Solar War Stories: From the Financial Front Lines
Two CEOs and three CFOs of solar companies shared lessons learned from closing recent financings at the Infocast solar finance and investment summit in San Diego in late February. The panelists are André-Jacques Auberton-Hervé, chairman and CEO of Soitec, Edward Fenster, CEO of SunRun Homes, Matthew McGovern, chief financial officer of Gerlicher Solar America Corp., Michael Metzner, chief financial officer of Recurrent Energy, and Michael Whalen, chief financial officer of SolarReserve. The moderator is Keith Martin with Chadbourne in Washington.
MR. MARTIN: Michael Whalen, what have you financed recently and how were the financings structured?
MR. WHALEN: In September last year we completed the financing of our inaugural solar thermal project called Crescent Dunes in Tonopah, Nevada. It is a 110-megawatt facility that will generate electricity using a power tower. The financing involved raising both debt and equity. The debt was a $737 million loan guarantee from the US Department of Energy. The equity came from ACS Cobra, which is also our construction contractor, and from Banco Santander. This was the culmination of a considerable amount of work. SolarReserve itself is a major investor in the transaction.
MR. MARTIN: How long did it take to close the financing from start to finish?
MR. WHALEN: It was two years of activity from when we applied to the Department of Energy. The Department of Energy spent more than a year evaluating the tenders it received and on preliminary activity. We agreed to the final term sheet in January 2011 and completed the financing in September 2011.
MR. MARTIN: You have some other projects that you are about to finance in South Africa?
MR. WHALEN: That is correct. We were awarded, as part of the renewable energy IPP procurement program in South Africa, two 75-megawatt photovoltaic projects in the first bidding round, and we are working with South African banks to finance the projects by June 2012.
MR. MARTIN: Michael Metzner, what has Recurrent Energy financed recently?
MR. METZNER: In fact, if you allow me some license for double counting by treating construction debt and term debt that will replace it as separate financings, we raised close to $1 billion in the last year and a half. In the most recent transaction, we raised both debt and equity for a roughly 90-megawatt portfolio of five solar PV projects with the Sacramento Municipal Utility District as the offtaker. The construction debt came from a consortium of banks and had a term debt option. The equity was a partnership that was formed among KKR, Google and us. There was both tax equity and cash equity.
MR. MARTIN: Google was a tax equity investor and KKR the true equity?
MR. METZNER: We have been a little mum on some of
the details, but you can probably figure it out. We also closed a construction revolver with Mizuho for $250 million to finance construction of about 20 individual solar PV projects in Ontario that will benefit from the feed-in tariff program there.
MR. MARTIN: How is financing different in Canada than the United States?
MR. METZNER: It is not nearly as tax driven and not as
MR. MARTIN: Returning to the US, how long did it take from start to finish to close the financing for the US project in which KKR and Google invested?
MR. METZNER: Start to finish was four months.
MR. MARTIN: Matthew McGovern, what has Gerlicher financed recently?
MR. McGOVERN: We have been focused primarily on commercial-scale distributed generation projects. At the end of the fourth quarter, we closed on three sites for a cold storage facility in southern New Jersey. We worked with a family office that stepped in to take full ownership, including the tax equity position. We also have an internal credit line that we arranged in Europe through a syndicated loan facility. The credit line was led by a BayernLB and is about €180 million.
MR. MARTIN: Focusing on the New Jersey projects, which I think you told me are a total of 18 megawatts, how long did the financing take from start to finish?
MR. McGOVERN: It was probably six months. It was with a group that probably did 40 megawatts last year, so the group was familiar and relatively comfortable with the process.
MR. MARTIN: What form did the transaction take with the family office?
MR. McGOVERN: It was a sale leaseback
MR. MARTIN: Ed Fenster, you are a financing machine. What have you done in the last six to eight months?
MR. FENSTER: Unlike the larger-scale developers here, we have a constant flow of projects. In 2011, we represented at least a third of the California residential market and we think about the same percentage of the national market. We are always originating new customers and placing new rooftop solar systems in service, and this leads to a steady stream of financings. Most of our transactions involved around $100 million in tax equity commitments. In September, we closed a tax equity transaction where the investor took the Treasury cash grants and we retained the depreciation. Hopefully in the next couple of days, we will be closing another transaction in which we will be keeping most of the depreciation, but the tax equity investor will be sharing in it as well. We are through committee on a partnership flip transaction that involves investment credits rather than Treasury cash grants. In December, we added a working capital facility of about $25 million to fund construction. Our construction turns very quickly, but there is a lot of it, which leads to a need for working capital.
MR. MARTIN: These are portfolios of residential solar installations. The first and second transactions you described sound like inverted leases, and you say you are working on a partnership flip transaction. How long do these deals take from start to finish?
MR. FENSTER: It was probably 18 to 24 months for the September closing measured from the initial investor contact. The one that we are closing now was a two to three month process. Discussions about the partnership flip transaction on which we are now through committee started in 2008.
MR. MARTIN: I am certain you set the record for the
longest negotiation. André Auberton-Hervé, your most recent financing was a project in South Africa. How is the financing structured?
MR. HERVÉ: It is a 50-megawatt project. We launched on it last November. The project was underwritten by Investec Bank in South Africa. One had to have the financing in place in order to bid into the government RFP.
MR. MARTIN: Let me ask both André Auberton-Hervé and Michael Whalen, since you both have projects in South Africa, how does the cost of capital in South Africa compare to the US and Europe?
MR. WHALEN: The program in South Africa is very much focused on rand denominated financings. In terms of raw numbers, the cost of capital is certainly higher than you would see in the US, reflecting the inflationary environment in South Africa. Because of restrictions within the South African market on capital and on currency movement, there is a fairly small but pretty deep and liquid market.
MR. MARTIN: I imagine there is a political risk element
MR. WHALEN: Whenever you look at emerging markets, that is obviously something you take into consideration. Political risks are sometimes underestimated even in our home market in California. [Laughter.]
MR. MARTIN: Permit me one tangent. Ed Fenster, Michael Whalen, what is it about the solar industry that causes companies to spell their names as a single word: SunRun, SolarCity, SolarReserve? Why?
MR. WHALEN: It turns out that space is very expensive so we are just trying to economize. [Laughter.]
MR. MARTIN: Ever vigilant when it comes to costs! Our panel discussion today is about war stories from the financial front lines. Starting with Ed Fenster, tell me what lesson you took away from your most recent financings.
MR. FENSTER: We work with homeowners and turn around and deal with project finance investors who are less used to the demands of dealing with residential customers. The amount of time a developer like us must spend on operational efficiency and compliance is significant. We need considerable infrastructure to marshal inventory, oversee installation, monitor performance, and handle 25,000 customer service calls. We have fault tolerant metering systems, multiple cellular networks, multiple technologies. We can move meters from one system to another. We are PCI compliant when it comes to handling credit cards and appropriately licensed with everyone in the state of California. We comply with an array of consumer protection rules and regulations. We take data security measures to protect customer specific information.
Regulatory awareness is our business.
It is enormously time consuming to find suitable installers. We reject 40 to 50 installers for every one that we take into our system. We run training and quality assurance programs.
These are all things we have to have in place before we can raise the first dollar of financing. For us, financing is less about the financial terms of a transaction and more about ensuring that we have the operating business in place to manage thousands or tens of thousands of homeowners.
MR. MARTIN: Your business has more in common with the cable television business than with a power company. You are wiring lots of houses, and you need lots of people to monitor the systems. Michael Metzner, what lessons did you take away from your recent financings?
MR. METZNER: We are always trying to achieve the right balance between optimization and simplicity in order to get the deal done.
The leveraged partnership flip transaction we did recently to raise both debt and tax equity had a syndicate of four lenders and a separate tax equity investor, each with its own demands. This meant we had to move to the least common denominator on debt terms and pricing. We were negotiating in the midst of volatile capital markets with various global crisis unfolding.
The single biggest lesson is to know when to stop trying to optimize every little piece of it and focus on getting it done.
Set it up ahead of time with an optimal structure, but things are going to change and be willing to roll with the punches. Keep it simple and know when you might have to leave a few basis points on the table in order to ensure a higher probability of getting across the finish line. As an old boss, John Rowe at Exelon, used to say: “Pigs get slaughtered.” Know when to fold your hand.
MR. MARTIN: Don’t behave like you belong in the Tea Party movement. Don’t be ideologically pure. This is like government. You have to compromise to get something done. Another lesson, you told me before this, is to anticipate that the tax equity investor will want a forbearance agreement in a deal in which there is also project-level debt.
Mr. METZNER: Yes, that’s exactly right. You need to have a good idea at the start of the process what each of the parties will require. Line up the whole deal the best you can before you start. Another obvious lesson is discipline your process. When you have seven or eight parties, four banks, two equity partners, not to mention all your contractors, keeping the momentum going becomes key in keeping everybody on the reservation. That is a huge challenge.
MR. MARTIN: Matthew McGovern, a lesson you took away from your financings?
MR. McGOVERN: I think the key takeaway for us was the need to understand where risk tolerances lie among the various parties. Financing is a process of identifying risks and allocating each to the party best able to manage it. For example, one risk we ended up having to take as the sponsor was credit risk of the customers and, at times, even the REC or renewable energy credit value.
MR. MARTIN: Part of the risk allocation is driven by which financing structure you choose. You chose a sale leaseback which really puts most of the risk on the developer as lessee.
MR. McGOVERN: Correct.
MR. MARTIN: André Auberton-Hervé, what lesson did you take away from your experience in South Africa?
MR. AUBERTON-HERVÉ: The key to all financings is to be transparent, get started early and cultivate a long-term relationship with the banks. You need to be transparent, you need to work early enough and have long-term relationships with the banks. Having an ongoing dialogue with the financial community is part of our DNA.
MR. MARTIN: Michael Whalen, what lessons did you take away from your recent experience to the Tonopah project?
Mr. WHALEN: To a certain extent, it was a unique activity because it was part of a program that had a definite end date associated with it. At times, as we slogged through the process, I thought a little bit about the Shakespearian expression, “Neither a borrower or a lender be” or its modern equivalent, “He who goes a borrowing goes a sorrowing,” but I am happy to say that it ultimately led to a good result. Something we learned in the process is that, despite the high profile of the DOE loan guarantee program, it is not about politics; it is the process and ultimately all about the project and whether the economics were strong enough and the risks allocated in a manner to satisfy each of the financiers from whom we were asking for support.
MR. MARTIN: Will we hear you testify to that effect
before one of the Congressional panels that is investigating the program?
MR. WHALEN: I certainly hope it does not come to that. Another lesson is I disagree with the popular advice book: Do sweat the small stuff. There were a lot of details as part of that process that may have seemed small early in the development phase, but that proved to be very, very challenging to deal with later when one is dealing with a finite date to close. Work with all elements of your team to keep on top of the details. Finally, a financing is not just a closing but also a long-term relationship that requires considerable maintenance. Reaching the first draw after closing was as much of a concerted effort as the execution of the financing documents,and successive draws will be as well.
MR. MARTIN: Are there any other lessons anyone wants to add from recent financings?
MR. METZNER: This is a nod to our general counsel, Judy Hall, who reminds us that the seller of a project has maximum leverage during the bidding process. Get a markup of the purchase and sale agreement and get as much detail as possible, because your negotiating leverage is only going to diminish from that time forward.
MR. MARTIN: That is especially true if you have a deadline when you have to close.
MR. McGOVERN: Exactly. It is easy to focus too much on the headline numbers or terms and not really focus on some of the key things that will cost you down the road when you will not have time to find an alternative.
Section 1603 Program
MR. MARTIN: Ed Fenster, you have been dealing with the Treasury Department on cash grants. They are the basis for some of your financings. How has that experience been? Has it been what you expected?
MR. FENSTER: Yes. The Treasury Department is getting increasingly sophisticated in how to think about these transactions. We have now received a large number in grants, none of which has ever been adjusted, and we have a reasonably good ongoing dialogue with the Treasury. We have never submitted an appraisal that assumes an unrealistically low cost of capital. The Treasury sees such appraisals occasionally — for example, with a 6.5% capital cost assumption — and takes issue with them. I think the program has been working well. We have been able to submit applications 15 days after our rooftop systems are placed in service. As we move into 2012,
I suspect there will be additional scrutiny of valuations in transactions involving related parties. The focus that the Treasury is putting on this is welcome and hopefully will lead to some sort of standardization inside the industry.
MR. MARTIN: The Treasury posted to its website on
June 30, 2011 benchmarks of $4 to $7 a watt indicating what it thinks are reasonable values for solar projects. Where you are on this range depends on the size of the project. The smaller projects are at the upper end of the range. In your experience, are the grants being paid today still within this range?
MR. FENSTER: Yes. We think we do well on those dimensions in the marketplace.
MR. MARTIN: Michael Whalen, given that it took you two years to get through the DOE loan guarantee process, was it worth it? If the program is renewed in the form of a clean energy bank by a new Congress, would you line up again for such financing?
MR. WHALEN: Our solar thermal projects in the United States tend to be concentrated in the western United States, so we must deal with federal land issues as a matter of course. Therefore, some of the qualms that other developers may have had with entering into a federal process did not apply to us. We were already engaged in that process. Our site is on federal land. I think that it was absolutely worth it. We were able to secure long-term financing at a price that is very beneficial for the project and ultimately for the ratepayers in Nevada. Our sense is that the outside world looks at the Department of Energy diligence and scrutiny as positive and as a sign of support for the technology.
Cost of Capital
MR. MARTIN: How important is a low cost of capital? Is there a way to quantify how much a 100 basis point reduction in cost of capital reduces the electricity price you can offer?
MR. METZNER: Every 100 basis point increase would add $15 or so to the electricity price.
MR. MARTIN: So a 100 basis point reduction in cost of capital means you can reduce the PPA price by $15 a mWh.
MR. METZNER: Roughly. Different projects vary within a range, but the cost of capital translates directly into the clearing price for power in these bidding processes. That is why it is so important to continue to find lower costs for capital to be competitive.
MR. MARTIN: Financing is a search for lowest cost capital. CFOs draw capital from six different sources. The cheapest capital is a Treasury cash grant that covers 30% of the capital cost and is free money. Next cheapest is federally-guaranteed debt, then straight debt, then tax equity, then subordinated debt and then true equity. The government is pulling away the two cheapest tiers. The Treasury cash grants are phasing out, and government-guaranteed debt is largely gone except under a US Department of Agriculture program for projects in rural areas and possibly guaranteed debt from export credit agencies.
What direction do you expect to move in your search for lowest cost capital now that the bottom two tiers are being pulled away?
MR. WHALEN: The lowest cost of capital is obviously one of the criteria that we look for, but we also take into account other things like how quickly we will be able to secure it and whether we are using the next financing as a launch pad to achieve other financings.
There will clearly be an impact in the cost of capital with the expiration of the section 1603 and 1705 programs. I am not sure I view the section 1603 program as free money. It is the cash equivalent of an investment tax credit that was already on the statute books. The government was concerned after the economy collapsed about the ability of developers to get value for the investment credit. I think to that extent it was extremely effective.
MR. MARTIN: Let’s assume the section 1603 program will not be extended. Where will you look to replace the capital in the two cheapest tiers?
MR. METZNER: There are short-term and long-term answers to that question. Each answer is specific to the kind of developer you are, the technology you are using, and your particular situation. It is hard to replace something like the Treasury cash grant. But the investment credit is still there. There is still a huge untapped amount of tax capacity that is on corporate balance sheets. I know that traditional tax equity providers like to say, “It’s hard to unlock that,” but it has never been easy to raise financing in this business, and I think developers will have to try to unlock some of that.
MR. MARTIN: So unlock additional tax capacity.
MR. METZNER: Then there are production tax credits. Our friends in the wind market know that the production tax credit for wind is expiring, and there is tax capacity that is currently being absorbed by the wind market that might be freed up for solar.
MR. MARTIN: So wind failure leads to tax equity bonanza for solar.
MR. METZNER: Maybe there isn’t a great replacement, so it just puts more pressure on having better projects: better quality PPAs, better quality construction and equipment contracts and essentially driving down the perception of risk among investors so that you can make up for that lost grant. I think that is really the long-run answer.
MR. MARTIN: Let me reframe the question slightly. European banks are having capital adequacy problems. Many are withdrawing from the project finance market. What does one do in the face of this to find low cost capital?
MR. FENSTER: First, I would say we never found the DOE loan guarantee program to be a low cost form of capital.
Expiration of the grant program will push people to tax equity transactions using investment tax credits. We are already moving in that direction, and have not necessarily seen any meaningful change in cost of capital. The universe of buyers is slightly smaller. One new direction in which are moving is we are waist deep in an asset securitization program where we will be selling publicly-rated debt. That is a new source of capital that gets you out of the bank market. US banks are not really equipped to hold assets for more than five to 10 years. The people who are more likely to do that buy publicly-traded bonds. Asset managers, pension funds and life insurance companies, plus stripping the projects down to send the cash in that direction and the tax benefits in another direction are where I see the market headed over the next couple of years.
MR. MARTIN: So ABS or securitization structures may be your future. Anybody else? Where else do you think you will look for low cost capital in the future?
MR. McGOVERN: We will be trying to increase efficiency and strip out layers. In the past with the section 1603 program, you could draw capital from multiple sources. Now for us the Holy Grail is to find a participant who is all-in-one. It can take all the tax benefits and lend part of the capital cost or put in equity. That is the most efficient.
MR. MARTIN: The current solar company earnings reports in Photon, a magazine that does a good job of covering the solar industry, make rather unsatisfying reading. Many of the large solar companies have been reporting disappointing earnings in the last few issues. Is this just a problem with equipment manufacturers with over capacity or does it also infect the developer side of the business? Are developers better off with the travails on the equipment manufacturing side?
MR. WHALEN: The real question is to whether there will be meaningful consolidation of manufacturers upstream. Some consolidation is already occurring, and you should begin to see that represented in the profit and loss statements of the manufacturers. However, the real price setters in the market are the Chinese.
MR. MARTIN: André Auberton-Hervé, do you feel this pressure to consolidate as a manufacturer?
MR. AUBERTON-HERVÉ: I think there are two markets. There is one that is driven mainly by the policy in Europe. Eighty percent of PV is installed in regions where the sun is really not the strongest. There is a new market that is emerging, which is one of utility-scale projects in higher radiance areas. I have been in the industry for 30 years. It is a very dynamic one. The renewable energy today is moving geographically. Solar is moving south. Wind is moving north in Europe. I see two different markets, and one is in the sunbelt where people are investing in large-scale utility projects.
MR. MARTIN: Ed Fenster, there is a trade complaint pending in the United States against Chinese solar cell manufacturers. There is a possibility of large duties being imposed retroactively up to 90 days before a preliminary determination. The first preliminary determination is due in late March. How is the threat of duties affecting financing?
MR. FENSTER: We were very concerned about this in December and ended up placing a large order with a Korean manufacturer as a hedge against it. What we have seen happen in the marketplace is that the large Chinese manufacturers have developed enough capacity outside of mainland China that even if an enormous tariff is imposed, costs to
purchase those panels may not go up by more than a few cents because the solar cells will just be resourced to Taiwan or Malaysia. It is an interesting process. Certainly, it is very important for a US developer not to be the importer of record. I am not sure what the true economic incentive of the plaintiff was, but at this point, I do not see the threat of tariffs as a risk to US development.
MR. MARTIN: Here is my final question. What do you feel is missing among financing options on offer today in the market?
MR. WHALEN: I am surprised there has not been a combined debt-tax equity alignment.
MR. MARTIN: The tax equity investor should also be the lender?
MR. WHALEN: I am surprised nobody has married the two in some sort of combined offering. We end up in debates about forbearance agreements. I am surprised this hasn’t been packaged better.
MR. MARTIN: I have a feeling we will hear from people right after this panel because there are several tax equity investors who do both in the same deal.
MR. WHALEN: Sometimes two groups within the same institution are farther apart than separate institutions.
MR. MARTIN: Spoken like a former banker. You know the inside story.