Wind M&A: Market trends & transactional considerations

Wind energy market M&AUnderstanding trends in the wind mergers and acquisitions (M&A) market, along with various business, regulatory, tax, and project-specific considerations, is critical to achieving a successful deal in today’s competitive landscape.

Recent developments
The wind M&A market saw significant activity during the first three quarters of 2012. According to one market source, asset sales were up 15% year-to-date as compared to the 2011 year-to-date numbers through Q3. M&A activity seriously began to wane in Q4, as the December 31st expiration of the production tax credit (PTC) loomed last year. Ultimately, Congress extended the PTC for wind projects, which start construction by the end of 2013. This extension will prove a catalyst for increased development and acquisition activity. However, the Internal Revenue Service has yet to provide guidance on when construction is deemed to have started for the PTC extension.

Foreign and domestic independent power producers and utilities continue to be active buyers in the US wind market. In addition, institutional investors—particularly funds, insurance companies, and foreign pension funds—have emerged as active participants. Amid an environment of uncertainty, and with coordinated central bank easing and a low interest rate environment (US, German, Japanese, and UK 10-year yields are around or below two percent), these institutional investors frequently seek steady, higher yielding investments, with low correlation to traditional equity and debt investments. Accordingly, they are mainly interested in investing in operating or late-stage construction assets. Because wind investments tend to have low operating and fuel costs, return profiles can be fairly predictable and attractive.

Sellers are coming to the market for a variety of reasons. Certain developers, as a part of their strategic plan, are selling development and construction-stage wind projects to long-term buyers. In response to continued Eurozone fragility, some European-based parents are shedding US assets to strengthen their balance sheets. At the same time, some larger companies are looking to exit non-core business areas through wind asset sales. Turbine manufacturers are also expected to be a source of continuing M&A activity, motivated by finding projects and markets for their turbines.

The wind power market remains competitive and challenging, currently favoring developers who are able to maximize project economics. Many high-wind areas of the country are power purchase agreement (PPA) or transmission-constrained environments. Plus, the ongoing low price of natural gas, which competes as a generation resource, hampers sustained development.

Tax equity trends
Tax equity is frequently an essential part of the project capital structure. There was an estimated $5.3 billion in tax equity investments in 2012, and wind received $2.5 billion of that total amount. Most wind projects utilize the PTC.

Solar energy projects factor into the overall tax-equity outlook. The Treasury cash grant, in lieu of investment tax credits (ITC), only remains available for solar projects that met the “start of construction” criteria by year-end 2011. Solar projects not meeting this requirement will need investors willing to utilize the ITC—typically a large balance sheet investor. This need for solar tax-equity will increase competition for tax-equity demand overall.

The traditional tax equity pool in the US, which consists of around 30 investors, might not be large enough to serve increased demand, causing more expensive pricing. New tax equity investors, such as tech companies, utilities, large industrials, and integrated oil companies could, therefore, play a bigger role in the coming years to meet the demand for tax equity. Evidencing this trend, a small number of non-traditional tax equity investors committed capital to projects in 2012. However, it’s unclear whether 2013 will be the year these players make more significant investments, given the relative illiquidity and complexity of tax equity investments, and constant uncertainty caused by on-again/off-again US energy subsidy policies.
 
Transactional considerations
Buyer and seller trends in the wind M&A marketplace, coupled with the dynamic nature of the tax equity market, elevates the importance of optimal transaction structuring and diligence. On the seller side, structuring a transaction requires attention to sponsor motivations. Some sponsors prefer to retain a minority equity stake in a project, whereas others look to sell entire projects.

At the development stage, the timing of a sale can create different valuations and attract different types of investors. The purchase price could be structured as an asset sale, or as a sale of project company membership interests, depending on a number of different considerations. The allocation of liability for project-specific risk and credit support are crucial considerations during early-stage negotiations. Other key contractual provisions must be analyzed closely, including: indemnification; representations and warranties (and their survival following closing); closing conditions; consent rights prior to closing; and the transfer requirements for permits and key contracts.
    
On the buyer side, diligence cannot be underestimated. Key considerations include: permitting; transmission; interconnection; project contracts; and real estate. A buyer should closely analyze change of control considerations, as well as management considerations, such as voting rights and ongoing project management.

In addition to business concerns, parties must grapple with a variety of tax and regulatory considerations. Buyers of construction or near-construction stage projects should engage with the tax equity investor or project lender and the seller at an early stage. Parties should consider the implications of a 708 termination if 50% or more of the profits and capital interests in a partnership holding the project company are transferred within a 12-month period. Such termination would result in a re-start of the depreciation period for project company assets. Investors should also consider recapture considerations, stretched depreciation, and the use of blocker corporations for foreign entities. Pension funds require special attention, as co-investment in projects employing tax equity can pose critical tax issues for non-taxable entities.
    
On the regulatory side, dealmakers must consider applicable requirements to file with federal agencies, such as the Federal Energy Regulatory Commission (FERC) and state and local energy authorities, as a condition to closing the deal. For foreign in-bound investors, Committee on Foreign Investment in the United States (CFIUS) clearance is advisable. Filing with CFIUS is voluntary, but failure to file potentially opens the transaction up for future divestiture. Pursuant to CFIUS recommendations following a transaction closing, President Obama ordered a Chinese firm to divest itself of recently acquired Oregon wind projects, apparently because of the project’s proximity to a military flight training range. This CFIUS review and subsequent order demonstrate the risk in forgoing a filing with CFIUS and request for clearance before consummation of the transaction.
    
Institutional buyers raise unique coordination issues regarding tax equity. Tax equity investments are typically structured to provide investors a preferred rate-of-return until a pre-determined internal rate-of-return is achieved. This structure can conflict with the institutional investor’s need for a cash-on-cash return. Transfer limitations, driven by tax laws and traditional project partnership agreements, also make investments like these less liquid than some institutional investors prefer. Given such constraints, many institutional investors, especially pension funds, might favor projects at or near the partnership flip stage of a project, when the tax equity investor is exiting the deal.  

The future
The coming year should be another active year for buyers and sellers of wind projects. The PTC requirement for commencement of construction by December 31st, 2013, will drive transaction timing. New players and non-traditional purchasers will be active on the acquisition and financing side. As always, careful transaction structuring and diligence is critical to any successful wind M&A transaction.


Paul Zarnowiecki, partner, and Christopher Gladbach, managing associate, are both based in the Energy and Infrastructure Group at Orrick, Herrington & Sutcliffe LLP in Washington, DC.

Orrick, Herrington & Sutcliffe LLP
www.orrick.com
 


Author: Paul Zarnowiecki & Christopher Gladbach
Volume: March/April 2013