The price is right – how much is your renewable energy project really worth?

At the highest level, valuation methods for renewable energy can be broken into two main categories: discounted cash flow (DCF) and multiples valuations, two approaches which are in practice not mutually exclusive.

The DCF method involves forecasting the future cash flows generated by a project and discounting them back to calculate the Net Present Value (NPV) using a discount rate. At risk of overexplaining the basics, the point of discounting cash flows back to the present is to account for the time value of money (money now is better than money later). The discount rate is linked to key project parameters, such as the asset class, the geography, development and offtake risks, the degree of leverage, and the asset life. It is therefore primarily correlated to the risk associated with the project and also includes the cost of capital prevailing in the market. So, for example, a floating offshore wind project under construction off the coast of Taiwan will have a significantly higher discount rate than an operational solar farm in Germany. This means that even if the projects were to have similar cash flows, the valuation of the project with the higher discount rate will be substantially lower than the one with less risk and a lower discount rate. This is to account for the higher return required by those taking on more risk. To calculate the cash flows, we build large, complex financial models that integrate all technical and financial parameters of a project. DCF valuations tend to be viewed as more accurate, but only if reliable data for the project is available, and even then, many sensitivities and various scenarios (e.g. refinancing, a further sell down to lower cost of capital investors etc.) need to be run to take potential variations into account. As the valuation result can be highly sensitive to the assumptions used, DCF models rely on accurate, project specific information. Whilst this is the method we almost always use as the basis of our valuations of projects or portfolios of projects, it’s not always the best port of call if there isn’t sufficient visibility on the project’s or corporate’s inputs.

Multiples, on the other hand, can take various forms (EV/EBITDA, EUR/MW etc.) and tend to provide a more high-level benchmark valuation, reflecting current market sentiment. This second technique is a relative valuation method that compares a specified metric of a project or company to those of comparable projects or companies. The valuation is based on a multiple, which for corporates most commonly takes the form of an Enterprise Value/EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) multiple, derived from similar previous transactions, and should therefore be reflective of the market. The key challenge with this approach is to find “similar” peers to be compared with (same asset maturity, corporate cost structure etc.). Corporates with normative cashflows (i.e. taking long-term growth into consideration) can be valued by multiplying their EBITDA by the EV/EBITDA multiple of similar recent transactions to calculate the enterprise value. To get the equity value, the debt remaining is subtracted from the enterprise value, while the cash on account is added to the enterprise value. This is the amount that would be paid to acquire 100% of the company. Occasionally, this method can be used to get a benchmark for valuations of projects too, particularly in the biogas sector. Generally, for plants under construction, the annual EBITDA from the first full operational year is used, whereas for projects in operation the EBITDA from the previous full year is used. However, there would need to be sufficiently reliable data available to calculate what the EBITDA of the project would be.

A key limitation of this method is that it does not consider project-specific variations such as interest, taxes, non-cash expenses, wind/solar resources, land leases, offtake agreements, financial structuring, contractual terms etc. This type of valuation also ignores the impact of future refinancing, changes in revenues, and inflation as it shows a moment-in-time valuation.

Given these limitations, when working on both project and corporate transactions we would generally suggest carrying out a DCF valuation to at least include in your price considerations.

Valuing project development pipelines is slightly different. If a project is still in development, the equity value is often calculated on a EUR/MW basis (depending on the development stage it is in). Theoretically we could use the DCF method by applying higher discount rates to different stages of a project’s development so as to reflect the risks attached. For example, the discount rate of an operational onshore wind project over its remaining lifetime would be a high single digit number (7-8%), whereas it is 1% to 2% higher for an investment at ready-to-build (RTB), to pay for the higher construction risk and associated double digit compressed return. Going further upstream, the high risk at early- to mid-stage development requires returns of 20% or above for those phases alone, which factors into the blended long-term discount rate over the lifetime of the project. This results in an additional premium compared to RTB projects, therefore reaching a discount rate of at least 12%.  This is self-explanatory – the earlier stage the project, the higher risk it is, the higher the cost of capital. Unfortunately, the project, or some sites in a development portfolio, may not ever be realised. Therefore, if this method is used, a “chance of success” percentage tends to be incorporated into the model as well, multiplying valuation at RTB by the probability of the project being realised. However, it is also often too early-stage to have received fixed EPC quotes, or even grid connection costs, limiting the accuracy of the capex and opex assumptions used.

Given the uncertainty, it is generally more defensible to only start attributing DCF values to projects post planning. For that reason, for projects or pipelines in early to mid-stage development, we tend to use a valuation multiple per MW based on key development milestones achieved. These key parameters include, amongst others, securing the site, permitting, grid connection and offtake agreements. To give you an idea of the scale of valuations as a project progresses, we would typically say that an offshore wind farm in early-stage development could be worth less than ~ EUR 50k/MW, whereas one in mid-stage development (until shovel ready) could be in the range of ~ EUR 50-150k/MW[1]. It is worth noting that even though a project stage might be similar, there may be large variations between projects, driven by (i) project specific parameters such as their grid connection date, grid connection costs, land/seabed lease costs and location etc., and (ii) market specific dynamics and bottle necks (e.g. a project with a seabed lease in a market where tenders are very competitive or with grid connection in a highly grid constrained country) would all impact the valuation and need to be taken into consideration.

This is often called the project’s premium i.e. the project valuation “before” the investor injects the project equity in to fund the capex/construction of the project. This EUR/MW multiples valuation method can also at times be used to sense check DCF valuations of projects already in construction or in operation (with the limitations stated above).

To exemplify the valuation impact of the varying methods, we’ll give a very simple case study example with the disclaimer that these assumptions are to be taken with a hearty pinch of salt. Say we assume there is a 100 MW onshore wind project about to enter construction, with:

• Capex of 100M EUR
• Opex of 3M EUR/year
• 100% PPA for the 20-year lifetime at EUR 60/MWh
• 3% indexation on both revenues and opex
• 70% gearing at an all-in interest rate of 5.5% with a 15 year-tenor

Using the DCF method, with a 10% discount rate, the NPV would be ~ EUR 32 M. Using the EUR/MW multiple method, assuming a multiple of ~ 300k/MW at the start of construction, the valuation would be ~ EUR 30 M as well. However, if the indexation rate were to be increased from 3% to 5%, ceteris paribus, the DCF valuation would increase to around EUR 50 M, whereas the multiples valuation would stay the same. Whilst this isn’t a realistic example given this change wouldn’t happen over night and we would be using an indexation curve in the model rather than a fixed rate, it emphasises the ability for a DCF model to reflect any change of assumption very efficiently, whereas multiples are based on market data points requiring time to reflect new market developments. This is a key limitation of the multiples method. Of course, using the example above, if the increased inflation rate sticks, we would eventually see a change in multiple of the transactions since.

There are some alternative valuation methods, which are more commercial agreements amongst parties (e.g. as part of joint-venture agreements) than pure financial methods. For example, an incoming investor could value an opportunity in development stage by using a multiple of the development expenditure to date (e.g. 3x) plus a strategic premium. This is highly dependent on the investment structure, as valuations can also be spread across upfront payments and milestone payments (e.g. agreements where the incoming party will co-fund the remaining development expenditure, resulting in a lower upfront valuation). We have also seen methods where someone is looking to acquire a portfolio of projects or a platform that includes an early-stage future pipeline of projects, and they simply assume an approximate capex requirement per technology per MW and an associated expected return. These assumptions could then be used to calculate a very high-level valuation that is discounted back to today.

On top of these methods, it is also important to note that some renewable projects or companies, much like other purchases in our lives, will simply be worth more to one party than to another. A wealthy art collector missing that one piece to complete their collection will most definitely be willing to pay more for the canvas with a splodge on it than I would. (Somewhat) similarly, if I am a large oil and gas company with deep pockets and impending decarbonisation requirements and carbon taxes, the value I would place on the large nearby biogas plant, the green hydrogen developer, or the multi-GW offshore wind lease will tend to include a strategic premium.

As you can see, the development stage and availability of reliable data tend to dictate the best means of valuing a project. Often a combination of methods is required. For example, the EUR/MW multiples method could be used to value a corporate’s development pipeline, which could be added to the DCF valuation of its projects in construction and operation, before adding the strategic value of the team’s existing knowledge and capabilities to the company’s valuation. This valuation could then be sense checked by multiplying the company’s EBITDA with EV/EBITDA multiples of similar recent transactions in the market. It is worth noting that these methods are also all generally interlinked, and technically as per the Gordon Growth Model, an EV/EBITDA multiple of say 15x could be another way to consider a 7% return on that specific EBITDA (without considering any growth). It is also important to remember that no valuation method could have predicted the market fluctuations that occurred due to global events, like COVID or Russia’s invasion of Ukraine. The level of impact of these macroeconomic situations on a project’s business case/accuracy of any DCF model used would have largely been determined by the variability of the assumptions. You can derisk the chance of the assumptions fluctuating by means such as hedging, fixed contracts, and insurance, but that’s a whole other topic (which we would also be happy to help with!).

[1] This is for illustration purposes as it is market specific