BARON

INSIGHT

SECOND QUARTER 2015

Investing in Renewable Energy

James Stone, VP, Portfolio Manager, Baron Energy and Resources Fund; Rebecca Ellin, VP, Research Analyst

One of the keys to Baron's approach to investing in energy is to seek

growth companies and growth opportunities brought about by changes
in technology, trade flows, infrastructure investment, and capital
intensity. This approach first led us to opportunities driven by
technological advancements that helped to unlock new reserves and
production from unconventional (mostly shale) resources in the U.S., and
the concomitant demand for infrastructure to process, store, and
transport products to markets from these new geographies.
In the past 18 months, our focus on growth has led us in a new direction
within the energy industry: renewable energy, and in particular, solar
energy. As with unconventional resources, we believe renewable energy
is one of the most significant growth opportunities in energy today. Two
major trends are driving the adoption of solar: (1) technological and
other improvements that are making solar an increasingly costcompetitive source of electricity in many countries (grid parity); and
(2) increasing consumer and geopolitical desire to reduce pollution,
which encourages the use of renewables. The emergence of innovative
financing models known as yieldcos is acting as an additional catalyst
for the conversion to renewables by significantly reducing the cost of
capital and enabling companies to raise more capital at these lower, also
more attractive rates.
Global Solar Demand to Grow at CAGR of 14.5%
120

99

GW

62

65

53

60

44
40

27

29

India

US
China

2010

2011

2012

2013

2014

As Industry Scales, Prices Fall

Europe

21
20

As the use of solar grows, solar businesses are also starting to enjoy the
benefits of economies of scale. As solar companies add customers, costs
associated with functions such as sales, marketing, regulatory and
compliance do not increase commensurately. We believe customer
acquisition costs will continue to decline significantly as customer
awareness increases, soft costs come down, and more supportive policies
are put in place. This creates a virtuous circle of lower costs driving
greater demand.

Other markets

Japan

36

In the past few years, the cost of solar panels has plummeted, driven down
by technological advances in photovoltaic (PV) cells and an explosion in
solar panel manufacturing in China. The average solar panel now costs
about 75% less than it did just five years ago, and the price continues to
fall. The newest method for producing the PV polysilicon used in making
panels takes a tenth of the energy than that of previous techniques. This
shortens the manufacturing time, allowing faster and cheaper production
of solar panels. In addition, the energy conversion efficiency of both PV
and thin film technologies has increased significantly, further driving down
the cost/watt for all forms of solar energy. In the past three years, the cost
of installing utility-scale solar has fallen 57% in the U.S. and costs for
residential solar has seen a similar decline in cost.

2015E 2016E 2017E 2018E 2019E 2020E

Source: Credit Suisse estimates

A decade ago, the solar industry was in a nascent stage, largely dependent
on government subsidies to stay in business. Most companies that went
public were commodity-type manufacturing businesses, focusing on price
competition to sell relatively undifferentiated products or services, or
engaged in a technology arms race with few clear winners. It was a challenge
to find investment opportunities that met the Baron criteria: significant

$9.00

7,000

$8.00

6,000

$7.00
5,000

$6.00
$5.00

4,000

$4.00

3,000

$3.00

2,000

$2.00

1,000

$1.00
$-

0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Solar PV Installations

Source: GTM Research, SEIA

Solar PV Prices

Solar PV Installations (MWdc)

86
74

80

Grid Parity Is Here

Blended Average Solar PV Price ($/watt)

CAGR of
14.5%

100

competitive advantage, strong long-term growth potential, experienced

management, and attractive valuation. Recent transformative developments
in the solar energy industry, however, are producing what we believe are
excellent investment opportunities and we fully expect more to come.

The steep decline in cost means that solar energy in now at levels of grid
parity in many regions across the globe, especially in emerging markets,
where electricity costs tend already to be high. At least 30 countries are
currently at grid parity on an unsubsidized basis, including Australia,
Brazil, China, France, Germany, India, and Spain, according to Deutsche
Bank Market Research. In the U.S., more than 14 states are currently at
grid parity, and by 2016, that number is expected to climb to close to 47
states, according to the same research.

Early adopters such as Intel Corporation, Nokia Oyj, and Keurig Green
Mountain, Inc. already source 100% of their electricity from renewables.
Other companies are moving in that direction. A number of major retailers
with large flat rooftops ideal for solar, including Wal-Mart Stores, Inc., IKEA,
Kohls Corporation, Macys, Inc., and Walgreen Co., are installing rooftop
solar. Across other sectors, corporations ranging from Campbell Soup
Company, General Motors Company, and The Procter & Gamble Company
to Cisco Systems, Inc. and Verizon Communications, Inc., are converting to
renewable energy to power all or large parts of their businesses.

Growing Commitment to Renewables

With governments, corporations and individual consumers increasingly

turning to renewables to meet their electricity needs, we think the markets
may underestimate the projected impact of the solar revolution on the
utility industry. Many commentators seem unduly focused on the disruptive
effects of solar and overlook the opportunities that large solar projects bring
to the utility value chain. Contrary to popular belief, solar is not primarily a
residential phenomenon. In 2012-13, 80% of solar installations were utilityor large-scale projects. While the prospects for small scale distributed solar
generation look favorable, we are equally, if not more, enthusiastic regarding
the outlook for commercial and utility-scale solar markets.

While solar currently accounts for only 1.2% of electricity generation

worldwide, the percentage is growing rapidly and is expected to
accelerate. In 2014, investments in solar powered electricity projects rose
25% to $149.6 billion, representing a record high share of total energy
investments. According to Bloomberg New Energy Finance, investments
in electricity generating assets over the next 25 years may total about
$12 trillion, of which renewable energy should account for $8 trillion, and
solar for as much as $3.7 trillion of the total. This compares to only about
$1.2 to $1.3 trillion for coal and nuclear, respectively. A key driver of the
growth in solar continues to be the declining cost and increasing
efficiency of the technology, as well as emerging technologies for energy
storage that will further enhance the competitiveness of solar and other
renewables in the electricity markets. It should also be noted that the
growth opportunity in renewables should be largely divorced from the oil
price outlook, as oil is scarcely used around the globe to generate
electricity. Furthermore, over time, we anticipate that natural gas prices
will continue to decouple from oil prices around the world as natural gas
remains an important fuel source for power generation.
Across the globe, the appeal of renewables is building among
governments and consumers, both at the residential and commercial
levels. China, whose capital city, Beijing, has become notorious for its
smog levels, has a target to install 100 gigawatts (GWs) of solar by 2020.
India plans to install 100 GWs of solar by 2022. The European Union
plans to increase renewables to 20% by 2020. To put this in perspective,
the total solar installed base worldwide was only about 250 GW at the
end of 2014.
In the U.S., 29 states and the District of Columbia have enacted
regulatory programs known as Renewable Portfolio Standards (RPS)
mandating that electric utilities produce or purchase certain levels of
power from renewable sources. The legislation typically sets a renewable
energy target between 10% and 30% of total energy capacity by a
specific date. Nine other states have non-binding goals supporting
renewable energy. California has the most aggressive RPS program, calling
for one-third of electricity to be generated by renewables by 2020. Earlier
this year, the California governor proposed expanding that goal to 50%
by 2030.
Large corporations are also increasingly turning to renewable energy to
power their operations. According to a survey conducted by Ceres in late
2012, 60% of Fortune 100 companies and more than two-thirds of the
Fortune Global 100 have set a renewable energy commitment, a
greenhouse gas (GHG) emissions reduction commitment, or both.
For many companies, electricity is one of the largest operating expenses,
and renewables can help significantly reduce long-term operating costs.
In addition, the use of renewables can help companies achieve GHG
emissions reduction goals, demonstrate leadership on corporate
responsibility, and hedge against volatility in conventional fuel markets.

We believe solar demand is set to grow strongly in the U.S. and emerging
markets as a result of ongoing solar electricity cost reduction and
supportive government policies. As noted, Bloomberg New Energy
Finance and other experts are forecasting that renewable energy and in
particular solar projects will garner the lion share of new investment in
electricity generation with strong growth in all three end markets utility
scale, commercial & industrial, and residential. In the next 25 years global
power-generating capacity is set to transform, shifting from two-thirds
fossil fuel-based to 56% zero carbon-emissions. Many existing nuclear
plants are nearing retirement age. Solar projects are far quicker, cheaper,
and less problematic from a political and regulatory perspective to
construct. Similarly, many coal plants are being retired for age, efficiency
and environmental reasons. Solars comparatively clean environmental
profile is especially compelling in emerging markets like China and India,
where air quality has become a significant quality of life concern. In fact,
in markets heavily dependent on coal for electricity generation, the ratio
of coal-based wholesale electricity to solar electricity has already
dropped from 7:1 four years ago to less than 2:1 today, according to
Deutsche Bank Market Research. That ratio could likely approach 1:1 with
the next year, according to the same report.
Global Gross Annual Capacity Additions by Technology, 2013-30 (GW)
400

Flexible capacity
Solar thermal
Small-scale P V
Utility-scale P V
Offshore wind
Onshore wind
Biomass
Geothermal
Hydro
Nuclear
Other
Gas
Oil
Coal

350
300
250
200
150
100
50
0
20132015

2020

Source: Bloomberg New Energy Finance

2025

2030

Investing in Renewables
Our first meaningful foray into investing in renewable energy was
SunEdison, Inc. Formerly known as MEMC Electronics, a semiconductor
manufacturing company, SunEdison has transformed itself into a
renewable energy project developer with a global sales and installation
capability. SunEdison is now the world's largest renewable energy
development company, and it has a large inventory of existing generating
assets and future development projects. In 2014, it expanded beyond
solar into owning and operating wind assets as well, further expanding its
total addressable market.
In 2014, SunEdison also created TerraForm Power, Inc. to own and
operate renewable power generating and transmission assets, principally
solar, with long-term power purchasing power agreements that are
expected to deliver stable cash flows to be paid out to investors as
dividends. TerraForm is a yieldco, an innovative financing structure that
operates as the renewable energy equivalent of the master limited
partnerships (MLPs) used by conventional energy companies. Yieldcos are
growth-oriented public companies created by a parent company that
bundle long-term contracted operating assets to generate predictable
cash flows. The recurring dividends that result are similar to bond
payments but like MLPs, yieldcos are traded like a stock.
Corporate Structure of a Yieldco

As growth investors, we take positions in yieldcos that we expect to

increase in valuation. However, the 3-6% dividend payment on yieldcos
is also attractive, especially to fixed income investors in search of yield.
Many yieldcos plan on growing their dividend by more than 15% over the
next 3-10 years. Yieldcos also provide investors with geographic and
customer diversification by bundling projects from different regions of
the U.S. and the world, with different end markets.
SunEdison plans to retain a substantial portion of its developed solar
projects and drop them into TerraForm, rather than sell the projects to
third parties as it did previously. This change will more than triple
SunEdisons retained value for each project due to the substantially lower
cost of capital of TerraForm and SunEdisons ability to capture the
residual value of each project. We think this change will enable SunEdison
to create substantial value for shareholders, as well as increase its
participation in the rapidly growing market for solar power.
SunEdison has announced its plans to form another yieldco called
TerraForm Global, Inc., to be focused on renewable power plants in
emerging markets. The company is purchasing wind, solar, and hydro
assets in developing nations to drop down into the new yieldco. Baron
participated in a private placement deal by TerraForm Global ahead of its
IPO. Given the virtually open-ended opportunity in countries and regions
such as China, India, the Middle East, and South America, we believe
others will soon follow SunEdisons move into emerging market-focused
yieldcos. We expect to see more yieldcos forming overall as each
successful yieldco IPO and increase in share price creates confidence in
the strategy among other developers.
We have also invested in Abengoa Yield plc, a yieldco created by the
Spanish multinational Abengoa, S.A. focused on renewable electricity
generation and transmission in North America. We expect most of the
growth at Abengoa Yield to come from the acquisition of developed
renewable electricity generating and transmission assets in the form of
dropdowns from its parent company, or the acquisition of similar
projects from third party developers.

Conclusion

Source: Bloomberg New Energy Finance

The structure of yieldcos has been around for a long time but was first
applied to renewable energy only in 2013, when the energy giant NRG
Energy created a yieldco that included renewable energy assets. In less
than two years, 13 more yieldcos have launched. Developers of
renewable energy projects have found that yieldcos are their least
expensive cost of capital. Like MLPs and real estate investment trusts
(REITs), developers structure yieldcos to maximize tax loss carryforwards
and use depreciation to minimize the tax bill at the corporate level and
avoid double taxation, in order to maximize returns for investors.
Yieldcos also allow developers to separate the risk profile of different
aspects of their business, providing investors with an attractive pure play
opportunity to invest in de-risked renewable power generation cash
flows.

We believe that renewable energy, and in particular solar energy, is one of

the most significant growth opportunities within the energy industry
today. Declining costs have shrunk the economic gap between solar and
conventional sources of energy, and solar energy is now at levels of grid
parity in many regions in the U.S. and across the globe. We expect the
economics of solar to continue to improve as a result of a continued
decline in the costs of solar panels, balance of system (all PV system
components except panels), and financing. In addition to lowering the cost
of capital, the innovative financing structure of the yieldco has served to
de-risk renewable assets and increase the appeal of pure play renewable
opportunities for investors. While the percentage of energy from
renewables is still relatively small, we believe the growth rate over the next
several years and likely beyond could be quite meaningful. Therefore, we
have increased our commitment to this segment of the energy industry in
the past 18 months and our investments in renewable energy represent
around 10% of the Baron Energy and Resources portfolio. We continue to
look for additional investment opportunities in this sector.

Baron Sales & Relationship Management

INSTITUTIONAL
JAMES BARRETT
DAVID KAPLAN
MEETA SINGAL
JENNIFER NIGRO

VP, Head of Institutional Sales, 212-583-2076, jbarrett@baronfunds.com

VP, Senior Director, Institutional Sales, 212-583-2033, dkaplan@baronfunds.com
VP, Director, Institutional Sales, 212-583-2055, msingal@baronfunds.com
VP, Director, Institutional Sales, 212-583-2101, jnigro@baronfunds.com

FINANCIAL INSTITUTIONS
CARLA F. AVILA
ROGER MACK
ASHLEY BRADLEY
CHELSEA M. AMEEN

VP, Head of RIA Sales, 212-583-2183, fmaiorano@baronfunds.com

RIA Sales East/Midwest, 212-583-2083, rthurau@baronfunds.com
RIA Sales West, 212-583-2138, lcassal@baronfunds.com
RIA Sales Midwest, 212-583-2167, sdunlap@baronfunds.com
RIA Sales East, 212-583-2079, srode@baronfunds.com

INTERMEDIARY
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VP, Head of Intermediary Sales and National Accounts, 212-583-2034,

djudice@baronfunds.com
STEPHANIE GISRIEL
National Account Manager, 212-583-2187, sgisriel@baronfunds.com
BILL ZOROVICH
External Wholesaler Northeast, 646-556-5473, bzorovich@baronfunds.com
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External Wholesaler Central, 773-450-7495, jrommel@baronfunds.com
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RON STANKIEWICZ
External Wholesaler NY Metro, 917-287-7248, rstankiewicz@baronfunds.com
SCOTT KOZIOL
External Wholesaler Southeast, 404-433-6137, skoziol@baronfunds.com
WAYNE OUIMETTE
External Wholesaler West, 310-292-6255, wouimette@baronfunds.com
You should consider the investment objectives, risks, charges, and expenses of the Funds carefully before investing.
The prospectus and summary prospectus contain this and other information about the Funds and can be obtained
from the Funds distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Please
read them carefully before investing.
The discussion of market trends and companies throughout this report are not intended as advice to any person
regarding the advisability of investing in any particular security. Some of our comments are based on current
management expectations and are considered forward-looking statements. Actual future results, however, may
prove to be different from our expectations. Our views are a reflection of our best judgment at the time of the
publication of this report and are subject to change any time based on market and other conditions, and we have no
obligation to update them. Investing in the stock market is always risky. Baron may not achieve its objective. Portfolio
holdings may change over time.
Portfolio holdings as a percentage of net assets as of June 30, 2015 for securities mentioned are as follows:
SunEdison, Inc. Baron Opportunity Fund (2.5%), Baron Fifth Avenue Growth Fund (2.0%), Baron Energy and
Resources Fund (3.5%), Baron Global Advantage Fund (5.6%); TerraForm Power, Inc. Baron Asset Fund (1.3%),
Baron Opportunity Fund (1.4%), Baron Focused Growth Fund (2.0%), Baron Energy and Resources Fund (1.9%), Baron
Global Advantage Fund (2.8%); TerraForm Global, Inc. Baron Opportunity Fund (1.1%), Baron Fifth Avenue Growth
Fund (1.9%), Baron International Growth Fund (1.1%), Baron Emerging Markets Fund (1.0%), Baron Energy and
Resources Fund (3.0%), Baron Global Advantage Fund (4.1%); Abengoa Yield plc Baron Small Cap Fund (0.2%),
Baron Energy and Resources Fund (1.4%). Portfolio holdings may change over time.

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