Alphabet, better known as Google, announced it would be accessing the municipal prepaid electric bond market to help fund its burgeoning capital plans. We believe this may be the first of many tech deals in the muni market, as other hyperscalers take note of Google’s successful municipal bond financing. However, there is a limit to the depth of municipal market demand, especially as it relates to the size of planned spending by hyperscalers. 

By way of background, the muni prepaid gas/electric market allows investment banks to raise money from investors to facilitate sales of gas to municipal utilities at a discounted rate. The investment banks can keep the proceeds of a prepaid gas bond issue for themselves or pass the proceeds on to separate entity, known as a funding recipient. The funding recipient takes on the responsibility to make periodic purchases of gas, acting as the guarantor of the transaction. Prepaid transactions have become an advantageous way for a corporation to issue debt in the municipal market at a lower borrowing rate and diversify their market access.  

The prepaid gas market has evolved drastically since its beginnings in the late 1990s. The market started as a means for bulge-bracket investment banks to diversify their funding sources as the funding recipient. In recent years, we have seen funding recipients evolve from large, traditional banks to regional banks, foreign banks, traditional insurance companies, private equity-linked insurance companies, a hedge fund, a REIT, and an investor-owned utility … and now, a massive technology company. Prepaid gas deals have also incorporated more investor-friendly provisions, including standardized documentation and structures. As the number of prepaid gas funding recipients has grown, so have the types of investors.  

While mutual funds were the predominate buyers of the original funding recipient structure, anecdotal evidence suggests separately managed accounts and individual bond buyers have scooped up prepaid gas in recent years.  

However, the municipal market is no stranger to corporations. There is a whole “industrial development” bond sector in the municipal sector, packed full of household names: United Airlines, Intel, Exxon, Waste Management, etc. In fact, nearly 20% of the Bloomberg High Yield Municipal Bond Index is in the industrial development sector. Corporations can be eligible to issue tax-exempt bonds if certain criteria are met, such as economic development and/or job creation. In the case of prepaid gas funding recipients, there does not seem to be any defined criteria for eligibility.     

With the municipal market having a history of funding corporations, we ask ourselves how deep municipal market demand is for corporate-backed paper. The answer can be found by examining the growth of the prepaid gas market. The amount of gross issuance in the municipal market has notched record levels across the last couple of years, and the prepaid gas market has tripled in size in only five years. The explosion in issuance of prepaid gas bonds has also led to prepaid gas bonds growing as a percentage of the overall municipal index. While municipal buyers have absorbed this growing portion of the market in stride, how palatable to investors would an even larger increase of hyperscaler prepaid gas bonds be?

Hyperscalers are incentivized to tap the municipal bond market because they pay interest rates that are often only a fraction of taxable corporate debt (~80-90%). Adding municipal bonds to their funding mix would bring down their WACC (weighted average cost of capital), especially for Google, which recently announced a very expensive $85B equity raise. While there is capacity to issue more in the way of prepaid gas/electric bonds because only ~3% of these energy sources have been prepaid by municipal utilities, the scale of issuance plans by the hyperscalers dwarfs current prepaid gas issuance levels in the muni market. Despite the economic incentives for hyperscalers to issue prepay gas bonds, the size of their capital plans will test the municipal market’s depth of demand. The Alphabet deal was sized between $1 billion to $1.25 billion and is being issued by the California Community Choice Financing Authority.