NZSA Disclaimer
Paul McBeth is the editor of The Bottom Line and Curious News, and previously worked at BusinessDesk for 15 years.
Investors are being asked to do a lot of heavy lifting in the IPO.
It’s been a long time between drinks in the New Zealand initial public offering market, which puts a heavy burden on solar developer Lodestone Energy’s plans to tap investors for up to $100 million.
And to make matters trickier, the renewable energy firm is using new rules that let issuers use alternative metrics, rather than the prescribed financial information that was often too expensive and not necessarily all that helpful to investors.
Funnily enough, investors don’t like change and the Lodestone offering has come in for close scrutiny on forums such as ShareTrader and Reddit communities including Queen Street Bets and Personal Finance NZ.
Lodestone is leaning on operating metrics because it’s still developing solar farms and plans to deploy about $600 million of capital over the coming six years. The payoff depends on delivering the planned expansion, so near-term earnings and cash flow aren’t the whole story.
That seems fair enough at first glance. You don’t expect something to be spitting out cash when it’s hitting up investors and bankers for money to build two or three $50 million solar farms every year for the next six years.
Here is that rainbow I’ve been praying for
And this is very much a growth play, adding new solar sites and making a push into the potentially lucrative retail market, which it hopes will be delivering two-thirds of its revenue by 2032.
The bulls like Lodestone’s ability to execute, building five farms at a cost of about $50 million apiece since it was set up in 2019, with 266 gigawatt-hours a year providing enough energy to power 33,000 homes. If it hits its 2032 target, it’ll have 16-to-18 farms generating between 802 GWh and 888 GWh, or roughly 3.5% of Forsyth Barr’s 25,057 GWh projected pipeline of new solar development across the sector.
And its push into the retail market – while tricky – comes with the potential reward of a bigger margin if it can pull it off. Using the same virtual rooftop model it uses with commercial customers, Lodestone wants households and small businesses to buy power off its solar farms without needing to install their own panels. When the sun doesn’t shine, the company expects to top up the difference through hedging in the wholesale market and buying electricity from third parties – something it expects will amount to a tenth of the generation it sells.
If the company delivers an earnings yield of between 12% and 20% on its project costs, it reckons it should be able to build the existing pipeline without having to return to investors for a top-up.
What’s more, the three- and six-year projections are built on Lodestone’s existing development plans. It also has other levers for growth, such as the Haldon solar farm in the Mackenzie Basin that is much larger than its existing projects, or battery energy storage systems, which it sees as a likely addition to its portfolio when the market moves to more intermittent renewable energy.
And the money is being put to work rather than funding an exit from existing shareholders, who are coming along for the ride. Escrow arrangements have about 46% locked in until Lodestone releases its March 2027 annual result, presumably in May next year, and another 33% is locked up until the following September half-year result, likely to be out in November 2027.
I can see all obstacles in my way
Still, the sceptics have valid concerns.
The energy sector has done its darnedest to train people to focus on earnings before interest, tax, depreciation, amortisation and fair value adjustments on their hedging instruments, which seems to be a useful gauge when it comes to tracking the value of generation capacity.
But the measure does exclude some important costs, such as interest and the capital spending needed to maintain and replace equipment over time.
Where it does come in handy is if and when a bigger player decides to hoover up one of the little guys that’s nibbling into the retail customer base and competently executing on building new farms.
Contact Energy’s acquisition of Manawa Energy was at an enterprise value-to-ebitdaf multiple of 16 times, while the 2021 Tilt Renewables takeover and carve-up was at a heady multiple of 28 times.
At the $2.25 IPO price and incorporating the projected uplift in debt, Lodestone’s enterprise value-to-ebitdaf multiple would be around 19 times the forecast ebitdaf in the 2029 financial year, falling to 8.6 times in 2032 as those earnings grow.
The majors aren’t great comparators given their more diverse generation profiles and dominant customer bases, but Forsyth Barr research puts the five-year average enterprise value-to-ebitdaf multiple at 8.9 times for Genesis Energy, 12.2 times for Mercury, 16.7 times for Meridian Energy and 11.7 times for Contact.
Look straight ahead, nothing but blue skies
The problem is that interest still needs to be paid, and the upfront cost of equipment doesn’t magically negate the fact that equipment needs replacing at some point. Basically, ebitdaf can be useful for comparing operating performance but isn’t a measure of free cash flow.
Lodestone will also need to refinance its $119.8 million facility with Westpac next year against a backdrop of rising interest rates. The company is well aware of that risk, with refinancing at the top of its list of potential risks an investor needs to bear in mind. It judges the likelihood to be low but the potential impact significant.
Delivering on its plans to build two or three new solar sites a year should also be on investors’ minds. The same goes for the planned push into retail markets and maintaining the commercial and industrial customers that Lodestone’s locked into five- to 20-year contracts – longer than the typical one-to-three years that’s the industry norm.
Ditto for energy market pricing, hedging and the regulatory risk that continues to hang over the sector.
For those with a bearish tilt on the Lodestone offer, there are degrees. Some won’t touch it with a 10-foot bargepole and are sounding the alarm, others reckon it’s too rich for their blood but might entertain it at the right price once it’s listed.
Therein lies the rub – there’s a right price for almost anything.
Gone are the dark clouds that had me blind
There are some pretty big ifs in there. That gets to the classic investment conundrum: whether the potential reward of future cash and a more valuable company is worth the risk involved.
Rising bond yields won’t be doing Lodestone’s weighted average cost of capital any favours. That leaves the investment bankers with the task of explaining why the solar developer’s WACC should only be a percentage point or two above the 6%-to-7% estimates used by the big gentailers.
But this is where our narrow investment world is failing investors.
There’s been little in the way of publicly available research on the Lodestone IPO to aid investors in their decisions and there hasn’t been a rush of investment professionals keen to talk about the pros and cons of the upcoming float.
That’s a missed opportunity at the big end of town to explain why capital markets matter, especially in the oh-so-sexy sector of renewable energy development.
And while the investment forums might be a little more rough-and-tumble, their brutally honest opinions at least give the wider investing community something to consider when wading through the offer documents.
Image from Evgeniy Alyoshin on Unsplash.