Participants

Mike, President and CEO of Pattern Energy Group (PEGI)

Nate Abercrombie, The Stock Podcast

Interview Transcript

Nate:         Hello, and thanks for tuning into the IWTB podcast. Our guest today is Mike Garland, president, and CEO of Pattern Energy, ticker symbol PEGI, and more commonly called PEGI. Pattern is a wind energy company and commonly referred to as a yieldco. Yieldcos are a fairly novel type of company. They are very similar to MLPs in that they own and operate infrastructure assets and they pay out most of their cash flows to investors in the form of a dividend, hence the yield in yieldco. Similar to drop down MLPs, many yieldcos fund growth projects by issuing shares or equity to purchase an operating asset from a related party. But the biggest difference between MLPS and yieldcos are the assets they own. While MLPs are primarily oil and gas infrastructure, yieldcos primarily own renewable energy assets.

Nate:         PEGI was one of the first publicly traded yieldcos in the US, with an IPO in 2013. PEGI is one of the largest independent owner/operators of wind energy assets in the US and Canada. Just recently, Pattern announced a big entrance into the Japanese market with an acquisition. Pattern owns 2.9 gigawatts of generation capacity. To put that number in perspective, if all of PEGI’s generation was operating at full capacity, Pattern could put Doc Brown’s DeLorean through time almost two and a half times.

Doc:          “But I need a nuclear reaction to generate the 1.21 gigawatts…. 1.21 gigawatts. .21 gigawatts. Great Scott.”

Marty:       “What the hell is a gigawatt?”

Nate:         Yeah, that’s right. If you got that Back to the Future reference, I’m talking to the right people. In all seriousness, the general rule of thumb is that one gigawatt of generation capacity is roughly enough to power 700000 homes. Denver County, where I live, has about 311000 houses. So Pattern’s 2.9 gigawatts of generation, operating at full capacity, could provide enough power for all the houses in 6.5 Denver counties. Suffice it to say, that’s a lot of electricity.

Nate:         It’s probably important to provide a little more detail about the yieldco model and how the model became broken a few years back. If you look at Pattern Energy’s corporate structure, you’ll see that PEGI is 92% owned by public investors and 8% owned by Pattern development. You’ll learn more about this in the interview, but one needs to think of Pattern Energy is the owner/operator of assets and Pattern Development as the company that takes all the risk in getting a wind energy facility from concept through construction.

Nate:         Pattern Development essentially gets a project across the finish line and then sells the project or wind facility to PEGI. So when you hear backlog or development backlog, that’s in reference to the total number of gigawatts Pattern Development currently has in the race. Based on the most recent investor presentation, backlog consists of about 10 gigawatts of total capacity and about one gigawatt earmarked for potential sale to PEGI.

Nate:         Most yieldcos work in a similar way. A few years back, a company called Sun Edison, which was also a yieldco sort of. It owned two other yieldcos called Terraform, and I think it was Terraform Global, became the poster children for renewables in yieldcos. The management team targeted massive growth targets. Sun Edison’s stock price went from about $2 a share in 2012 to $32 a share in 2015. That was the year everything fell apart.

Nate:         Investors started to realize that they didn’t know everything they probably should know about Sun Edison and the company eventually filed for Chapter 11 in April of 2016. The whole story is complex and involves some pretty shady deals from what I understand. Hopefully we’ll see a business case or even a documentary someday soon. But the big picture is that the negative publicity and super negative investor sentiment for yieldcos affected the entire space. Leverage or debt levels draw a lot of investor attention, and rightly so, because it’s one of the biggest risks when you’re making an equity investment.

Nate:         But investor attention on leveraging debt in the renewable space quite possibly became a little bit of a distraction, depending on how you look at it. And growth is a big concern now, given the uncertain policy outlook in Washington. And the other big concern is the inability, or at least the perceived inability, to fund growth when equity issuance may not be feasible given the extremely high cost of equity in the yieldco space.

Nate:         But not all yieldcos are alike. That’s why it’s a real pleasure to have Pattern’s Mike on the program to talk about Pattern’s business model and the outlook for the industry. But before we get to the interview, let’s hit on high-level financials, industry terms, and [cell 00:06:42] side ratings.

Nate:         PEGI’s share price, as of this recording, was almost $18 a share. Market cap is about $1.7 billion cash on hand, a little over $100 million. Total debt of about $1.9 billion and a minority interest of about $1.3 billion. This results in an enterprise value, or an EV, of about $4.8 billion. PEGI pays a dividend of $1.69 per share, which means the dividend yield is 9.4% today. You’ll hear more about the dividend during the interview, but PEGI’s board made the decision this past quarter to keep the dividend flat after increasing it about 35% since the IPO in 2013.

Nate:         Consensus estimates for 2018 aren’t super helpful, especially after you hear Mike talk about using multiples like EV to EBITDA for a business with so much going on on the tax side of things. But it might be helpful to know that management has provided CAFD guidance of $151 to $181 million. If you’re wondering why the range is as wide as it is, keep in mind that we’re talking about wind energy and you need the wind to blow in order to make money.

Nate:         The midpoint of guidance is $161 million, resulting in a CAFD yield of 9.8%. If you’re wondering what CAFD is, you may recall the acronym DCF from the previous interview. Yieldcos have their own term for basically the same metric. This is CAFD, which stands for Cash Available For Distribution. You’ll also hear the acronyms PPA, PTC, ITC. These are all pretty wind or renewable specific. PPA stands for Power Purchase Agreement and it’s essentially a contract that allows a wind facility to sell production at a certain price. These agreements or these PPAs are anywhere from 10 to 25 years long. PTC stands for Production Tax Credit. ITC stands for Investment Tax Credit. And just keep in mind that the PTC is more specific to wind and the ITC is just a little bit more specific to solar.

Nate:         And then lastly, you may hear the term ROFO. ROFO stands for Right Of First Offer, which basically means that Pattern Energy has first dibs on buying an asset that Pattern Development would like to sell.

Nate:         The Bloomberg Terminal includes ratings and recommendations from 14 sales side analysts, with nine of the 14 having buy ratings on PEGI’s stock. The average price target, including neutral rated or cell rated analysts, is $22.25 a share. With all that covered, let’s get to the interview. I hope you learn something and I hope you enjoy.

Nate:         Mike, I can’t say thanks enough for coming onto the program. Getting management teams to agree to an interview hasn’t been the easiest task in the world, and you said yes and I thank you from the bottom of my heart.

Mike:         Okay. Well, I hope this goes. It’s interesting. I guess it’s the age thing that most CEOs don’t understand that. There’s been a change in communication approach to life in our business.

Nate:         Well, so I was hoping that we could just start out talking about your background and how you got involved in the renewable energy business and the role you played in building Pattern Energy.

Mike:         Yeah. Thanks a lot. I have been in the business a long time. I think I did my first wind project in 1989. So I got into the business, really, through energy efficiency and wind renewables. Pattern was spun out of a disaster company called [inaudible 00:10:39] in June of 2009. And the development company basically, we brought a bunch of employees with us, about 80 employees, and we got funding from [inaudible 00:10:55] investment fund and some co-investors and that’s really when we kicked off our business.

Nate:         That’s great. So what were some of the critical steps for you and for Pattern and building one of the most, or probably the preeminent, pure-play wind business around today in North America?

Mike:         Yeah. The number one step is finding capital that supported our development opportunities. But really, it was hiring smart people and then having a no fear, anything’s possible attitude where we didn’t feel that we couldn’t get things accomplished. We felt like when we though tit through, we could make it happen. So that’s really the thing that drove both our development efforts and our going into the operations business and building one of the best-operating groups in the country.

Mike:         So that’s been the driver for us.

Nate:         What were the issues early on, starting out? Was it just getting the investors comfortable with the tax incentives? And we’ll get into that a little bit later, but tax incentives, or was it just the technology? Was it because it was so new or what was it?

Mike:         No. Actually, it was really, we had a good track record of developing opportunities and we had a good backlog of projects. But there weren’t that many investors out there that were willing to invest heavily in the development side, and by having a good, strong track record, there were a lot of startups, people saying “Hey, this is a good market, there’s going to be a lot of opportunity to grow renewables in the coming decade and more.” But there weren’t that many people that could go to investors and show them actual returns on invested capital during the development period and we were able to do that and were able to attract a number of very interested private equity type investors to support our spin out. Riverstone, we’ve known a number of the Riverstone principals for year and had a good rapport. The nice thing about what we were able to accomplish in raising capital is we hooked up with people that understood business there. Riverstone primarily only invested in energy. Most of their principals have been around various forms of energy for decades. So they had good access to the market for us to help us with our opportunities. And it also facilitated our being able to explain why we were doing things the way we were doing them and making decisions more quickly because they had really, a strong foundation in our energy business.

Mike:         So that was a Godsend really, to find knowledgeable capital that could move quickly with us and getting us moving immediately. And the great thing about it is we went out in June and by November, we were financing our first project. So we needed somebody that could move quickly with us.

Nate:         How long has that relationship existed?

Mike:         Well, I’ve known a couple of the principals for decades. So they’ve been around the energy business, a couple of them have been involved like Chris Hunt and even in the wind business. But we’ve crossed paths and worked together. One of their former principals, who was a client of our investment banking days, where we had come up with a pretty unique structure to acquire some assets, so we got to know him really, really quite closely.

Nate:         That’s great.

Mike:         Yeah.

Nate:         So tell me about the development process and just what is involved in building a wind farm?

Mike:         In the wind business, you really have to start with the land and there’s two elements of it that are obvious. One is, is it good land for wind resource, and two, is it accessible in terms of interconnecting to the grid. Then you have to then step back and look at the macro features of “Is there somebody there that wants to buy your power? Is it a sensitive place for permitting?”

Mike:         So we typically, it’ll take anywhere from six months to six years to develop a good wind site. The first one or two years is really around getting the data on the site, what are the wind characteristics, how complex is the site, is it fairly uniform over the entire site or do you have to look at special features within the site and move operations around or locations of turbines around. In recent years, it’s become, really, a fascinating business because it used to be, you’d look at an entire wind site and say “Okay, what are the average wind conditions we’re seeing here?” And pick an average turbine for the site and estimate your energy production and do your economic analysis to determine how feasible it is to do the project.

Mike:         Now we go in and some sites, we have maybe six or eight [met 00:16:20] towers where the past, we’d only have a couple, we may have various LIDAR equipment, others, to measure the wind. More specifically, what the wind characteristics are like, where we want to put the turbine. And in some cases, where we even pick different turbines for different locations. They’re not fundamentally different. We typically will use similar models that may have different blade lengths. So for example, in the [Miko 00:16:47] project in British Columbia, we have two different turbines. One or more robust turbines where the wind’s higher at the front ridge and then the back ridge, it sees a little lower wind, so we can go with longer blades, and so on.

Mike:         The manufacturers and we are getting far more sophisticated. So that takes a little more intensity upfront than it used to. But you spend a good one to two years. Some people have done it in six months. I don’t think that’s such a good idea, but you spend one to two years gathering the data and looking at reference stations in the area to build up 20, 30, 40, 50 year history of data.

Mike:         Then, in parallel to that, if you think you have a good wind site, you may be doing your permit work, which will take one to two years, and so it takes a good couple years to fully develop it. Then it’s just a question of the market. Is there an outlet for the market? Is there adequate transmission connection?

Mike:         So it’s a very interesting process. Sometimes you need to be patient. We’ve had deals that have gone dormant for six years and then all of a sudden the market becomes really active in the area and a demand for electricity, especially renewables, and all of a sudden it pops up and in a year we’re building the project. So the development cycle, the development business has the short and long and cycles that you’ve gotta be flexible and be able to react to it.