Shrinking venture capital and private equity are now making way for project financing in the renewable energy sector, according to an expert panel at a cleantech financing panel during San Francisco’s Cleantech Forum.
“Project finance is stronger – we’ve seen a lot of companies come back into the marketplace,” said Skip Grow, Morgan Stanley’s managing director of cleantech.
“The real pitch point there is really tax equity – so much of the project economics particularly in both utility scale and in the distributive market are driven by tax credits.”
Matt Maloney, Silicon Valley Bank’s national head of its cleantech practice, said the bank does not lend until credible institutional investors are involved in a project. The involvement of strategic partners is becoming a critical factor in the bank’s decision whether to lend or not – more so than several years ago.
“There may or may not be strategic involvement, but I think the business plan needs to incorporate what role the strategic [partner] is going to play and when. I’m not sure that was the case previously and certainly not in information technology,” he added.
Morgan Stanley’s Grow agreed. “[Strategic partners] are a critical piece of the financing puzzle. You could say they are probably the leading source of equity for a number of these companies.
“If, for instance, you need $100 million to build the first plant, there are very few [VC and PE] financiers to provide that. And so strategic [partners] have stepped in, filling the void,” he added.
Perhaps against expectations, venture capital and private equity remained buoyant immediately after the global financial crisis in 2008, but in the past couple of years those sources of capital have virtually evaporated. In the fourth quarter of 2012, they fell sharply to a total of $700 million, down from $1.7 billion in the same period a year prior.
“The syndicates that are involved are tiring [because] they made three fundamental errors: under-estimating capital intensity, and when we hit the downturn a few years ago that was clearly magnified; they underestimated the political and policy risks involved; and lastly they underestimated the global commodity dynamics” said Silicon Valley Bank’s Maloney.
Session moderator Jill Feldman, Chair of Morrison & Foerster the Financial Transactions Group, asked the panelists to explain what stage a project has to be in in order to be viable for an M&A transaction.
“Everything has to come together at the same time – financial close occurs simultaneously with a PPA [price purchase agreement] executed and signed and permitting is taken care of. That’s where we think the risk-return is optimal,” Morgan Stanley’s Grow said.
“If you are trying to sell or finance a project when it’s early pipeline, the risk-return [ratio] is 20 or 30 percent; that’s where it can get fairly expensive,” he added.
Ali Mirza, Head of Project Finance at Regenerate Power – a developer, financer, owner and operator of mainly utility-scale solar projects – warned that the process of attracting capital can be “very frustrating.”
Raising capital until you get a PPA is very challenging, but even after gaining a PPA, financial investors demand a security deposit to ensure that the project will perform.
He said a large amount of capital that was going to renewable projects is now going to shale gas, merely because of a more favorable risk-reward ratio. “[Shale gas] is a huge resource in the U.S. The investment is not necessarily going into finding reserves but into the pipelines.”
Falling costs in wind and solar have certainly reinforced the renewable sector’s appeal to investors. For instance, solar panel prices have fallen sharply across the world. Yet utility-scale projects are still proving difficult to get off the ground because of the difficulty in assessing what the cost of capital would be.
“There are still a lot of people bidding on these utility-scale projects, trying to look for and not only estimate what the tax environment will be, but estimate the cost of financing,” Morgan Stanley’s Grow said.
“Winning a PPA does not necessarily mean winning the mandate. Panel prices coming down is obviously one very favorable aspect from a project-financing point of view, but it isn’t making it that easy,” he warned.
Looking forward, members of the panel were confident the market would begin to benefit from financial innovation to fund both large- and small-scale wind and solar projects.
“One of the few bright spots in cleantech is lots and lots of discussion and innovation around yield play,” Morgan Stanley’s Grow said. “We’ll see examples of yield curves and securitization where cash equity component of a project will be syndicated – we’ll see it in utility scale, we’ll see it on the distributive side and in residential solar.”