What happens when energy dealmakers, flush with cash, see a market with limited investment opportunities? The answer, increasingly, is to either accept lower returns, or channel some of Wall Street’s creative spirit to match big funds with bigger ideas.
To be sure, there is no shortage of non-public equity targeting power and renewables assets, consistent with the broader theme of abundant private capital chasing few opportunities. Financial and institutional buyers are thought to collectively oversee a pool of cash earmarked for energy deals well in excess of $125 billion, an unofficial estimate offered by industry participants who advise on power and renewables transactions.
By comparison, the combined market capitalization of power generators NRG Energy Inc., Dynegy Inc. and Calpine Corp. was roughly $9.2 billion, as of Dec. 28. The combined market capitalization of renewable developers and installers First Solar Inc., SunPower Corp., Sunrun Inc. and Vivint Solar Inc. was about $5.4 billion.
That unofficial figure does not account for cash that could be deployed, perhaps jointly, alongside publicly traded strategic investors, whose growth prospects from regulated operations may be tested as energy demand lulls, and macroeconomic pressures mount.
Yieldcos, especially those with management independent of their parent-sponsor, also represent buyers said to be re-entering the deal mix.
"At any point, it feels like there is four to five times more capital available than there are opportunities to invest it,” said Dean Keller, senior managing director for power, energy and renewables investment banking at Guggenheim Partners, whose team uses the $125 billion estimate as shorthand for the addressable market.
That could mean looking at opportunities abroad, like I Squared Capital did with its own $3 billion fund, agreeing to purchase Duke Energy Corp.’s Latin American generating assets.
But with a narrow list of worthwhile domestic competitive power and contracted renewables assets subject to healthy competition, buyers are forced to tap the debt markets, accept lower returns on equity or venture into riskier deals.
"The risk appetite for some institutional investors is definitely changing," observed K&L Gates partner Eric Freedman, who advises institutional clients on energy transactions.
While that new risk appetite among certain buyers may extend into contracted assets, it stops short of entering the scrum for competitive power portfolios tied to ongoing divestitures, even if capacity payments and hedging contacts have eased investor concerns.
The culmination of the year’s largest power portfolio sales points to a buy-side dominated by specialty private equity funds, including those managed by ArcLight Capital Partners LLC, Blackstone Group LP, Riverstone Holdings LLC and LS Power Group, who possess operations expertise, and a knack for securing debt on the backs of major buyouts.
In many ways, specialty power funds, particularly those with stand-alone operational divisions, have found major appeal with sponsors, amassing the capital needed to consistently rise to short-list of portfolio sales.
That might explain why Brookfield Asset Management Inc.'s most recent C$14 billion infrastructure fund was oversubscribed, along with what could be the imminent close of as much as a $15 billion fund managed by Global Infrastructure Partners, whose holdings include Competitive Power Ventures.
The value proposition of investing in power appears predicated on an ability to extract efficiency from scale itself, positioning private equity specialists as the main arbitrageurs of a dislocation in public and private valuations.
"It is important for players looking to invest in power or infrastructure assets to have as many tools in the chest as possible," said Lee Davis, CEO of Lightstone Generation LLC, the Blackstone-Arclight joint venture created to manage assets being acquired from American Electric Power Co. Inc. "We have tried to assemble a team that can operate in just about any market."
Negotiating fuel supply contracts, for example, may be one way to leverage a growing power portfolio, particularly in the absence of a major commodities price recovery.
Should sentiment around competitive power rebound, exit strategies contemplated by private equity, to include a public spinoff, would require critical mass of about 20,000 MW of combined capacity, one power and utilities equity analyst mused.
Where conventional power assets appear largely the dominion of private equity, demand for renewable assets among institutional buyers and less-aggressive funds is robust, and as a result, has compressed returns.
"Where you could make 10-12% unlevered returns five years ago, that same utility-scale project today with a quality offtaker puts you below 7% in unlevered returns," Roth Capital Partners Managing Director Jesse Pichel noted.
Those returns are a safe bet for institutional investors and some infrastructure funds, but do not pass muster with private equity, who are also hesitant to invest in development-stage projects.
"It is hard to justify putting money to work in a private equity sense when project level returns are 9%," Orion Energy Partners CEO Nazar Massouh said.
Finding an edge in the renewables market may mean forming loose partnerships with developers, akin to BlackRock Inc. and Southern Co. teaming with EDF Renewable Energy, or D.E. Shaw & Co. Inc. with First Solar and 8minutenergy Renewables.
Outside of development, the commercial and industrial market, as well as residential solar markets, appear fragmented, and encumbered by due diligence processes that lack for enthusiasm when potential investors learn that advisory legwork is similar to that of utility-scale projects, an observation offered separately by two senior deal advisers.
That may provide an opportunity for private equity, particularly around distributed generation.
"The private equity play is an aggregating first-tier or second-tier home solar companies," said David Crane, senior operating executive at Pegasus Capital Advisors, suggesting that once the proper business model sets up positive cash flow, strategic buyers, like utilities or even technology firms, may soften up to owning a share of the solar market.
As elusive as that business model is, a growing sense is that aggregating market verticals, namely commercial, industrial and residential scale markets, in a private capacity could push the market along.
The advent of a clearinghouse for commercial and industrial entities, who lack sufficient creditworthiness, is one possibility around aggregation contemplated by at least one corporate buyer, which could add much needed liquidity.
"Big black solar boxes that spit out cash, but without visibility on those drivers or risks, do not make successful public companies," said Darrell Crate, managing principal at Easterly Capital LLC , a private equity firm that is set to bring solar services aggregator Sungevity public in the coming year.