An introduction to alternative organization and financing ... · AGA/EEI . PwC June 2015 Agenda . 1 Overview and Market Drivers . 3 : 2 Readiness & Execution ; 16 . Page . 2 . PwC

An introduction to alternative organization and financing structures

Strictly Private and Confidential

June 2015

AGA/EEI

PwC June 2015

Agenda 1 Overview and Market Drivers 3 2 Readiness & Execution 16

Page

2

PwC June 2015

Overview and Market Drivers

3

PwC June 2015

Side-by-side

4

1 Overview and Market Drivers

MLP/Partnership REIT Yield Co.

Summary

• Receive at least 90% of gross income from passive sources • Interest, Dividends, rent,

commodities, activities directly tied to minerals or natural resource activities

• Corporation that invests in real estate and receives rents from real property

• Permitted a deduction for dividends paid, and the amounts thus distributed (including capital gains) are taxable only to the shareholders

• Company formed to hold assets offering dividend yield and growth profile

• No legal or regulatory restrictions on asset or income type unlike MLP’s and REIT’s

Typical Assets

• Pipelines, midstream, shipping, refining, specialty chemical, propane, oil field, other

• NNN, malls, healthcare, mortgages, industrial, lodging, self storage, apartments, office, timber, other

• Typically, long-term contracted unregulated generation assets, including renewables

Structure

• A publicly traded limited partnership • True pass-through entity

(D&A reduces unit holder taxes)

• Corporation that makes a REIT election

• Not a “true” pass-through entity

• Publicly traded corporation, may have partnerships underneath

Taxation of Vehicle

• Does not pay any federal income tax at entity level

• Taxed as a corporation • Special deduction for dividends

paid

• Taxed as a corporation • Through mix of assets, taxable

income generally managed to zero

Economics of Distributions

• No required distributions, other than partnership agreement requirement (usually 100% less reserve-coverage ratio)

• Must distribute 90% of taxable income to shareholders

• Generally distributions >100% to pay no federal tax. (Might still have some state taxes or taxes on taxable REIT subsidiaries)

• Mix of assets may also create little to no earnings and profits (E&P), such that distributions would be return of capital

• Taxable dividend to the extent there is E&P

PwC June 2015

Side-by-side (continued)

5


MLP/Partnership REIT Yield Co.

Tax Characteristics of Distributions

• No required distributions, other than partnership agreement requirement (usually 100% less reserve-coverage ratio)

• Operating dividends are not-Qualified Dividends (subject to individuals tax rates)

• Might include return of capital (not currently taxable – reduces investor basis)

• Might include capital gains distributions (lower rates may apply)

• Distributions are taxable as dividends to the extent of E&P;

• Might include return of capital (non currently taxable – reduces investor basis).

Benefits to investors

• Elimination of corporate level tax typically leads to higher valuation from investors

• Flow-through of tax shields/deferrals to investors (e.g., accelerated depreciation)

• Elimination of corporate income tax typically leads to higher valuations

• Low cost of capital vehicle • State taxes less complicated for

individual investors • International investors to invest in

U.S. real estate in a tax-efficient manner

• Elimination of corporate level tax through management of taxable income

• Simpler compliance

Concerns for investors

• Tax issues to investor more complex

• May increase investor state withholding and filing requirements

• May be problematic for foreign and tax-exempt investors

• REIT compliance (at entity) may be complex

• Higher tax rates apply on dividends for individual investors

• Need to feed • Constant management of tax

profile

PwC June 2015

YieldCo multiples have trended above other typical generation business models

6


Source: CapitalIQ

High Peer

Low Peer

As of April 30, 2015

YieldCo

REIT

MLP

Merchant

Hybrid

Regulated

.x

5.x

10.x

15.x

20.x

25.x

30.x

35.x

40.x

45.x

50.x

55.x

TEV/EBITDA

PwC June 2015

As interest rates have decreased, investors have sought and moved to yielding investments like utility stocks

7


Source: Bloomberg

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

US

BB

B U

tility

Bon

d Yi

eld

(%)

Util

ity In

dex

-Sha

re P

rice

Inde

xed

to 2

005

Dow Jones Utility Index and US BBB Utility Bond Yield

Dow Jones Utility Index US BBB Utility Bond Yield (20-Year)

PwC June 2015

While there are certain key similarities, all YieldCos are unique

8


NRG Yield Pattern Abengoa Yield NextEra Energy Partners

TerraForm (SunEdison)

8point3 (SunPower / First Solar)

Primary Focus M&A Wind International Wind / Solar Solar / Wind Solar

Location US US / Canada / Chile N. America / S. America / Europe

US / Canada US / UK / Chile / Canada

US / Chile / Japan

Asset Mix Gas / Wind / Solar / Thermal

Wind Gas / Renewable / Transmission

Wind / Solar Solar / Wind Solar

Initial Assets (MW) 1,359 1,041 1,010 990 808 432

Drop Down Assets (MW) 1,059 746 491 1,549 (+11,000) 1,109 1,131

Contract Tenor (Years) 16 18 26 21 18 21

ROFO Term 5 years 5 years 5 years 6 years 6 years 5 years

Percentage Contracted 96% 88% 100% 100% 100% 100%

Stated Growth 15-18% 8-10% 10-12% 12-15% 15% 12-15%

Sponsor Ownership at IPO 66% 68% 69% 80% 64% Pre-IPO

Dividend Policy 90% Payout 80% Payout 90% Payout 80% Payout 85% Payout Pre-IPO

Independent Management √ √ √

Conflicts Committee √ √ √ √ √ √

IDRs √ √ √

Subordination √ √ √

CAFD Commitment √

Forbearance √ √

Interest Payment Agreement √

Dual Class Vote √ √

PwC June 2015

YieldCos have generally shown strong performance since their IPOs

9


Source: CapitalIQ, Company Filings/News Releases, PwC Analysis

Market data as of April 30, 2015

NRG Yield Pattern Abengoa Yield NextEra Energy Partners

TerraForm (SunEdison)

IPO Date July 2013 September 2013 June 2014 June 2014 July 2014

IPO Price ($) 22.00 22.00 26.00 25.00 25.00

Current Price ($) 49.20 28.98 33.91 42.37 39.53

Performance Since IPO 124% 32% 30% 69% 58%

Annualized Dividend ($)1 1.56 1.37 1.04 0.82 1.08

Dividend Yield 3.2% 4.7% 3.1% 1.9% 2.7%

Market Cap ($MM) 1,702 2,007 2,713 792 2,214

Enterprise Value ($MM) 5,681 3,970 6,644 2,695 4,416 1 Based on most recently declared quarterly dividend

-

10

20

30

40

50

60

Stock Price ($)

NRG Yield Pattern Abengoa Yield NextEra Energy Partners TerraForm

PwC June 2015

Reserve margins are expected to tighten as coal retires

10


Source: Ventyx and NERC

NEPOOL

Percentage Above Target Reserve Margin

Changes in reserve margins reflect impacts from multiple factors, including anticipated coal retirements.

+30% 25% 20% 15% 10% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% -6%

2018

WECC California

WECC Other

ERCOT

SERC Southern

MISO North

SERC TVA

SPP

SERC VACAR

New York

NEPOOL

PJM

FRCC

MISO South

MISO North

2017

WECC California

WECC Other

ERCOT SERC Southern

SERC TVA

SPP

SERC VACAR

New York NEPOOL

PJM

FRCC

MISO South

MISO North

WECC California

WECC Other

ERCOT

SERC TVA

SPP

SERC VACAR

New York NEPOOL

PJM

FRCC

MISO South

MISO North

2016

WECC California

WECC Other

ERCOT

SERC TVA

SPP

SERC VACAR

New York NEPOOL

PJM

FRCC

MISO South

MISO North

SERC Southern

2015

WECC California

WECC Other

ERCOT

SERC TVA

SPP

SERC VACAR

New York NEPOOL

PJM

FRCC

MISO South

MISO North

SERC Southern

SERC Southern

2014

PwC June 2015

Historical and future capacity additions are largely driven by gas prices

11


Source: SNL, EIA

* EIA’s reference case does not include proposed rules such as the GHG New Source Performance Standards, which could limit future coal additions

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

0%

20%

40%

60%

80%

100%

$/M

MB

tu

New Capacity Additions by Fuel Type

Gas Coal Nuclear Renewable / Other Henry Hub Spot Price Henry Hub Futures (4/30/2015)

PwC June 2015

Shale production and weather events have impacted natural gas pricing

12


Source: SNL

MT

WY ID

WA

OR

NV

UT

CA

AZ

ND

SD

NE

CO

NM

TX

OK

KS

AR

LA

MO

IA

MN

WI

IL

IN

KY

TN

MS AL

GA

FL

SC

NC

VA WV

OH

MI

NY

PA

MD DE NJ

CT RI MA

ME

VT

NH

MI

Sumas

PG&E Citygate

SoCal Border

Waha

Cheyenne

Henry Hub Houston Ship Chanel

FGT Period Henry Hub Spot Price

2008 $8.90

Jan 2014 $4.68

Apr 2015 $2.61

Bakken

Powder/Green Basin River

Barnett- Woodford

Barnett

Eagle Ford

Haynesville

Antrim

Woodford

Marcellus-Utica

Legends Natural Gas Trading Center/Hub

Shale Gas Play

Algonquin

Denver Julesberg Dominion S

TETCO M3

2008

Jan 2014

Apr 2015

Transco Z6 (NY) Chicago

4.64 2.57

8.90

4.68 2.61

8.56

4.57 2.54

8.92 7.53

2.60

10.14

25.49

3.41

9.34

4.44

1.55

9.87

22.51

1.77

10.10

29.84

2.31

6.54

4.71

2.30

7.74

4.60

2.15

8.64

4.74 2.87

7.94

4.72

2.44

7.67

4.55

2.41

PwC June 2015

Renewables will continue to play a growing role in the nation’s generation supply

13


Source: Department of Energy (Database of State Incentives for Renewable Energy)

Sta tes w ith n o RPS sta n da r dSta tes w ith RPS sta n da r d less th a n 2 0%Sta tes w ith RPS sta n da r d betw een 2 0% to 3 0%Sta tes w ith RPS sta n da r d g r ea ter th a n 3 0%Sta tes w ith n on -per cen ta g e ba sed RPS sta n da r d

Many states have implemented RPS to be generally achieved from 2010 through 2025

Legend

15% by 2020

25% by 2025

25% by 2015

20% by 2010

33% by 2020

25% by 2025 20% by

2025

15% by 2025

30% by 2020

15% by 2015

20% by 2020

5,880 MW by 2015 10,000 MW by 2025

20% by 2020

15% by 2015

10% by 2015

10% by 2015

15% by 2021

30% by 2020

105MW

12.5% by 2021

10% by 2015 10%

by 2015

25% by

2025

12.5% by 2027

10% by

2025 15% by 2025

25% by 2025

18.5% by 2021 NJ 20.4% by 2021

DE 25% by 2026 DC 20% by 2020 MD 20% by 2022

CT 27% by 2020 RI 16% by 2019

MA 15% by 2020 NH 24.8% by 2025

ME 40% by 2017 VT 20% by 2017

30% by 2015

PwC June 2015

Renewable incentives in addition to accelerated depreciation

14


Source: Department of Energy (Database of State Incentives for Renewable Energy)

Incentive

Production Tax Credit (PTC) IRC sec. 45

Investment Tax Credit (ITC) IRC sec.481

Federal Renewable Grant (Cash Grant) Sec. 1603 of ARRA1,2

Benefit (Cents/ kWh)

Construction Start Date3

Duration (Years)

Benefit Construction Start /

Online Date3,4

Benefit Construction Start Date5

Online Date

Before

Wind 2.3 12/31/2014 10 30% 12/31/2014 12/31/20166 30% 12/31/2011 1/2013

Solar NA 30% 12/31/20167 30% 12/31/2011 1/2017

Geothermal 2.3 12/31/2014 5 30% 12/31/20147 30% 12/31/2011 1/2017

“Closed-loop” Biomass 2.3 12/31/2014 10 30% 12/31/2014 30% 12/31/2011 1/2014

Fuel Cells NA 30% 12/31/2016 30% 12/31/2011 1/2017

Other 1.1 12/31/2014 10 10% 12/31/2016 10% 12/31/2011 1/2017

1 The tax basis of the property must be reduced by 50% of the amount of the ITC or grant 2 ARRA = American Recovery and Reinvestment Act 3 For 12/31/2014 construction start projects, based on IRS guidance, if placed in service by 12/31/2016 projects will satisfy the continuous construction and continuous efforts tests. When using the “physical work” test to satisfy that construction has begun by 12/31/2014, IRS guidance specifies that the test will focus on the nature of work performed, rather than the quantity or cost of work. When using the financial “safe harbor” to satisfy that construction has begun by 12/31/2014, IRS guidance specifies that 5% or more of the total cost of the facility must be paid or incurred by 12/31/2014. 4 Project types with 12/31/2014 fulfillment dates must be under construction by such date, while project types with 12/31/2016 fulfillment dates must be in-service by such date 5 Construction needs to have begun by 12/31/2011 and is defined as beginning when more than 5 percent of the total cost of the property has been paid or incurred 6 Expires 12/31/2016 for small (<100kw) wind installations and 12/31/2014 for large installations 7 Reverts to a 10% permanent investment tax credit for solar and geothermal after 12/31/2016 and 12/31/2014 respectively

PwC June 2015

The EPA’s proposed renewable building block under the Clean Power Plan indicates significant new renewable deployment in certain states

15


Source: EPA, Department of Energy, PwC Analysis

MT 556 MW

WY 1,650 MW

ID 260 MW

WA 3,619 MW

OR 2,040 MW

NV 1,121 MW

UT 415 MW

CA 4,256 MW

AZ 641 MW

ND 59 MW

SD 0 MW

NE 806 MW

CO 1,516 MW

NM 701 MW

TX 16,943 MW

OK 2,302 MW

KS 1,185 MW

AR 994 MW

LA 2,037 MW

MO 478 MW

IA 0 MW

MN 0 MW

WI 1,384 MW

IL 3,594 MW

IN 1,522 MW

KY 630 MW

TN 1,584 MW

MS 1,803 MW

AL 5,259 MW

GA 4,088 MW

FL 8,030 MW

SC 3,439 MW

NC 4,093 MW

VA 4,034 MW

WV 4,099 MW

OH 4,580 MW

MI 1,625 MW

NY 8,708 MW

PA 14,097

MW

MD 2,321 MW

DE 414 MW

NJ 4,049 MW CT 931 MW

RI 142 MW

MA 2,576 MW

ME 0 MW

VT NH 1,309 MW

AK 47 MW

HI 46 MW

VT and DC do not have affected units

Region

Assumed Capacity Factor State(s)

East 25% KY, TN, NC, VA, WV, PA, NY, NJ, MD, DE

Southeast 25% LA, MS, AL, FL, GA, SC

Alaska 30% AK

California 30% CA

Great Lakes 30% WI, MI, IL, IN, OH

Hawaii 30% HI

New England 30% RI, MA, NH, VT, ME, CT

Northwest 30% WA, OR, ID, MT

Heartland 35% OK, AR, KS, MO, NE, IA, SD, MN, ND

Mountain 35% NV, AZ, UT, CO, NM, WY

Texas 35% TX

Legend Implied Incremental Renewable Capacity1

0 – 2000 (MW)

2000 – 8000 (MW)

+8,000 (MW)

1 Implied incremental renewable capacity derived based on EPA proposed incremental renewable MWh by state (2029 target less 2012 baseline), converted to MW based on assumed regional capacity factors.

PwC June 2015

Readiness & Execution

16

PwC June 2015

Illustrative Roadmap for Launching an MLP, YieldCo, REIT

2 Readiness & Execution

17

Launch

Project Management Office (PMO) and Change Management & Communications

Implement stand-alone business

PwC June 2015

MLP

18


• MLPs provide for a single layer of taxation

• MLPs pass through income and tax attributes (e.g. tax credits or accelerated depreciation) to unit holders. Historically this structure has been utilized for investments in the oil and gas sector

• Benefits - Avoids double taxation - Tax incentives flow to investors

• Challenges - Requires ongoing access to quality

assets, manage conflicts of interest with parent

- Benefits from low interest environment - Proposed IRS ruling on qualifying

income

Structure Overview

Non-qualifying Operating LLC

PwC June 2015

YieldCo

19


• A YieldCo buys a large portfolio of contracted operating projects from the Sponsor (or other developers) and sells output under those contracts

• YieldCo provides a cash yield return to investors (Sponsor and Public)

• Benefits − Tax efficiencies through

depreciation methods − No need for regulatory change

• Challenges − Similar to MLP

Structure Overview

PwC June 2015

REIT

20


• Benefits - Avoids double taxation - Lower cost of capital

• Challenges - IRS approval?

• Allows for the "pass-through" ownership of income-producing property and thus a single layer of taxation

• Generally, required to distribute 90% of taxable income. The benefits of accelerated depreciation and tax credits remain within the REIT and reduce its required distributions

Umbrella Partnership

REIT

REIT Project Co.

% GP Interest

Contribution ofProperty for

% LP Interest

Investors

100% REIT Shares

Structure Overview

PwC June 2015

Incremental Costs to Achieve


21

List of Key Cost Initiatives One-Time

Costs Recurring (Annual)

Cost Increases

Transactional Costs X

1

Banking / Financing Fees X

Debt Recapitalization Costs X

Other [Advisory, Legal, etc.] X

Operational Costs X X

2 General

[Operations separation, TSA, etc.] X

3 Corporate Affairs, Communications and External Reporting X

4 Executive X

5 Finance X

6 Human Resources X X

7 Information Technology X X

8 Risk and Insurance X

9 Supply Chain X X

Other Costs X 10 Transfer taxes X

11 Earnings & Profit Purge X

PwC June 2015

Illustrative SEC Registration Timeline – MLP/YieldCo/REIT


22

PwC June 2015

Operation Transition Execution – Process & Approach


23

Planning Execution Operate

Project Initiation Day 1

Define Project

o Develop high level operating model

o Identify desired capabilities for in-house and/or out-sourced

o Establish project governance

o Develop Project Plan / Program with associated workstreams

o Develop Resource Plan – internal and external staff

o Develop Project Management Templates – Status Updates

Conduct Project Kick-off

Design o Develop Playbook –

Business Requirements Document for: – IT – Reporting – Qualification includes:

Tax and Transfer Pricing

– Treasury – Legal – Accounting / Finance – FP&A

o Develop business processes

o Identify KPIs and Performance Metrics

o Develop the future strategy

o Develop future state architecture

o Select System

o Finalize what activities will be in the TSA

o Draft Policies and Procedures

o Develop tax compliance models

o For REIT, develop standard lease language

o Implement governance strategy

Build / Test o Finalize Operating Model o Develop User Roles and

Responsibility o Build out IT infrastructure

– Develop testing strategy

o Develop Reports – Statutory – Supplemental

o Develop test scripts o Finalize Policies

~24 weeks

Operate o Support Post Go Live

Activities o Operate and Manage

TSAs o Support 1st Quarter

Statutory and Supplemental Reporting

o Continue to develop 2nd Day Reports

o Finish any additional system configuration that was deemed Day 2

Change Management and Communication

ILLUSTRATIVE

KEY Transition Milestones

PwC June 2015

Initial SEC registration and predecessor financial statements

• YieldCos, REITs and MLPs require registration with the SEC and ongoing SEC reporting

• Initial registration statement (Form S-1) must include:

− Three years of historical financial statements (two years if an “emerging growth company”)

• An “emerging growth company,” as defined in the JOBS Act, is a new issuer with less than $1 billion in annual gross revenues in its most recent fiscal year

− Management’s Discussion & Analysis

− Selected Financial Data, including Non-GAAP measures

− Pro Forma Financial Statements

• A “predecessor” must be determined based on the entity or entities that represent the major portion of the business and assets of the registrant. Preclearance with the SEC may be required


24

PwC June 2015

Carve-out financial statements

Wra

p U

p a

nd

T

ran

siti

on

B C E

His

tori

cal F

inan

cial

St

atem

ents

Preparation of Financial Statements Audit and Reporting

Project Management Office

Assessment

A

Preparation of carve-out financial statements requires a sequence of coordinated steps that combines the use of process, data analytics and technical accounting to produce a complete set of GAAP financials

A. Planning & Assessment: Objective of this phase is to define business and data scope, as well as carve-out principles (e.g. basis of presentation, carve-out methodology for each account, etc.)

B. Preparation of Financial Statements: Key components of this phase include: • Preparing technical white papers on accounting issues • Accumulation of financial data • Preparation of financial statements of the carve-out entity • Preparation of detailed audit packages • Upload the carve-out financial information into a reporting engine

for further reporting analytics and analysis

C. Audit and Reporting: Collaborate with Auditors to identify and resolve complex audit, accounting, and reporting issues in an efficient manner

D. Project Management Office: A robust approach centered around an efficient and effective use of carve-out resources, compliance with Client’s strategic objectives, management of data, quality controls and adherence to desired separation timeline

E. Wrap Up and Transition: Wrap-up and transition of knowledge and work product to Client

D


25

PwC June 2015

Carve-out and other financial statements


26

Key issue Considerations Actions

• Creating carve-out financial statements

• Determining other financial statement requirements

• Determine if the “carve-out” entity is a separate business, segment or group of assets

• Determine level of existing operations and financial data separation

• Determine if the historical financial information for the carve-out entity is available and if you can identify all assets and liabilities of the carve-out entity

• Determine information needed to develop a “reasonable” method for allocating:

• Shared services

• Corporate costs

• Corporate debt and interest expense

• Employee benefit plans

• Guarantor financial statements (Rule 3-10)

• Separate financial statements of unconsolidated subsidiaries (Rule 3-09)

• Identify carve-out assets/liabilities included in proposed transaction

• Map carve-out assets/liabilities back to legal entities and legal entity structure and historical financial consolidation

• Determine if carve-out meets the financial statement reporting and disclosure requirements of SEC Rule S-X

• Identify resources and related costs used by carve-out entity which are indirect. Identify other users of resources

• Develop rational allocation methodology based on cost drivers that is not complicated or burdensome to implement

• Develop “audit trail” of factual information supporting the allocation

• Determine impact of transactions with affiliates and related disclosure requirements within footnotes

• Identify any guarantor arrangements and determine if they are exempt from the requirement to present separate financial statements

• Identify any equity-method investments and determine if they are significant to the registrant (asset and income tests)

PwC June 2015

Other considerations

• Subsequent acquisitions or drop-downs will likely require additional efforts, including:

− Possible need for conflicts committee valuation and due diligence support

− Accounting and tax valuations

Step-up and allocation to tangible and intangible property

− Cost segregation analyses

• Subsequent drop-downs may trigger additional financial statement requirements, including:

− Pro Forma financial statements;

− Acquiree financial statements; and

− Recasted financial statements.

• Other issues may include:

− Calculating earnings per share/unit;

− Consolidation of operating companies;

− Other SEC-specific reporting requirements (e.g. segment reporting); and

− SOX 404 compliance.


27

PwC June 2015

Common accounting and reporting issues

• Financial Reporting Considerations − All structures commonly use the historical basis due to common control − Consolidation analysis based on partnership structure and ownership

• MLP Specific Considerations − Earnings per unit calculation is based on the two class method

• YieldCo Specific Considerations − Allocation of OpCo income to non-controlling interest (HLBV)

• REIT Specific Considerations − Sale-leaseback transactions and lease classifications − Schedule III – Real Estate and Accumulated Depreciation


28

PwC June 2015

Summary

• The energy, power and utilities industries have increasingly focused on alternative investment vehicles designed to hold assets and provide sustained and increasing cash flows.

• Alternative structures can provide access to a broader population of investors through the use of tax efficient vehicles that other industries already utilize

• The accounting and financial reporting complexities found in a YieldCo, REIT or MLP structures are similar, as all structures involve the transfer of assets into a newly formed entity or entities

• In connection with an IPO, the newly formed entity will need to file registration statements with the SEC and, therefore, may need to create standalone SEC-compliant financial statements for the first time

• The creation of standalone financial statements, as well as other financial statements required in a registration statement, may require significant investment in time and resources

• A number of complex accounting, carve-out, and SEC reporting issues often arise during the formation of a Yieldco, REIT, or MLP.

• Capital market windows of opportunity can open and close – it is important to be well-prepared when that moment arrives.

29


An introduction to alternative organization and financing ... · AGA/EEI . PwC June 2015 Agenda . 1 Overview and Market Drivers . 3 : 2 Readiness & Execution ; 16 . Page . 2 . PwC

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