Tax Equity in Renewables
Hey everyone, don't go by my title. I work at an IPP in their investments team as a Manager. I am familiar with tax equity on a project level, but am trying to figure out its impact on an asset / company level. I was going through NextEra's filings, and I can't figure out a few things:
Should tax equity be considered a debt (I know it gets classified as VIE) and how do you factor it into the Enterprise Value calculation? Do you just add the tax equity investment to the EV calculation?
Separately, but also kind of relatedly, I know in greenfield projects, sponsor/developer usually funds projects with a combination of tax equity and back leverage debt, the latter of which is considered non-recourse. I know what non recourse means, but I still want to confirm that for the purpose of calculating Enterprise Value, whether we still add this non recourse debt to the total debt outstanding?
A lot of good sources out there on how to model tax equity on a project level, but I haven't found anything that talks to on how to evaluate a renewable company (asset) that has tax equity and other kinds of debt embedded into it.
Would love to hear from P&U guys on the forum...
Bumping this
If someone has an explanation, can they please explain in a simple way, and maybe with an illustrative example with numbers?
Bump
Bump
Not US-based so I won't touch tax equity, but
Curious on the reasoning here - why wouldn't you? Non-recourse just means the debt is tied strictly to the asset not to the sponsor, it's still going to be part of the debt burden unless the sponsor walks away entirely from the asset giving up all equity in the process.
Bump
Commenting to follow.
Can’t say I’ve really looked at public filings, but I’d imagine that the existence of back-leverage at a project level would not show up in the public filings for the parent. To your point, this is non-recourse, meaning a liability for one of say NextEra’s wind farms wouldn’t be a liability for the NextEra corporate entity. Similarly, the tax equity partnership that owns the project sits below the parent entity that files publicly.
I could be generally off. Would be interested in hearing someone else more experienced chime in
reach out to [email protected]. he says he will explain it to you. finance professor at NYU and columbia
They literally offer a walk through of this on their website
https://www.investor.nexteraenergy.com/~/media/Files/N/NEE-IR/investor-materials/supplemental-resources/supplemental-presentations/tax-equity-partnerships-differential-membership-interests-vf.pdf
The problem with tax equity is that the investors want the structure to be as close as possible to a debt while still availing themselves to the tax benefits linked to an equity structure. You'd be excused to take quite different perspective on this instrument depending on whether you take an accounting, tax or corporate finance view.
As others have mentioned, non recourse debt is still debt, both at the project company and at the (consolidated) parent level.
You evaluate such asset by modelling out the cash flows to each segment of the capital structure - the tax equity investor, lenders and then remaining distributions to equity (i.e. FCFE).
Tax equity partnerships only exist at the project partnership level, why would they have an effect on the sponsor’s (i.e., NextEra’s) EV?
Unsure about the modelling implications but the below explains the structures and how they are meant to work. Perhaps with that information you can figure out the best approach. High level, I would expect it to be part of EV.
https://www.projectfinance.law/publications/2021/december/solar-tax-equ…
https://www.projectfinance.law/publications/2021/december/solar-tax-equ…
I work within renewables IB. I typically think of tax equity as a specific type of preferred equity, so to briefly answer your question, yes, it increases the enterprise value of the project and the parent company. We typically look at a valuation for a greenfield asset at COD as tax equity, plus debt, plus equity where the tax equity portion of the capital stack is equal to the tax equity investment. The tax equity investment can be determined a few different ways depending on the structure, but fundamentally, it is the NPV of any cash flows to the TE investor (typically small relative to the size of the investment), plus tax benefits from the investment tax credits (ITC) or production tax credits (PTC), plus tax benefits from income/losses (mostly losses due to high depreciation during the investment term). You can then add the value of any debt and common equity to get the enterprise value of the project. For the parent company, tax equity is still a source of capital, just at an entity below the parent, so you could value the equity of the company, then add any debt and tax equity that is at the parent or project level to arrive at the enterprise value of the company.
Thanks! You mentioned initially that when youre doing valuation at COD, you include the Tax equity original investment amouny as portion of the enterprise value dedicated to "tax equity". But later you mentioned that you do NPV on future value to tax benefits. If you do the latter, then your tax equity amount to be added to EV would be arguably higher than the original tax equity investment amount because the former factors in the TE investor's expected return. Can you please expand on this point?
After COD, the value of the tax equity would actually drop substantially if it’s using investment tax credits because they are recognized at COD and are usually a substantial part of the value. After the ITCs have been recognized, the value of the tax equity investment is only driven by any cash or tax benefits from income loses that the tax equity investor keeps receiving. For production tax credits the value of the investment would fall more linearly as you approach the end of the investment tenor because PTCs are recognized over a 10 year period.
This whole question around EV is a bit miscalibrated - what really matters is what purpose you are trying to think about EV for. Depending on what you are trying to accomplish, there are a few different ways you could go. Generally speaking, you care about EV because you're trying to calculate some kind of valuation metric, like EV / EBITDA, but I could imagine wanting to find EV for other reasons as well. The key, in any situation, is to make sure that everything you are looking at is on an apples-to-apples basis.
So, to start with, let's think about non-recourse debt at the project level. It is correct to say that the benefit of non-recourse debt is that the parent and other subsidiaries are not responsible for that specific project's debt. In other words, the entity is "bankruptcy remote" and if that single project fails, it's not cross-collateralized by other projects or by the larger business' cash flows. All of that really has no bearing on whether you should consider that debt part of EV though. From a purely theoretical perspective, the "total enterprise value" should include the project level debt. However, as I alluded to above, you're usually getting EV for the purpose of calculating an EV / EBITDA multiple. In that case, what you really care about is how you are calculating your EBITDA. If you are fully consolidating the project's financials into your EBITDA, then you should include 100% of the project-level debt in EV to keep things apples-to-apples. If you are not consolidating to calculate EBITDA, and you are just recognizing a non-controlling stake equity interest (which captures post-debt-service profitability from the project), then you should not include the project-level debt in EV. The key question, in either case, is what financials from the project you are reflecting in the metric you're calculating, and then let that flow through to how you treat the debt for EV (for example, I could imagine a bespoke EBITDA that captures proportional EBITDA from projects based on ownership stake, which would suggest also including your proportional ownership of the project debt).
Okay, now let's talk about tax equity. Tax equity is weird, because it is a unique form of capital that is enjoying the benefits of tax attributes that would not benefit the owner of the rest of the project's equity. Now, let's think about that in the context of EBITDA. EBITDA is a pre-D&A, pre-ITC, pre-PTC figure - in other words, it doesn't include any of the benefits that tax equity is paying for. So based on that apples-to-apples principle, it would not make sense to include tax equity in EV if you are trying to calculate EV for the purpose of an EV / EBITDA multiple. Of course, tax equity is still representative of capital that was put into the system to fund project construction, so if instead your purpose in calculating EV was just to try and get a marker on how "big" a company is, I could see an argument for including tax equity. The challenge, as alluded to by someone else above, is that you're probably not going to have the information necessary to actually amortize the tax equity as it receives return of capital and return on capital. So in practice, I've never seen anyone include tax equity in EV.
Long story short, for all of these questions, you should always be making sure you understand what question you're really trying to answer, and that all of the figures you use are apples-to-apples.
Agree on the debt part.
On tax equity, have seen models from banks as part of M&A process, where they include tax equity in the EV calculation. This makes sense because a certain portion of cash benefits (EBITDA - Interest - Change in WC - Taxes - Maintenance Capex) are also allocated to tax equity both pre flip and post flip. And so when you're calculating EV/EBITDA, you should include tax equity because you as a sponsor (as well as back-leverage lender) are not getting 100% of EBITDA, maybe 80% of it pre flip, and 95/99% post-flip.
Thoughts? Also, if you don't mind me asking, what's your role/job?
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