Summary: The back half of 2016 was very busy for renewables M&A and 2017 is already showing signs of being just as busy... and competitive. There is a shortage of good assets coming to market and at the same time competition is as fierce as ever, with Asian buyers now queuing up alongside European institutions and funds, all in search of long term, inflation linked returns.
In this article, we provide a quick primer on key risks in renewables M&A transactions.
1. Selling Leveraged
More and more we are seeing assets change hands whilst “leveraged” i.e. with existing project finance facilities remaining in place.
This usually begins with one of the parties saying, “let’s just leave the debt in”. Simple in concept, less so in practice.
In reality, lenders are unlikely to just “leave the debt in” place despite the change of ownership. Instead, the buyer is likely to end up with a new facility agreement, new security documents, and a long list of conditions precedent to satisfy. If there are changes to the amount borrowed, the buyer may also end up with new models, swaps and other requirements to provide comfort to the lender on bankability.
All of this adds to execution risk, the transaction timetable and to costs, and is something to be considered carefully by both buyers and sellers before proceeding.
2. Standing Behind the SPA
With sellers in the renewables market typically falling into one of two camps – (i) developers; and (ii) funds – there is a general reluctance to stand behind the warranties and covenants in sale and purchase agreements (“SPAs”). These are sellers who are taking profits, distributing them and are generally uninterested in meeting claims from the buyer 1, 2 or even 7 years later.
In some cases these issues can be managed, to an extent, through good due diligence and small escrows for specific issues. However, increasingly, the best solution is warranty and indemnity (“W&I”) insurance: specific insurance under which the buyer insurers the SPA such that it can claim against the insurer (rather than the buyer) if it needs to make a claim.
This is a great solution in many cases: the buyer has protection under the SPA from an insurer with a strong covenant, while the seller achieves the “clean break” it needs. Premiums are also increasingly competitive – sometimes as low as 1% of the insured amount - making this a relatively affordable solution.
Still – W&I insurance is not entirely without risk. Care needs to be taken to ensure the scope of insurance and amount of cover are appropriate, any uninsurable risks are managed and the timing impact on the transaction is properly managed. There is also the issue of who takes responsibility for the cost of the insurance – a point to be agreed upfront.
3. Title Troubles
Of all the items covered in due diligence, it is almost always real estate that creates issues. Recent examples include litigious neighbours, sheep grazing under solar panels, funky sub-lease structures and landlord attempts to hijack grid connections.
Often, these issues can be worked through, or even insured. Other solutions may also be appropriate. The key is to get on top of these issues early in the transaction to ensure they can be properly managed in good time.
Like real estate, planning issues also come up frequently. At the development stage this may take the form of an outstanding judicial review of a planning application, while post development it is common for planning amendments to be required to approve the slightly different “as constructed” project. Again, a lot of these issues are manageable or insurable, but do require early identification.
5. Development Strings Attached
Most renewables assets are – at least in theory – developed in special purpose vehicles (“SPVs”), with the intention that the SPV can then be used in a project financing structure or sold on a stand-alone basis.
In reality, this is rarely the case and, more often than not, the developer of the project will still be sitting with some contracts or other rights or obligations that should be in the SPV. As a result, it is not unusual for there to be some restructuring that needs to take place at or prior to completion.
6. Capturing Hidden Value
One of the key attractions of renewables assets is that they are simple, right? Well… perhaps not so simple. In particular, complexities may arise when it comes to identifying, allocating and pricing hidden value items.
This goes beyond looking at net current assets on the balance sheet of the SPV and extends to hidden items of value within the project agreements and security arrangements. In recent transactions we have helped clients identify five or six hidden value items, which have enabled them to capture material value upside.
In addition, it is important to ensure the SPA properly reflects the financial assumptions underlying the transaction, including when economic risk (the benefit of the revenues and burden of the debt and equity) transfers.
These are key areas as – unlike many of the other contingent or potential risks allocated in the SPA – these provisions have a clear, tangible financial impact i.e. they are real cash in, or out, at completion.
At face value, renewables assets are attractive due to their simplicity. However, with the hidden complexities of such projects, and the highly competitive nature of the market at present, those involved in renewables M&A transactions need to ensure they are able to manage risk from the outset.