David Tepper (Trades, Portfolio) of Appaloosa Management isn’t a letter writing type of guy. The fact that he sent out an open letter to the board of TerraForm (TERP, Financial) is very surprising. It isn’t a letter demanding change but a letter stating his concerns about TerraForm’s strategy and its relationship SunEdison (SUNE, Financial), an important position of David Einhorn (Trades, Portfolio)’s Greenlight Capital.
The relationship between SunEdison and TerraForm Power is like a developer and a real estate management company. SunEdison develops and sells energy projects while TerraForm Power owns and holds power generation assets.
SunEdison often sells completed projects to TerraForm Power, referred to as dropping down assets. The former company is an agressive growth company (or at least it was until recently), and the latter is a stable high yielder. Their cooperation allowed them to operate with a more efficient capital structure.
Initially Tepper agreed with this strategy:
Until recently, TERP's business purpose was to act as a vehicle to hold and finance a high-quality portfolio of fully developed wind and solar power assets that were supported by long-term power purchase agreements with large, investment-grade corporate counterparties. Isolating these projects within a ring-fenced vehicle made sense for both TERP and SUNE, as the most efficient cost of capital could be obtained by segregating them from the operational, developmental and construction risks of SUNE's main operating businesses.
But recent deals have soured him on the cooperation as he views these as SunEdison dropping down low quality assets to shore up its balance sheet (emphasis mine).
The July announcement of the acquisition of the Vivint Solar (VSLR, Financial) portfolio of residential rooftop assets marks an unfortunate departure from this business model and appears to serve the sole purpose of promoting SUNE's desire to acquire VSLR's development and operating assets rather than enhancing the quality and value of TERP's holdings. Indeed, the shift to weaker counterparties (homeowners) and the higher risk profile inherent in these assets (small rooftop panels) also appears to disproportionately benefit the sponsor's incentive distribution right at the expense of significant downside financial risk to TERP. Worse yet is SUNE's stated intention (revealed through the release of an Interim Agreement between SUNE and TERP) to place 500MW per year of these inferior assets in TERP for the next five years.
The last sentence of the above paragraph is a key one in this letter as I suspect Tepper wants to raise awareness of how detrimental this would be to TerraForm Power and would like to stop it although he does not explicitly demand it.
Additionally Tepper is skeptical of the value of the reconfigured Invenergy transaction to TerraForm stakeholders (emphasis mine):
The reconfiguration of the lnvenergy transaction announced Nov. 9 is no better for TERP stakeholders and is obviously intended for the sole benefit of SUNE. These modifications will hand off SUNE's responsibility for a $388 million equity warehouse commitment to TERP – yet another departure from TERP's traditional role of owning permanently financed, income-producing assets. The investment also strains TERP's resources and significantly raises its leverage and financial risk profile.
Tepper believes TerraForm Power’s stock price getting hammered is the result of taking on these subpar projects, and he questions these business decisions.
He can't do much about the assets that have already been acquired, but it is possible this letter is a first step toward preventing this business from continuing. It is also a first step toward making changes happen at the board level although that possibility isn’t raised by Tepper:
Thus, it is obvious that the deterioration in TERP's security prices and credit profile this month results from (among other things): (1) the transmission of financial stress related to its sponsor's ambitious growth objectives and overextended financial commitments; and (2) TERP's incomplete and selective disclosures. TERP's "reliance on third party acquisitions" has little bearing on either of those factors. We note the advertised increase in the number of independent directors on TERP's board and trust that the Corporate Governance and Conflicts Committee (the "Conflicts Committee") will appropriately investigate these and any other related-party transactions to ensure that they are conducted for the benefit of TERP stakeholders.
It is hard to see how the market assesses Tepper’s letter as both SunEdison and TerraForm Power are sharply up, but the premarket announcement that SunEdison is not going to pay $250 million for a 16% stake in the Brazil Renova project (which would be subsequently sold to TerraForm Power’s emerging market sister company TerraForm Global [GLBL]) confuses the issue.
It looks like TerraForm Power is up mainly because of Tepper throwing his weight around. TerraForm Power trades below 0.5x book value, its trailing 12-month yield is more than 18%, and its forward P/E iw around 19. More problematic are the $250 million in EBITDA and $2.5 billion of debt. Currently it is up about 30% premarket in response to the letter.
