Valuing methodologies of Cleantech Attractiveness.
Prime Energy Cleantech: In the current economic environment, investors are increasingly focusing upon upgrading their investment appraisal processes and rigorously stress testing projects before committing investment capital.
The need for robust valuations
In the current economic environment, investors are increasingly concentrated upon upgrading their investment appraisal processes and rigorously stress testing projects before committing investment capital. Given the large amounts of investment in the cleantech sector and the significant level of transaction activity, being able to value portfolios of assets and renewable companies in a consistent and robust manner has therefore never been more important, and specialist knowledge and skills are often required. Valuations of assets and companies can be required for a whole range of different purposes, including:
► For commercial purposes, to determine the price for an acquisition or disposal, or to support a major investment decision.
► For financial reporting purposes, e.g., the allocation of the acquisition price between tangible and intangible assets (known as purchase price allocation) and establishing the fair market value of fund investments for portfolio reporting purposes.
► Within a regulatory context, for determining if an agreed transaction price is ‘fair’ and ‘reasonable’
► For tax authorities, when entities are transferred between different tax jurisdictions or for transfer pricing purposes as part of a business restructuring program
► Within the context of a dispute or litigation
Normally, more than one approach will need to be taken into consideration in order to arrive at a supportable valuation range.Often the basis of value can be different depending on the purpose of the valuation being performed. Normally, more than one approach will need to be considered in order to arrive at a supportable valuation range.
Income approach
The income approach focuses on the income-producing capability of the business or asset. This approach assumes that the value is measured by the present worth of the net economic benefit to be received over the asset’s life. The methodology usually adopted is the discounted cash flow methodology (DCF). This approach, and the financial models which are required to support it, are becoming increasingly important given the current focus upon cash metrics in the optimization of capital investments.A financial model is developed to generate cash flows using input assumptions for capital and operating expenditure, feedstock costs, feed-in tariff or electricity price, governmental policy
support, output utilization and taxation. The resulting cash flows are then discounted at a rate which reflects the overall risk of the project. It is critically important that cash flow analysis is underpinned by robust financial models.For fully operational renewable projects, 100% of the projected cash flows are included in the valuation. However, pipeline renewable projects, i.e., those projects still in development phase, present a more complex problem, as the realization of these cash flows depends upon planning consent etc. One potential solution is to risk weight the cash-flows depending upon the development stage of the asset in question. As the project moves through the various stages, value accumulates over time following a ‘value accretion curve.’The risk profile of a project changes
significantly as each of the various stages is completed, and large increases in the value of the project can occur as certain key milestones are passed.
The value accretion curve for a wind farm will vary according to project and location — specific factors, such as the wind resource of the location, the planning approvals process and the level of government subsidies that apply in the relevant country. However, an important common factor is that the risk profile of a project changes significantly as each of the various stages is completed, and that large increases in the value of the project can occur as certain key milestones are passed. For this reason, significant value can be generated by taking a project through some or all parts of the development stage and then exiting or refinancing the asset. For other clean technologies, the value accretion curves would generally have the same overall shape, but could potentially differ significantly in detail. For example, compared with wind farms, a biodiesel plant would typically have significant technology risk associated with it, while obtaining planning permission would generally be less of a concern. Therefore, selecting a strong technology provider and finalizing sound technical designs could add significant value to a project.Variations of the income approach, including ‘excess earnings’ and ‘relief from royalty’ methods, are commonly used to value intangible assets of this nature.
In particular circumstances, for example, purchase price allocation and tax transfer pricing, it may be necessary to value the intangible component of the business. Within the cleantech sector, potential intangible assets include permits (e.g., land lease agreements), favorable or unfavorable contracts including power purchase agreements and pre-feasibility stage assets. Variations of the income approach including ‘excess earnings’ and ‘relief from
royalty’ methods are commonly used to value intangible assets of this nature.
Based on the research of Ernst & Young
