The YieldCo structureUnlocking the value in power generation assets

Renewable, utility and broader power-producing companies continue to evaluate this new yield-based structure that offers investors high yields while raising capital for sponsor companies.

The YieldCo structure: unlocking the value in power generation assets 1

Yield-based investment vehicles are evolvingSince the early 1980s, yield-based investment vehicles — primarily master limited partnerships (MLPs) — have been a popular option for yield-starved investors and energy companies seeking capital. Today, there are more than 120 publicly traded MLPs with a combined MLP market capitalization of around $600 billion — spurred by the boom in domestic oil and gas production and the growth in associated infrastructure.

Another emerging asset class, the YieldCo, has evolved over time — all in an effort to attract yield-based investment capital (similar to the MLP market). A YieldCo is a publicly traded corporation that, like an MLP, provides stable and growing distributions for investors from operating assets that generate a predictable stream of cash flow.

Unlike MLPs, however, which are restricted on the types of income that they can generate (i.e., at least 90% of an MLP’s gross income must be “qualifying income” (such as revenue from exploring, producing, transporting, storing, processing, refining, and certain activities related to certain minerals and natural resources)), YieldCos have no technical restrictions on asset or income composition (again, other than market expectations of stability in cash flow). Consequently, YieldCos can be created from assets that would not generate the qualifying income required for pass-through treatment under the current tax law.

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The primary constraints are that the YieldCo’s assets must produce a stable stream of cash flows over time, and typically the YieldCo has significant operating losses, tax credits or other items that result in a reduced corporate-level tax burden on the YieldCo. Also, often YieldCos project little to no corporate-level taxable income for several years going forward. The result, therefore, is that an investor typically has an expectation of a “tax shield” on its investment. In the YieldCo context, to the extent that the investor receives a distribution that is characterized as a return of capital (as opposed to a dividend — distributions are generally taxable as dividends only to the extent the corporation has current or accumulated earnings and profits), the investor would generally not be taxable on any such amounts for so long as the investor has sufficient tax basis in its investment — hence a level of “tax shield.” Although the YieldCo “tax shield” is different from that of a traditional MLP due to the differences in applicable tax rules, the net result is similar in that the investor has an expectation of a tax burden on its investment at a level significantly lower than the cash it is expected to receive.

This relatively new corporate structure, first seen in its current iteration in 2013, offers significant value for both investors and sponsor companies, especially those in the renewable and conventional power generation space. In fact, early power-generating YieldCos have outperformed the traditional independent power producers in the market, attracting attention from a range of potential sponsor companies and investors alike.

The chase for yield and a broader base?The driver behind both MLPs and YieldCos is simple: in today’s market, there is an abundance of capital chasing yield-based investments in what has proven to be a long-term, low-interest-rate environment. This is a trend that will likely continue for years to come, as more members of the Baby Boomer generation retire.

Today’s yield-based investment products (especially with the relative yields) can offer an attractive option for individual retail investors and institutional funds — strong dividend income from a diversified portfolio of lower-risk, high-quality assets. Although the number of YieldCos in operation is relatively small, most investors in this asset class are earning healthy yields, with anticipated long-term dividend growth targets between 8 and 15%.

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Aside from the cash distribution profile of a YieldCo, the YieldCo structure itself is beneficial. Unlike a traditional flow-through MLP, a YieldCo is often classified as a corporation for US federal income tax purposes (with an ownership of an equity interest being the ownership of corporate stock). The classification as a corporation is important in the sense that such classification likely broadens the investor base in this yield-based vehicle to non-US investors and tax-exempt investors (which, for a variety of tax reasons, have traditionally not been major players in MLP investments).

FormatThe YieldCo structure typically involves the sponsor company contributing cash-generating assets into a limited liability company (the LLC). The YieldCo then raises cash from the public through an initial public offering (IPO) of its stock, and uses the IPO proceeds to buy an interest in the LLC. The sponsor retains an economic interest in the LLC but typically has no economic interest in YieldCo, only a majority voting interest, which allows the sponsor to control investment and operational decisions.

YieldCo benefits and considerationsIn general, successful YieldCos share a few key attributes that enable them to attract investor attention while maintaining the appropriate economics for the sponsor. For example, companies that have long-term contracts in place — with strong, creditworthy counterparties — instill investor confidence that the company will be able to make stable distributions. Investors also look for sponsors with a sufficient base of cash-generating assets that may be dropped down to the YieldCo in the coming years, to ensure growth and long-term total return on investment.

YieldCos can theoretically deliver a combination of benefits that can address perceived limitations of other structures — namely, (1) the YieldCo offers a promise of regular and predictable cash distributions, unlike the majority of publicly traded stocks; (2) the YieldCo offers a tax shield to its investors (similar in net result to that of an MLP for certain periods); and (3) as a corporation for US federal income tax purposes, non-US investors and tax-exempt investors may have a greater investment appetite for this trending vehicle.

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Overall, the YieldCo structure (if properly implemented and planned for, and with the right asset base) may enable companies to access public capital for future growth, increase the valuation multiple of their assets, gain a global investor base and, ultimately, unlock value.

If your company shares these characteristics, creating a YieldCo might be a lucrative strategy. The benefits are clear:

• Increasing market familiarity/comfort level

• Long-term growth potential

• Access to capital markets/acquisition currency

• No qualifying income requirements

• Potential lower cost of capital

• Access to institutional investor/non-US capital

At the same time, making a well-informed decision requires a good deal of effort and experienced insight to determine if your company’s particular situation is well-suited for a YieldCo approach. For example, similar to an MLP and other public entities, YieldCos require significant time and expense spent on investor relations, reporting and disclosure activities. Further, there is increased demand on management’s time and attention, and there are additional, and sometimes complex, governance and fiduciary obligations.

Similarly, thorough tax modeling and planning is required to ensure that the structure is beneficial both to the sponsor and the public, as well as planning to carefully evaluate monetization options. Modeling is critical, especially in connection with forecasted distributable amounts, as the ability to accurately project cash taxes, including state taxes and other matters, is essential in determining the “tax shield.”

Additionally, the executive team should thoughtfully and thoroughly consider the impact on accounting and financial reporting. In essence, companies considering a YieldCo should approach the process just as they would any other IPO.

Experience countsEY has experience in helping senior executives understand the benefits — and challenges — that the YieldCo structure offers. Our team can help you understand the complexities of this corporate structure and make informed strategic decisions that can enable your management team to maximize value and stimulate growth in the years to come.

For more information contact:Greg Matlock +1 713 750 8133 greg.matlock@ey.com

Deborah Byers +1 713 750 8138 deborah.byers@ey.com

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.