Analysis - Renewables valuations come back to Earth

News Analysis 17 April

Analysis - Renewables valuations come back to Earth

Developers and investors bringing US renewables assets and portfolios to market in late 2022 or 2023 cannot be blamed for expecting to be met with piles of cash. The previous year saw such opportunities – platforms in particular – spark bidding wars and sometimes sky-high multiples. Then in August President Joe Biden signed the Inflation Reduction Act (IRA), enacting a wish list of incentives for the renewables industry.

But instead of a boon, the market for these deals has cooled in the last six months, a wide swath of investors, bankers, and advisors across the industry told sister publication Infralogic. Buyers have tightened their belts, in large part because of rising interest rates as well as ongoing inflation and supply chain issues.

“It was a sellers’ market up until that point,” says one New York-based investment banker, referring to around the start of 4Q22. “It’s probably a buyers' market now.”

But sellers have been slow to adjust to this new pricing reality and have brought their deals to the market expecting something like the valuations seen eight to 12 months ago, several people spoken to for this article say. The result is a gap between what buyers are willing to pay and what sellers expect to receive, leading to a slowdown in M&A activity across the renewables sector.

The incentives of the IRA have only widened this gap. While the law created a slew of incentives for projects, there are still open questions about the details of the law’s implementation. This includes specifics regarding added bonuses for domestic content and projects in communities affected by the shutdown of a coal plant. While buyers are not ignoring the IRA, their assumptions regarding its implementation tend to be more conservative than those marketing assets would hope, according to several sources.

“I don’t think it’s made M&A easier,” another energy banker says of the IRA.

While it is hard to gauge the impact on valuations, this dynamic has certainly slowed deal flow. People in the sector speak of stalled-out sale processes, and platforms that were expected to come to market but have not.

According to Infralogic, 56 US-based renewables M&A deals closed in the period from 1 January, 2022 to 15 April, 2022, while 34 US-based renewables M&A deals closed in the same period this year.

Platform value

It was not long ago that it felt like a golden age when it came to demand for renewables assets, platforms in particular.

Among other transactions, Consolidated Edison [NYSE:ED] received 6.8bn from RWE [ETR:RWE] for its clean energy business in a deal that launched last spring. MEAG paid USD 300m for a 12% stake in Boston-based Longroad Energy in a deal that launched in early 2022. Brookfield Renewable [TSX:BEP] bought two platforms, Scout Clean Energy and Standard Solar, for USD 1bn and 540m, respectively. Origis Energy sold a majority stake to Antin Infrastructure for more than USD 1bn in late 2021; three years prior, a 20% stake in the company sold for just USD 38m.

But even then, there were ample reasons for hesitation. Chief among them was the rising cost and falling availability of supplies such as solar cells and modules, spurred by both economy-wide supply chain issues and the threat of tariffs and custom seizures of Asian imports. Inflation had also started to bite. Altogether, a longstanding trend of decreasing project prices, which allowed developers to ink PPAs and count on prices to drop by the time they began construction, reversed itself. By late 2021, developers were going back to their offtakers to renegotiate their PPAs.

By spring of 2022, meanwhile, it was clear that inflation was far from transitory, and that March the Federal Reserve began raising interest rates. The Fed raised rates nine times in a year, bringing the federal funds rate from .25% to 5% this March.

“These are fixed assets and the spread between debt and equity has gotten much tighter, which makes the returns on the projects much tighter,” Linea Energy founder and CEO Cassidy DeLine said. “That may not be at the forefront of a developers’ mind when they are thinking in terms of cents per watt of a development fee, but it does very much affect real project returns.”

The existing supply chain issues were already a concern for the industry; alongside inflation, the impact on project returns was heightened.

“The more the supply chain pushes delivery of your equipment out into the future, the more you are subject to the inflation bug,” says the energy banker. “They work together and they can erode returns.”

Market re-adjustment

By the fourth quarter of 2022, the M&A market had readjusted.

“Once inflation and interest rates started seeping in coupled with the supply chain, and now coupled with the volatility of the market [after Silicon Valley Bank’s failure] and everything else, I think that generally speaking things have slowed down quite a bit,” says the New York-based banker.

This shift was first apparent in the public markets, which saw IPO processes hit a standstill and valuations drop, according to the banker. Energy storage products and services company Fluence Energy, while not a perfect comp, has lost roughly 30% of its public equity value compared to trading levels at the end of 2021, before the Fed began hiking interest rates.

“At the end of the day, developers are high growth businesses and they’re not immune from some of the downturn that we’re seeing in other high growth businesses,” Patrick Verdonck, of Verdonck Partners, said in an interview. “Investors are probably dialing back some of their risk exposure.”

Moreover, the specific factors impacting the renewables industry, like higher EPC and capital costs for wind turbines, solar panels, and batteries, are adding to the changing dynamic. “What you are watching is new risk allocation, new pricing, higher discounts, lower premiums,” says the renewables banker.

One investor says that a host of processes expected to come to market have been delayed, perhaps because of market conditions.

“It could just be the usual delays on the sellside, but it is a bit interesting, I think, that all of these processes are delayed,” the investor says. “There is just a bit of hesitancy or caution by potential sellers because there is this uncertainty that people obviously are afraid that they are going to get way less than they expect.”

Sellers have sought to downplay the impact of interest rates, the investor says, noting that demand for renewable energy remains high.

“The IRA obviously helps but it's a bit naive to believe that people will just invest their money at the same rate of return as they did 18 months ago when interest rates were near zero,” he says.

The IRA has been widely called a game-changer for renewables, extending tax credits for wind and solar while creating new incentives for technologies such as standalone storage. What this means for the M&A market is unclear, however.

“IRA, while it has increased the value of your average project, it has also decreased the value of the electron that that project delivers to the grid because of the surge of renewables that we see coming into the grid,” said DeLine. “That is a dynamic that still needs to be processed by the industry.”

The industry is also still processing the impact of transferability of tax credits and has been awaiting details on domestic content requirements and what qualifies as an “energy community,” or a census tract eligible for an added bonus to tax credits. Key guidance on energy communities was just published this month, but some questions about which areas qualify remain unresolved, according to Norton Rose Fulbright Partner David Burton, a tax equity specialist.

“There was already a skepticism that buyers brought to the table that sellers didn't have,” says the energy-focused banker. “The IRA helps the seller to see even more value in these pipelines, and I think buyers continue to remain skeptical around the economic feasibility of these things.”

It’s not so bad

All this isn’t to say that the M&A market is dormant. Platforms and assets continue to trade hands – already this month, a subsidiary of Libra Group bought solar and battery portfolios from Saturn Power. And projects and platforms continue to come to the market. Greenbacker Renewable Energy Company, hep global, and Apex have all recently launched deals.

“It's not like [deals are] not going to get done. They absolutely will,” says the New York-based banker. “It's just that there needs to be a resetting of buyer and seller expectations of prices.”

Many see the state of the market 12 months ago as the anomaly, where, as the renewables banker puts it, “people were getting really big premiums for just bringing [stuff] to market that was really pretty half cooked.”

At the time, a renewables-focused managing director at one investment bank says, there was outsized demand for renewables platform.

“There were a ton of folks that were very eager and anxious to do a deal 12 to 18 months ago. And the folks that came to market were seen as very much in demand in terms of scarcity value,” says the managing director, describing the dynamic as asymmetric. “As more transactions occurred, as investors executed one or in some cases several deals, there is just a natural pulling back in terms of how aggressive folks were in the marketplace.”

Now, he sees a “healthy, functioning market.”

“We were starting from a place that was really a sellers’ market and where sellers could command the price they wanted,” said DeLine. “So I see it as a little bit more as a correction.”

For quality assets and platforms, there is still a healthy interest, says Dennis Tsesarsky, CEO and managing partner at boutique renewables bank Onpeak Capital.

“There continues to be strong interest in quality renewables and energy transition assets and platforms. Due to increased volume of potential investment opportunities post IRA and market volatility, top sector investors have been more selective,” Tsesarsky says. “As a result some situations with less robust fundamentals or less differentiation vis-a-vis peers have been taking longer to clear or not clearing.”

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