Solar, Wind Power

Vendor Financing Pros and Cons

Issue 2 and Volume 2.

The renewable energy project finance market is still emerging from its hibernation beginning in late 2008, which witnessed the drying up of capital flowing into renewable energy projects. One interesting result has been the emergence of vendor financing. With vendor financing, the equipment manufacturer (either the turbine manufacturer in wind or the panel manufacturer in solar) bundles the equipment with financing.

Naturally, only manufacturers with large balance sheets are able to provide financing. Since many renewable energy manufacturers are pure manufacturers with limited balance sheets, they are not able to provide financing.

From the perspective of the project developer, balance sheet financing from the equipment vendor offers a clear benefit: the potential for a lower-than-market rate in comparison to traditional project financing. The reason for this is two-fold. First, large corporations with good credit ratings (for example, the manufacturers) can tap into corporate debt facilities at better rates than smaller companies (the developers). Second, given difficult market conditions, it’s possible the vendor is willing to offer a lower-than-market rate to gain market share.

Additionally, assuming the equipment vendor has confidence in its own product, it does not have to conduct due diligence on itself. This can lower transaction costs whereas a third party financier would want to investigate the vendor and the vendor’s products.

Advantages exist for the vendor, too. The vendor can look more attractive to developers by solving not one but two pieces of a project’s puzzle. In today’s environment, developers need financing and equipment manufacturers need customers to buy their equipment. This becomes a perfect marriage.

The vendor also can capture more of the project margin by leveraging its understanding of the technology to make money in another part of the value chain.

For the developer, the downside of this financing strategy is that the vendor may only want to fund the equipment, not the whole project. The risk profile of financing the equipment vs. the rest of the project is quite different. A vendor may be loath to take on the risk of a 15- to 20-year project.

Moreover, for solar projects panels are currently less than 50 percent of the project cost. In this case, the developer would have to arrange for financing for the remaining cost. Wind turbines account for a larger portion of the project cost making this less of an issue. Either way, if the developer needs to arrange other sources of financing, transaction costs could rise.

From the vendor’s perspective, vendor financing could have implications for revenue and earnings. Depending on how revenue is recognized from the financing activity and the source of funds, it is possible that revenue and profit could be pushed into the future, reducing near-term earnings and market capitalization (and assuming the market maintains its multiple of earnings).

Vendor financing also uses financial resources that might otherwise capitalize different parts of the business; this presents an opportunity cost of the funds.

For vendors new to financing, this sort of structure means setting up a division, which has its own accounting and legal complexities.

Finally, there are potential antitrust concerns. In other words, could the vendor be seen as unfairly using its market power to force customers to take its equipment as a requirement to obtain financing? Although no immediate examples exist to point to, this remains a business risk for the vendor.

Vendor financing has been used in other industries involving big-ticket items. Some remember the days in the late 1990s when telecom vendors made it almost too easy for customers to buy equipment they didn’t really need, only to cause a bubble that ended up bursting. Such overzealous use of vendor financing is not appropriate. Easy money also helped trigger the housing bubble.

Today, the vast majority of large-scale wind and solar projects are financed by banks, government funding facilities and private and public bond issues. Vendor financing represents a small piece of the financing pie. But given the current environment of oversupply in both the wind turbine and solar panel markets, it’s likely we will see more vendor financing as companies with the ability to do so will use it as a competitive weapon to gain market share and/or move product piling up in inventory. Meanwhile, developers would be delighted to see another source of capital in a challenging financing environment.