Brookfield Renewable Partners (NYSE: BEP) has a history of making outside-the-box transactions to expand its renewable energy business so that it can grow cash flow and shareholder distributions at a faster pace. The hydropower-focused company, for example, invested several hundred million dollars into wind and solar power generator TerraForm Power (NASDAQ: TERP) over the past couple of years. The first deal bolstered TerraForm's financial profile while the second helped facilitate a needle-moving acquisition. Deals like those have leveraged Brookfield Renewable's financial strength to help others expand their clean energy operations, allowing Brookfield to earn strong investment returns.
The company recently announced its latest creative transaction by partnering with TransAlta (NYSE: TAC) to advance the Canadian power generator's transition to clean energy. The deal will allow Brookfield Renewable and its partners to put capital to work at attractive rates, which should power future growth.
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Digging into the deal
Brookfield Renewable and its partners have agreed to invest 750 million Canadian dollars (approximately $560 million) into TransAlta in two phases. The first one should close this May and will be in the form of CA$350 million ($262 million) of exchangeable debentures. The second should close in October 2020 and will be CA$400 million ($299 million) of redeemable preferred shares. Both will pay a 7% annual interest rate and will be convertible into an interest in TransAlta's hydroelectric assets. In addition to the direct cash injection, Brookfield Renewable has agreed to increase its ownership interest in TransAlta from 4.9% to 9% by purchasing shares on the open market over the next two years.
The conversion into a direct equity stake in TransAlta's hydro assets should begin in 2025. The reason the companies went this route is that TransAlta currently sells the power generated by these facilities under contracts that are below the current market rates. Those agreements, however, will expire in 2020. Because of that, the assets should be worth far more in the future if TransAlta can secure higher rate contracts to sell the power these assets generate. In a sense, this deal recognizes the future value of these assets.
TransAlta, meanwhile, will use the cash it receives from Brookfield for three things:
- It will reinvest CA$350 million ($262 million) to advance its coal-to-gas transition strategy that will see the company retire coal power plants and replace them with gas-fired facilities.
- The company will use up to CA$250 million ($187 million) to repurchase its stock over the next three years.
- TransAlta will use the remainder to advance the development of existing and new growth projects. These investments will help TransAlta achieve its goal of transitioning to 100% clean energy by 2025.
This transaction will also enable TransAlta to use some of its excess cash to repay CA$400 million ($299 million) of notes that mature next November. Further, it's adding another cornerstone shareholder in Brookfield, given that the company will boost its stake to 9%. Finally, TransAlta will add several new members to its board of directors, including two key leaders of Brookfield's renewables group.
Why Brookfield Renewable is making this investment
Brookfield Renewable doesn't need to make outside investments to power growth. The company currently estimates that a combination of inflation escalators embedded in its long-term power contracts, margin expansion opportunities, and new renewable facilities it has in development can support 6% to 11% annual growth in cash flow per share. That should enable the company to increase its distribution to investors -- which already yields a lucrative 6.2% -- by 5% to 9% per year.
However, the company has a proven track record of supplementing its internal growth initiatives with external investments that enhance its ability to increase cash flow. The company has invested $3.3 billion on these external growth initiatives since 2013, which has enabled it to grow cash flow at a higher rate. That trend should continue with the investment in TransAlta. That's because Brookfield Renewable will initially benefit from the interest payments on the exchangeable securities (and then the direct cash flows from the hydro assets upon conversation) as well as additional dividends from TransAlta. Meanwhile, over the longer term, it should profit from the increase in value from its investment in the hydro assets as well as its expanded stake in TransAlta.
This deal could be a long-term winner
Brookfield Renewable continues to show a willingness to structure creative transactions, which opens unique investment opportunities. That's certainly what we find in the TransAlta deal. The transaction structure will provide Brookfield with stable near-term cash flow from the convertible investments while enabling it to participate in the long-term value created as the hydro contracts reprice and TransAlta transitions to clean energy. This investment has the potential to grow Brookfield's cash flow at a faster pace in the coming years, which is another reason why Brookfield Renewable is a great stock for the long term.
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