IPO Preview: Hannon Armstrong Sustainable Infrastructure Capital

| About: Hannon Armstrong (HASI)
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Based in Annapolis, MD, Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI) scheduled a $200 million IPO with a market capitalization of $234 million, at a price range mid-point of $13 for Thursday, April 18, 2013.

Seven IPOs were scheduled for the week of April 15th. The full IPO Calendar is here.

S-1 filed April 4, 2013

Manager, Joint Managers: BofA Merrill Lynch/ UBS Investment Bank/ Wells Fargo Securities

Co Managers: RBC Capital Markets/ Baird

HASI is a REIT, specifically a specialty finance company employing 20 people. Each employee is valued at $12 million based on the mid-point of the price range of $13, with a market cap of $234 million.

HASI currently is wholly dependent on the US federal government, which seems to award contracts often without regard to the actual free market.

Companies dependent on a single customer are usually not well received by IPO buyers. HASI also produces a lot of income with only a few employees.

HASI earned $2.5 million for the December quarter. If HASI paid out 90% (as REITS typically do) of income, the yield to public shareholders would be 3.85%. For the December quarter net pre-tax income was 58% of revenue. HASI's business model invites competition from Wall Street firms that may have better connections to the federal government than HASI.

Also, it's hard to see what business HASI is in. For example in 2011 HASI made a "Gain on securitization of receivables" that was 56% of revenue; in 2012 it was 18% of revenue; for the December 2012 quarter it was 58% of revenue.

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For the above reasons, HASI doesn't seem to have an attractive model for IPO investors, who are most likely better off passing on the HASI IPO.

HASI is a specialty finance company that provides debt and equity financing for sustainable infrastructure projects.

HASI focuses on profitable sustainable infrastructure projects that increase energy efficiency, provide cleaner energy sources, positively impact the environment or make more efficient use of natural resources.

HASI began its business more than 30 years ago, and since 2000, using a direct origination platform, provided or arranged over $3.9 billion of financing in more than 450 sustainable infrastructure transactions.

As a result of an highly selective approach to project targeting, the credit performance of HASI's originated assets has been excellent. Since 2000, there has been only one incidence of realized loss, amounting to $7.0 million (net of recoveries) on the more than $3.9 billion of transactions originated during that time. This transaction, in an asset class in which HASI no longer participates, represents an aggregate loss of less than 0.2% on cumulative transactions originated over this time period.

Over this period, HASI has become the leading provider of financing for energy efficiency projects for the U.S. federal government, the largest property owner and energy user in the United States.

According to a November 2011 report from McKinsey & Co., or McKinsey, entitled Resource Revolution: Meeting the World's Energy, Materials, Food And Water Needs, or McKinsey's 2011 report, the estimated average annual capital investment needed (using constant 2010 dollars) to meet rising energy and water usage will grow from approximately $1.3 trillion in 2010 to $2.0 to $2.2 trillion in 2030.

The McKinsey report also identified real property energy efficiency improvements as presenting the single highest resource productivity gain potential over the period from 2010 to 2030 of the more than 130 opportunities studied.

HASI has traditionally financed its business primarily through the use of securitizations, including the Hannon Armstrong Multi-Asset Infrastructure Trust, or Hannie Mae.

In these transactions, HASI transfer the loans or other assets we originate to securitization trusts or other bankruptcy remote special purpose funding vehicles.

Large institutional investors, primarily insurance companies and commercial banks, have historically provided the financing needed for a project by purchasing the notes issued by the trust or vehicle. The securitization market for the assets HASI finances has remained active throughout the financial crisis due to investor demand for high credit quality, long-term investments.

As of December 31, 2012, $1.6 billion of the outstanding financings HASI owns or manage for sustainable infrastructure projects were held on its balance sheet or in securitization trusts.

HASI funds such transactions with securitized debt whereby HASI seeks to match the maturities of the debt obligations with the maturities of the assets. HASI normally retains residual economic stakes in the transferred assets and continues to manage and service these assets in exchange for fees and other payments.

In some cases, HASI structures the transactions as financings for accounting purposes and continues to carry the assets and the corresponding liabilities on its balance sheet in special purpose funding vehicles.

HASI also generates fee income for arranging financings that are held directly on the balance sheet of other investors or by providing broker/dealer or other services to project developers.

U.S. Federal Government
The U.S. federal government, which is the largest property owner and energy user in the United States, is actively involved in numerous sustainable infrastructure projects. HASI's U.S. federal government energy efficiency financings (which are not subject to the normal government budgeting process) provide capital to enhance the energy efficiency of U.S. federal government buildings and installations.

The U.S. federal government is increasingly evaluating clean energy projects, including those that may result from the U.S. Army Corps of Engineers July 2012 Request for Proposals to procure up to $7 billion of clean or alternative energy generation over the next ten years.

State and Local Markets
The U.S. Energy Service Company Market has estimated that the state and local markets account for more than 70% of the estimated 2011 revenue of Energy Service Companies (ESCOs).

Private Sector Owners and Developers
According to a 2009 McKinsey report, commercial buildings with improved energy efficiency have an estimated 6% higher effective rent and a 16% premium in valuation over similar non-energy efficient buildings.

Competition includes specialty finance companies, savings and loan associations, banks, private equity, hedge or infrastructure investment funds, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, utilities, project developers, governmental bodies and other entities.

HASI also encounters competition in the form of potential customers or origination partners electing to use their own capital rather than engaging an outside provider.

HASI produces a lot of income with few employees. HASI's business model invites competition from Wall Street firms that may have better connections to the federal government than HASI.

As of January 1, 2013, HASI employed 20 people. Dividing 20 into the expected market capitalization of $234 million means that each employee is valued at $12 million.

All directors, director nominees and executive officers as a group (11 persons), 35.5%

Entities affiliated with MissionPoint Capital Partners LLC, 55.4%

HASI intends to make regular quarterly distributions to holders of its common stock. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income

HASI earned $2.5 million for the December quarter, which is an annualized rate of $10 million. If HASI paid out 90% of $10 million based on a market cap of $234 million, the payout rate would be 3.85%.

HASI expects to net $182 million from its IPO. Proceeds are allocated as follows:

$110.0 million to complete eight financing transactions within 45 days of the completion of the IPO.

"HASI may fund $7.0 million of these financings through a securitization which would reduce the net proceeds used for these financings. The financings consist of six newly originated transactions and two other transactions that HASI originally financed through issuances of secured notes. HASI plans to retire these notes in order to retain a larger portion of project economics."

$4.2 million to repay an existing credit facility.

The net proceeds remaining after the uses described above, which, assuming HASI funds $7.0 million of financings through a securitization, are estimated to be $75.0 million, to be used to acquire additional assets and for general corporate and working capital purposes.

Disclaimer: This HASI IPO report is based on a reading and analysis of HASI 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: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.