SunEdison: Solar-As-A-Service & The YieldCo Model
SunEdison, one of America’s largest solar energy companies, has used extensive vertical integration to ensure quality and reduce costs. However, a recent misalignment of strategy and operations have caused investors to flee.
The Business Model
SunEdison (SUNE) was founded in 2003 by clean energy entrepreneur Jigar Shah, who envisioned a revolutionary solar-as-a-service business model that required little capital up-font and allowed commercial customers, such as retail outlets, government agencies and utilities, to pay as they saved on energy bills. This was done through securitization of long-term electricity contracts called purchase power agreements (PPAs) and led to a quadrupling of installed solar capacity from 2010 to 2015. In 2009, SunEdison merged with semiconductor company MEMC Electronics and refocused on developing and applying advanced solar technologies.
Currently, the company has three principle business segments that span the solar energy value chain. At one end, they have a silicon wafer manufacturing segment (called Semiconductor Materials) that produces silicon wafers for solar energy systems, as well as consumer electronics and other products. At the other end of the chain is SunEdison’s controversial “YieldCo” investment vehicle called TerraForm Power (TERP), which owns and operates energy generation assets (often purchased from SunEdison itself) and sells electricity through long-term power purchase agreements (PPAs) in order to pay a reliable dividend to investors. In the middle is the Solar Energy segment, which is develops, designs, installs, and services solar energy projects.
Minimizing costs is the key competitive metric in the commoditized energy business and competition along these segments is fierce. In the U.S., SunEdison competes with large renewable production and development companies NRG, NextEra and Solar City. Internationally, established Japanese and Chinese manufacturers such as SUMCO, Shin-Etsu Handotai and LG Siltronic, face off with SunEdison in the silicon wafer segment. In 2014, these companies flooded the market for solar PV modules and greatly depressed prices.
The Operating Model
SunEdison manages over 700 plants in more than 25 countries worldwide and remains one of the few solar companies that is truly vertically integrated from silicon processing to plant development, maintenance and servicing and, ultimately, to financing and securitization. This vertical integration is designed to afford several advantages to the company. First, having a silicon manufacturing segment lowers procurement costs at the project level and gives SunEdison better visibility into quality. Second, at the opposite end of the value chain, the practice of spinning projects into a YieldCo raises investment demand and lowers the cost of capital.
Specifically, the YieldCo model changed the way investors could gain exposure to clean energy, offering a high-dividend, pure-play wind or solar investment and attracting two types of investors that had not been interested before: income-seeking and socially conscious investors. Prior to this, wind and solar projects were retained on companies’ balance sheets with profits tending to be reinvested into new development, minimizing the dividends available to investors. Otherwise, they were mixed into funds with other types of conventional energy generation, such as coal, natural gas and nuclear, which precluded the pure-play clean energy investing.
A Misalignment of Operations and Business Strategy
SunEdison enjoyed meteoric stock price performance from 2012 to June 2015, rising 623% from $4.00 to $29.59. However, investors recently soured on the company due to a perceived a shift in business strategy that undermined the operational model of offering high-yield, stable returns to investors. This resulted in the stock falling to $3.92 in the fourth quarter of 2015.
The catalyst for this decline centered around SunEdison’s $2.2 billion acquisition of Vivint Solar in July. As analysts saw it, this deal marked a significant shift in business strategy for SunEdison. Rather than coming the stable long-term utility power contracts, Vivint’s revenue came from residential rooftop solar leases for homes across America who were deemed as much less creditworthy. This caused a domino effect in which the stock price of SunEdison’s YieldCo, TerraForm, plummeted, which reduced its ability to take on new projects from SunEdison, raising the company’s cost of capital and lowering its profitability. Activist investors went so far as to claim an inherent conflict of interest between TerraForm and SunEdision with TerraForm serving as a repository for SunEdison’s junk deals.
In fact, the Vivint deal followed a series of structural shifts in the company, in which it spun off its silicon wafer processing segment, regressing away from vertical integration, and went on an aggressive acquisition binge. These dramatic changes in its business strategy ended up undermining the company core competitive advantage and created misalignment between the business and operating model.
Sources:
Saania Malik. “Overview of SunEdison—An Outperformer in the Solar Power Industry.” Market Realist, Available at: http://marketrealist.com/2015/07/sunedisons-solar-energy-business-strategy-cost-control/
Cassandra Sweet, “SunEdison, Shares Fizzling, Promises a New Strategy.” The Wall Street Journal, Oct. 7, 2015. Available at: http://www.wsj.com/articles/sunedison-shares-fizzling-promises-a-new-strategy-1444230335
Louis Berger, “What You Need to Know About How Clean Energy YieldCos Work.” GreenTech Media, July 10, 2014. Available at: http://www.greentechmedia.com/articles/read/what-you-need-to-know-about-how-yieldcos-for-clean-energy-work
Great blog, Jeff. Very clear and shows your understanding of the space quite well.
I just wonder what the motivation for SunEdison’s major shift in business strategy was and whether, in addition to misalignment, there was miscommunication between the business and its investors. Did SunEdison believe that their growth was capped by exclusively serving the utility market? Did their extensive vertical integration allow them to de-risk some aspects of the residential solar market? I’ve got to believe that SunEdison management had some reasoning behind their change in focus and acquisition of Vivint – why did investor seem to see it so differently?
Great post, Jeff – had not fully understood their previous level of vertical integration; impressive how much value that symbiotic structure was able to create.
We were pitched on all sorts of solar development companies over the last two years and toward the end of my time, it really started to feel like a mini-version of the housing crisis. Folks were talking purely in terms of origination volume for residential and small-complex contracts and emphasizing that the next logical step was securitization of “subprime residential agreements”. Through the actions you described, it sounds like SunEdison might be setting itself up to be a power broker in that market – drawing parallels to the New Century Financial case, you have to wonder if it is trying to access growth in a way that may end up with runaway negative externalities; either way will be really interesting to see how it plays out.
Excellent post and very timely! In fact just in the past week the Vivint deal is back on the table at a reduced price to the original proposal. I have gone back and forth about what this means for SunEdison. Ultimately I feel it is a positive for both companies. SunEdison can use synergies from its manufacturing business to reduce the cost of Vivint to compete with SolarCity. The residential solar market is also growing extremely fast – an opportunity hard to miss even if it does result in a large increase of debt on the balance sheet. The YeildCo model offers an interesting dynamic to this as lower quality assets (nature of the residential solar business) will now be funneled through to investors.
I also agree with Will that this does sound largely like the events that led up to the housing crisis, just better managed – I hope.
It will be interesting to see how these entities (YieldCo’s, MLP’s, etc.) in the energy space (solar and even mid-stream oil) will play out.