View from the Executive Suite – August 2014

The ScottMadden Energy Industry Update | August 2014

Investment remains the dominant theme across the power and natural gas industries. Consolidation has been occurring in various sectors as well, although for different reasons.  Utilities remain relatively “under-consolidated” in comparison with other large, capital-intensive industries, although perhaps for unique reasons. Finally, some firms are looking at yieldcos as a master limited partnership alternative for renewable (and possibly “conventional”) generation investment. Read more below.

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  • Executive Summary
  • I Feel the Earth Move under My Feet The energy and utility industries continue to anticipate and react to potential fundamental shifts in the 100+ year-old model of investment, regulation, and earnings. Policy and regulatory changes are big factors driving the design of the new landscape. For many of these changes, significant investment in existing and new infrastructure is needed across all parts of the energy value chain. And by the way, load growth is no longer, so investment and cost recovery are uncertain.

  • CEO Themes: Messages to Shareholders
  • Sources: Company annual reports

Utility Mergers and Acquisitions: Various Sectors, Various Rationales

  • Note: *Rounded to the nearest $100M Sources: Industry news; SNL Financial; company press releases and investor presentations

  • Utility Industry Concentration Lags Other Capital-Intensive Industries
  • While utility consolidation continues, the sector lags other industries because of regulatory constraints and inherent local nature of energy infrastructure.
  • Note: Industry compilations based upon comparison of domestic (U.S.) companies with same NAICS codes Sources: Thomson Reuters; ScottMadden analysis

  • YieldcosA Fad or Here to Stay?
  • Sources: Latham & Watkins; Evercore; Gibson Dunn; Chadbourne & Parke; Bloomberg; FitchRatings; SNL Financial; industry news; company filings
  • Desire for Yield: Current low interest rate environment has investors looking for liquid, yield-oriented investments in diversified assets with stable, long-term revenues (e.g., power purchase agreements) Reduces Cost of Capital: Yieldcos ring-fence a project portfolio with a specific risk/liquidity profile and tax depreciation features. They are not commingled with other utility assets, thus lowering the risk premium applied to all Fill Gap for MLPs: Power generation assets do not qualify for MLP ownership, foreclosing a potential vehicle for yield-hungry power sector investors. Yieldcos can provide a structure to distribute cash from existing projects and solicit more cash to fund more project development Not as Tax Efficient as MLPs, But Close: Yieldcos are organized as corporations (vs. partnerships), so they are still subject to double taxation; however, this is offset by initial net operating losses and tax credits for early stage projects, and yieldcos throw off cash to investors while shielded from taxes during early years Retention of Control: Principal owners preserve a majority stake during the IPO, so they can offload some financial risk to outside investors and monetize operational assets but still maintain ultimate control No Development, at Least Initially: Typically, yieldcos do not develop projects, but right of first offer agreements with parent companies afford them growth opportunities Potential for Broader Application: Yieldcos have been established mostly for renewable asset development, but other steady earning assets could be amenable to being warehoused in a similar structure (e.g., transmission and distribution)
  • Selected Historical and Pending Yieldco Public Offerings

  • YieldcosA Fad or Here to Stay? (Contd)
  • Notes: *Incentive distribution rights provide for larger cash distributions to general partners that improve MLP financial performance as incentive Sources: *Latham & Watkins
  • Example Yieldco Structure NRG Yield (as of June 16, 2014)
  • NRG Energy, Inc. (NRG)
  • Public Stockholders
  • NRG Yield, Inc. (NYLD)
  • NRG Yield LLC
  • NRG Yield Operating LLC
  • Project Companies
  • Class B Common Stock 65.5% Voting Interest
  • Class A Common Stock 34.5% Voting Interest
  • Sole Managing Member 100% Class A Units 34.5% Economic Interest
  • 100% Class B Units 65.5% Economic Interest

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May we suggest:

The Energy Industry Update - Volume 16 - Issue 2

The energy industry is changing, and its regulatory and financial moorings are shifting. Competitive markets combined with other factors may lead to early nuclear unit retirement. Continuing changes in energy supply and demand patterns create a complex operation environment for electric utilities. Federal and state policy lines are beginning to blur as states have been increasingly intervening in FERC domain seeking favorable outcomes for their citizens and other local constituencies. In our Update, themed “As Yogi Berra Might Say…,” we look at the unusual picture drawn by the juxtaposition of these changes.

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