Anything but plain

In October, Leidos Holdings – formerly known as SAIC – announced that it had reached an agreement to assume ownership Enova Equity’s stake in a 37.5 megawatt biomass power generation facility in Plainfield, Connecticut.

Enova and SAIC originally partnered on the proposed biomass facility in 2011 after the project was awarded a 15 year power purchasing agreement from a Connecticut electric utility. To sweeten the deal, which already promised a steady return thanks to the power purchase agreement, the project was also eligible for a US government cash grant equal to 30 percent of its cost upon completion prior to 2014. In order to qualify for that grant, a component of the American Recovery and Reinvestment Act of 2009, construction had to be underway by the end of the 2011 calendar year.

The project eventually fell into the hands of Enova and SAIC, whose proposed biomass plant in Plainfield would run on construction and demolition project wood waste. The firms secured a French commercial bank to provide financing for the facility’s construction. 
Then, around the start of 2011 Q3, the European debt crisis hit. 

Finding a new partner

“SAIC and Enova came to us and said, ‘Listen guys, we are in a very difficult position’,” says Carlyle Group managing director David Albert. Albert and Rahul Culas manage Carlyle’s energy mezzanine strategy, which provides debt to North American energy and power projects.

Although the Plainfield project’s long duration and relatively low risk profile fit the mold of a typical bank deal, the onset of the debt crisis had given the French commercial bank cold feet, Albert says. The timing could not have been less fortuitous. If construction did not start by the end of the year, SAIC and Enova would miss out on the cash grant.

“Basically, the board of SAIC wanted to know that there was a third party coming in and providing a good deal on the capital and, as the French banks were out at that point, there was really no other alternative that you could go to,” Albert says. Given the time constraints, “none of the commercial banks were going to be able to get to the finish line by the end of the year for a project like this.”

Fortunately, many of the deal participants were already familiar with each other’s work. Several members of the Carlyle team knew SAIC from their time on Morgan Stanley’s project finance or structured finance desks, and one of the Enova’s professionals had been a Morgan Stanley client. 

Even then, “it was a very difficult time,” says Albert. “We looked at the deal and were very interested and said, ‘Listen, we can do it. We are clearly not the lowest cost of capital. If you had more time, we understand that you would go to a bank. But we need to keep our capital outstanding for at least a minimum period of time for it to be worthwhile for us to pursue’.”

“They knew that if we said we could do it, that we could get to the finish line in time.”

SAIC wasn’t interested in giving up their equity stake in the deal, but they were willing to accept bridge financing for the construction of the power plant. Carlyle obliged them with a $125 million senior note through its energy mezzanine fund, which was divided into two tranches. 

The first tranche, valued at $70 million, is a construction facility and term loan due February 2015. The second $55 million tranche expires in April 2014 and will be paid down upon the distribution of the government cash grant promised upon completion. Both tranches are ranked equally in the capital structure, Albert says.

For their part, SAIC injected their equity as deferred engineering, procurement and production costs structured as HoldCo notes in front of Enova Energy’s equity (SAIC – now Leidos – took over the Enova stake in October 2013).

Leidos did not respond to a request for comment. 

The firms announced the $225 million deal in January, 2012. The Plainfield facility is slated for completion in December, 2013, Albert says. 

Unique biomass

Although they were comfortable with the level of risk they took on with the Plainfield deal, Carlyle did perform some extra due diligence around the facility’s proposed fuel source. 

Unlike traditional biomass plants, which run on greenwood, the Plainfield facility will be fueled by construction and demolition wood waste trucked in from different landfills.

Fortunately, Plainfield benefits from a natural supply of wood waste as a result of Connecticut law, which bars putting certain types of wood waste into landfills. As a result, waste management firms often need to truck this wood waste out-of-state at a cost of up to $50 per ton. 

The Plainfield plant creates a more cost effective choice for waste management firms, as it will acquire the waste for $6 per ton thus represents material savings to those waste management firms. 

“The commercial banks are fine financing everything that have pass through contracts on them on the cost, but when you only have a fixed price on the off-take [i.e., the amount utility Connecticut Light & Power will pay for the power supplied by the plant] then what happens if you get squeezed on supply?” Albert says. “The cost of the supply of the wood is sufficiently low that the margin is quite robust. It’s relatively minimal, but it’s still a risk. Because the cost of the fuel was so low, that’s why the French bank was willing to do this.”

“We came in and we were comfortable with it as well because we ended up doing a lot of work to get comfortable with fuel supply in the area. We went out and did a lot of research – we met with a lot of the waste suppliers and got comfortable that there was more than many multiples of excess supply in the region.”

Final steps

Leidos is expected to finish construction on the Plainfield facility prior to the 2014 deadline, right in time to receive the Recovery Act grant. Once the government disburses the grant, Leidos will pay off the $55 million second tranche of the Carlyle senior note.

“At that point, what we imagine happening is that SAIC [Leidos] will just refinance out with commercial bank debt,” Albert says. “To raise $70 million of leverage on a $240 million contracted power plant should not be a challenging exercise.” 

Even though Carlyle considers Plainfield a success for its energy mezzanine portfolio, the investment’s risk / return profile likely falls at the lower end of the low to mid-teens returns the firm targets for the fund’s overall portfolio, Albert says.

Carlyle did not disclose the investment’s return to date.