March 10, 2019 - 1:20pm EST by
Ray Palmer
2019 2020
Price: 14.50 EPS 0 0
Shares Out. (in M): 193 P/E 0 0
Market Cap (in $M): 2,800 P/FCF 0 0
Net Debt (in $M): 1,350 EBIT 0 0
TEV ($): 4,150 TEV/EBIT 0 0

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In early November, it became apparent that California utility PG&E had some exposure to the California "Camp Fire" wildfires. On January 29, this exposure lead PG&E to file for bankruptcy. As a regulated utility, PG&E's bankruptcy will surely be a wild affair as a variety of constituents (regulators, politicians, creditors, equity committee, etc.) will try to weigh in, and all will have differing agendas. One of the questions that will need to be addressed is "What happens to PG&E's Power Purchase Agreements (PPAs)?" Clearway Energy (CWEN or CWEN.A, disclosure: long both) gets ~23% of its revenue and ~33% of its CAFD (cash available for distribution) from PG&E via PPAs, so the answer to that question will have more than a little impact on CWEN. The market clearly believes the answer will be very negative for CWEN; since early November, CWEN shares are down ~25%, pricing in substantial value loss from the PG&E contracts. It's my belief that the market is overreacting to the uncertainty here, and in most reasonable scenarios CWEN will be made roughly whole on their PPA agreements (whether from PG&E accepting the contracts, or from CWEN getting becoming an unsecured creditor and getting paid out in full). As the PG&E bankruptcy proceeds and it becomes clear CWEN will be made whole on their PPAs, I expect CWEN shares will appreciate substantially (pre-Camp Fire, they traded for ~$20/share (versus today's ~$15/share price), which I think is a reasonable estimate of fair value).

Let's start with some background, as it helps think through why this company exists. Clearway used to be NRG Yield where it served as NRG's Yield Co (it was very uncreatively named). Yield Cos were a popular structure a few years ago. Investors were desperate for dividends, and energy / development companies like NRG had assets like utility scale solar (large solar plants that are plugged into the transmission grid) that had long lives and predictable cash flows through long term PPAs with investment grade utility buyers. The development company could set up a Yield Co that paid out the majority of its cash as a dividend and promised continued rapid dividend growth. Investors would value the company based on their growing dividend stream, creating an extremely low cost of equity capital, which the Yield Co could then use to issue equity and fund more growth projects, thereby continuing to grow the dividend and creating a virtuous cycle of equity raises and dividend growth (a simplified way of explaining it: dividend investors bid the companies way above NAV, so the companies could issue equity at above NAV to fund growth projects and constantly grow the dividend). The model generally looked something like this: Yield Cos would pay out most of their cash as dividends and promise high single digit annual dividend growth. Investors would price their equity at a ~4% yield, and the Yield Co would issue equity at that level to buy energy projects with long term contracts at ~10% levered yields. Rinse and repeat and the company could grow their dividend forever. The energy development company (the Yield Co's "sponsor") also benefited: they would get an attractive price for the assets they would sell ("drop down") into the yield co, they knew they had a buyer waiting in the wings for any project they developed, and they had massive upside from Incentive Distribution Rights ("IDRs") that let them keep a percentage of any increase in the Yield Co's dividend/share (p. 148 of TERP's 2017 10-K has a great example of how IDRs work, so I won't walk through it here).

As happens to all "crazes", the Yield Co craze eventually ended. The catalyst for Yield Cos falling out of favor was SunEdison's bankruptcy. SunEdison had been a major sponsor of Yield Cos (sponsoring both TerraForm (TERP) and TerraForm Global)), and its collapse (combined with lower oil and gas prices, which lowered the viability of solar and wind projects that were a major portion of the yield co growth engine, along with a slight rise in interest rates somewhat cooling the dividend growth craze) brought some fear to the sector. Once the Yield Cos stock prices went too low, they could no longer issue equity at prices that would allow for accretive growth and the "virtuous" cycle stopped. Still, as far as crazes go, the Yield Co mania had a fairly decent ending: the assets the company had bought were real and backed by real cash flow, so while investors suffered losses as the dividend growth investors fled and the equity prices collapsed from above NAV to relatively fairly valued (or even undervalued!), the losses weren't the complete shellackings that generally come with crazes collapsing. TERP, for example, generally traded for ~$35-40/share at the height of the Yield Co craze in early 2015 (while paying ~$1.30/share annual dividend and generating CAFD/share of ~$1.35) and today trades for ~$12.50/share (while paying ~$0.75/share dividend and maybe $0.90/share in annual CAFD (CAFD = Cash Available For Distribution)), and TERP was among the biggest losers in the group from peak to trough.

In the wake of the Yield Co collapse, the Yield Cos were left without much purpose. Without the ability to issue equity, they couldn't really grow as high dividend payouts / IDRs consumed all of their cash. Some savvy investors saw the Yield Cos had been left for dead and swooped in to buy them at rather attractive (IMO) prices (this article lists several of the deals). Under pressure from some activists, NRG shopped their Yield Co (NYLD at the time; renamed CWEN post deal) and renewable development arm and eventually sold them to  Global Infrastructure Partners (GIP) in early 2018 (note that the deal appears to have been pretty competitive). GIP hosted a call right after they closed the CWEN deal where they pretty clearly laid out their investment thesis: organically grow CWEN's CAFD through performance improvements and cost cutting while using the company as a platform to buy more assets at attractive prices. GIP also noted that the deal made them a major CWEN shareholder, and, given the lack of IDRs at CWEN, the way GIP would profit from their business plan was through growing the value of CWEN's shares (again, many of the initial Yield Co's IDR structure rewarded sponsors for dividend growth at basically any price, so GIP benefiting mainly from improving CWEN's share price results in unusual alignment for this sector).

It's worth noting that GIP is a very knowledgeable sponsor for CWEN. GIP is an infrastructure focused fund with >$50B in AUM, and they have plenty of experience with renewable energy, Yield Cos, and development platforms.

Of particular interest when considering CWEN is GIP's investment in Terra-Gen and GIP's sponsorship of Saeta Yield. Terra-Gen is a major domestic renewable energy developer / operator with significant exposure to renewable in California that GIP bought in 2009 and sold in 2015. Saeta was a renewable Yield Co focused on solar and wind in Spain. GIP bought a stake in Saeta in early 2015 and then took a portion of the company public. TERP bought Saeta for a large premium in 2018 (see stock chart below). I mention these investments just to highlight that GIP is not a vanilla private equity sponsor who bought a stake in CWEN simply because they saw a good price; GIP has significant industry experience and was clearly knowledgeable on the workings / valuations of renewable YieldCos from their time with Saeta (interestingly, they announced the sale of Saeta the same day they announced their investment in CWEN) and with the California renewable energy space (from their Terra-Gen investment).

Ok, that brings us pretty much up to speed. GIP closed their investment in CWEN in September. As recently as CWEN's Q3'18 earnings call on November 6th, CWEN and GIP were talking about using CWEN as a growth platform and all of the profitable drop down and acquisition opportunities they had. Then PG&E / Camp Fire happened.

What effect does PG&E's bankruptcy have on CWEN? PG&E is CWEN's second largest customer, representing 23% of CWEN's revenue in 2018 (as well as 16% of their accounts receivable at year end, though AR is small and the 10-K notes they've already collected). CWEN is projecting ~$270m in CAFD in 2019 (~$1.40/share) and ~$995m of EBITDA, of which PG&E represents $90m of CAFD (~$0.47/share) and ~$280m in EBITDA. PG&E buys energy from CWEN under long term PPAs, and CWEN makes clear that these PPAs are "higher than currently estimated market prices" (see p. 16). It's easy to see why the market would panic over losing the PG&E revenues: in a disaster case where PG&E rejects the PPAs and CWEN has zero recovery, a cursory look at CWEN's balance sheet (which carries ~$6B of debt) would suggest that CWEN is going bankrupt.

I think that's way too simplistic for a bunch of reasons.

  • First, CWEN is a holding company, and most of their debt is held at the project level and is non-recourse to the parent. Only $1.6B of CWEN's debt is recourse to the holdco, and in a disaster scenario where all of the PG&E projects are worth zero, CWEN could simply hand their lenders the keys to the projects and walk away from the ~$1.4B in debt attached to the projects and equity holders would be left with the rest of CWEN's portfolio (generating ~$0.93/share in CAFD this year).
    • In this scenario, it's also 100% possible that some of the projects would be worth less than their debt, but some of the projects would have some equity value / could sign up new PPAs that would allow them to continue to generate value for CWEN. So the disaster scenario where all PG&E projects are worth 0 is a truly remote scenario.