Exit multiple / Terminal Value for Operating Solar Project

Hi all, I'm being asked to model the levered and unlevered returns for a Greenfield solar project in LatAm. The project life IRR is easy of course, but I don't know what you all might recommend for how PE funds would look at a project like this in terms of exit multiples - the asset would be fully operating, fully contracted with an investment grade rated off-taker (note the project itself would be in a non-investment grade LatAm country) but project is fully in US$. 

I'm currently modelling that it an exit in Year 8 at 10x (unlevered) FCF, is that in the ballpark?

Thanks in advance for the help! 

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Comments (12)

  • Associate 3 in PE - LBOs
Oct 18, 2021 - 3:21pm

At least the way my fund has always looked at it, we relied on a next buyer's assumed lower cost of capital assuming they would hold to life.  So basically your exit value is NPV of cash flow from time of your exit until full depreciation of asset (solar asset should have ~35 year useful life). 6% is probably a conservative assumption for cost of capital. At the very least this is a good gut check against any sort of cash flow multiple.

  • Associate 1 in PE - LBOs
Oct 18, 2021 - 7:37pm

At an infra MF. This is correct. Exit Multiple method is unheard of for assets, usually only seen in platforms. And even then, the lower CoC method approach is also still used. 

One thing to note - although solar assets have 35 yr useful life, depreciation is not SL in the US, it's MACRS. So 95% of the depreciable value is found in the first 5 years. Not sure how it is in LatAm. 

I would also disagree with an exit in Year 8. If you're modelling out a lower cost of capital buyer they're not going to want to touch the project with a larger merchant tail relative to contracted period (so in year 8, maybe you have 7-12 years left of contracted cash flows). Think about who a low cost of capital buyer is - it'd be a pension fund or utility that is happy to just get yield and have the assets on their B/S. You're going to want to model an exit either flipped at COD if you're the one taking on dev. risk, or around op. years 3-5. 

Oct 18, 2021 - 9:26pm

Thanks for the feedback. 

Just so I'm clear, a private equity infrastructure fund that has a development group would not, as part of its IRR/MOIC analysis, make an assumption as to the value of the asset at sale based upon a multiple of FCF? That's helpful to know. But I will say that for non-investment grade LatAm, I'd assume WACC closer to 12%, with debt alone probably at 7.5% and equity far higher of course. 

RE: depreciation, it's 20 years SL. Taxation is advantaged b/c the asset in a free-trade zone. 

RE: timing of exit. I can asset different year, but in this case it's a 30 year agreement that's actually structured as a government to government agreement. Not a exactly a sovereign guaranty, but certainly a credit enhancement for a project in challenging part of Central America. 

RE: natural buyer, I don't know who has appetite for this country, need to canvas the market to find out...could be domestic pension funds, not sure about the big direct investors like the Ontario Teachers, CPPIBs of the world would look at investing in this country. 

  • Associate 1 in PE - LBOs
Oct 20, 2021 - 10:44pm

No, that doesn't make any sense. A project's cash flows are modelled out to the end of its useful life. Maybe you can have some residual value with land use rights (which can be 40-50 years and therefore extends for another ~10 years past the life of a solar project) but you could also make the argument that decommissioning costs are equivalent to that and call it a wash.

Think about this theoretically - the reason you project out value in perpetuity using DDM or slap an exit multiple in traditional corporate finance is to take into account a) long-run inflation and b) extraordinary growth beyond inflation via cost structure optimization, top-line growth and/or exit margin expansion via increased industry optimism moving forward. None of these factors are present in just a project that already has inflation-hedged contracts and no growth beyond the interconnection and foundation/turbines/panels/modules already in the ground.  

The main variable from one owner vs the next in owning an asset is their cost of capital. Public strategies should have lower cost of equity and pension funds have long-dated reserves. Therefore your multiple arbitrage in a sell-down stems purely from just that. 

Whether a PE fund has a development group or not is irrelevant because the project already exists. It's purely an operational / EPC / tech. optimization play after the project is constructed. The development group itself only comes into the conversation from the PE fund's POV by not having to go into the market and pay a higher CoC premium for a project that someone else constructs - if you're like GIP and you own Clearway, you have in-house development where you're fully absorbing the development risk there and being able to flip the project yourself or hold on & collect steady yield. 

And correct, the exit landscape is important to diligence. One important note is the size of the project - not sure what LatAm projects trade at but assuming CapEx build costs of $1000-2000/W, if the project isn't at least 100 MW you're not going to have any interested buyers of scale. 

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Oct 26, 2021 - 4:08pm

Thank you for the detailed reply, slow response as I've not checked this site in a while. 

I've asked for clarification, and the developer wants to sell the project 2 years post-COD (off-take agreement is 30 years.) Capex is ~$1350/W including interconnection costs. 

To be clear, you're saying an infrastructure private equity fund at an asset manager would take ProjectCo's levered free cash flows (for the remaining years of the project) and discount them using their fund's hurdle rate (be that 15%, 18% etc). That is essentially what they are willing to pay for ProjectCo. Correct? 

Oct 26, 2021 - 9:08pm

gdj2000

Thank you for the detailed reply, slow response as I've not checked this site in a while. 

I've asked for clarification, and the developer wants to sell the project 2 years post-COD (off-take agreement is 30 years.) Capex is ~$1350/W including interconnection costs. 

To be clear, you're saying an infrastructure private equity fund at an asset manager would take ProjectCo's levered free cash flows (for the remaining years of the project) and discount them using their fund's hurdle rate (be that 15%, 18% etc). That is essentially what they are willing to pay for ProjectCo. Correct? 

You would not discount by an 18% WACC for a solar project. Infrastructure funds have lower hurdles

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  • Associate 1 in PE - LBOs
Oct 27, 2021 - 1:39am

No, not really. Wouldn't think of it as a hurdle rate. Cost of capital and hurdle rate are not necessarily inter-connected. For example, I would think OMERS' cost of capital is different between their strategies (infra vs others) which is one of the reasons they have a distinction btwn groups in the first place, but I would think hurdle rates between the strategies are mostly the same. The way carried interest works is that LPs get first rights to dollars up to x% (the hurdle rate), and then returns are then split pro-rata allowing the GP to catch-up and getting their y% (20%, etc). AKA hurdle rate is just the minimum threshold for GP to start getting carried interest in terms of distributions.

Cost of capital is more similar to opportunity cost if we really want to get academic, but in reality regarding the institutional/private capital realm, it's usually a defined range of min. returns required by the LP (/ mix of LPs). In North America, cost of capital for pension funds is usually seen somewhere btwn 6-9% unlevered. Insurance funds are say, 100-200 bps higher with PE funds being around 250-300 bps higher on top of that (but on the flip side, PE funds are usually more sophisticated w/ use of leverage and therefore levered returns here can quite competitive vs their counterparts).

Your comment is a bit confusing. Why does CapEx matter if the developer is selling the project to you 2 years post-COD? Or if you're buying the project from the developer and taking on some development risk in helping fund the project, why does the developer's desire of when to sell the project matter? Are you coming in as a minority investor? CapEx at $1350/W for a renewables project in a LatAm country is not extraordinary from what I've seen. Would take a deeper dive into the underlying project economics here and diligence the technical aspects of it (generation, merchant curves, availability, curtailment, etc).  

To put this really simply, you should model out cash flows and then discount back using a returns range that your fund is comfortable with assuming hold to maturity. You would then assume that a 3rd party buyer comes in [5 years] from now where they purchase the project at a lower range - hence some cost of capital arbitrage. This will have somewhere btwn a 200-700 bps uptick on your hold-to-maturity return assumption because of a) timing re: cash flows are coming in quicker and b) the 3rd party buyer's NPV of remaining cash flows [5 years] from now is higher than what yours' would be. 

Oct 27, 2021 - 12:24pm

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