $726 million in cash on September 30, 2015. Most of this cash was scheduled to go into the large Invenergy deal. The fact that that deal has 90% closed indicates that liquidity was there.

Most of TerraForm Power's assets are relatively new. Repairs and maintenance will increase as they age. Wind has a higher cost than solar.

Brian Wuebbels, the CEO, is also the CFO of SunEdison and prepared the financial statements now delayed.

Last fall, UBS estimated about 17% of TerraForm Power's revenues are from tax incentives which could go away. However, these tax incentives are long term. In most cases they last as long as the contracts themselves. The tax incentives are mostly state, not federal.

Growth will stall without new investors. This is the situation TerraForm Power is in now due to its low stock price.

The productivity of solar and wind energy producers is reliant on nature. For this reason they are also seasonal with the warmer months being the more productive for solar.

TerraForm Power has committed to buy $1.4 billion of renewable energy projects from SunEdison. I do not believe TerraForm Power can fund this commitment given the current stock price makes it difficult to raise equity. I believe since SunEdison controlled TerraForm Power when this commitment was made, this commitment is not enforceable.

TerraForm Power versus TerraForm Global

TerraForm Power is farther along than TerraForm Global in its investments. It is has more than sufficient cash flow available for debt service while TerraForm Global has insufficient cash flow for its debt service. Both showed significant cash on September 30, 2015. In both cases, that cash will be mostly gone within the next year as it is used for property investments. TerraForm Global is trading at a much larger discount to book than TerraForm Power. TerraForm Power was at 83% of book on March 24, 2016 versus 34% for TerraForm Global. The main difference is most of TerraForm Global's assets are in emerging nations. The risk of default by their customers is much greater than for TerraForm Power. For this reason I do not recommend TerraForm Global.

Dividend Coverage

The following chart shows proforma 2016 cash flow. The section from the top to the first CAFD number is from management's last presentation in the fourth quarter of 2015. It excludes the Invenergy deal which is now 90% closed. The part after that is my additions to account for the Invenergy deal and other changes since. Unlike most other companies, TerraForm's cash flows in the next year are relatively predictable due to the long term contracts for their revenues and a low level of operating expenses.

(in 000s)

Year Ending

12/31/16

Net income

$55,000

Depreciation and amortization

$160,000

Non-cash items

$19,000

Net cash provided by operating activities

$9,000

$244,000

Further adjustments to reconcile net cash provided

by operating activities to cash available for distribution:

Changes in assets and liabilities

-$9,000

Deposits into/withdrawals from restricted cash accounts

$7,000

Cash distributions to minority shareholders

-$20,000

Scheduled project level and other debt service payments

-$41,000

Non-expansionary capital expenditures

-$11,000

Contributions received pursuant to agreements with SunEdison

$27,000

Other

$11,000

Cash available for distribution (NASDAQ:CAFD)

$208,000

Subtract support from SunEdison (1)

-$46,000

CAFD without SunEdison

$162,000

Add Invenergy CAFD (2)

$81,000

CAFD without SunEdison with Invenergy

$243,000

Dividend to public shareholders at $0.35/quarter

$112,042

Dividend to SunEdison at $0.35/quarter

$84,510

Total dividends

$196,552

Excess cash flow

$46,448

Click to enlarge

Support from SunEdison is the $19,000 non-cash items and the $27,000 contribution received pursuant to agreements with SunEdison. Invenergy will increase TerraForm Power's megawatts by 50%. This is primarily wind power which has higher expenses than solar. That is offset by gains in G&A efficiency. Based on this assumed a 50% growth in CAFD.

Conclusion

TerraForm Power will be impacted by a bankruptcy of SunEdison. It will lose financial support projected at $46 million in 2016. Cash operating expenses may go up some without SunEdison sharing expenses. These items are partially offset by likely lower G&A expenses due to the Invenergy merger. Based on my calculations above, there is about a 24% cash flow cushion to cover the existing dividend.

There are numerous risks. The most immediate is the 10-K filing delay. I don't expect a significant impact on TerraForm Power as its revenues are transparent and under long term contracts and its cash operating expenses are low in relation to revenues. The yieldco model is out there and we know that other yieldcos have similar cash operating expense to revenues ratios as TerraForm Power. So we know, TerraForm Power's cash operating expenses if inaccurate, shouldn't change that much. Also a big risk is the current CEO who was responsible for the delayed security filings.

Yieldcos are most similar to REITs in that their revenues are essentially long term rents partially funded by long term debt. The biggest difference between REITs and yieldcos is that REITs assets generally hold their value or appreciate while yieldcos assets depreciate. In fact they may be worth little after the contract is up after 20 years due to higher maintenance costs and lower revenues because newer equipment will be much more efficient. REITs have a dividend yield of 3-5%. I believe you need to add 5% to that for yieldcos to account for their depreciating assets. That means the yield needs to be 8-10%. If TerraForm Power can maintain its dividend that means it should be trading at $14.00 to $17.50. If they need to reduce the dividend then a $10.00 - $15.00 price may be more appropriate.

Disclosure: I am/we are long TERP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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