Project_finance_introduction

ProjectFinanceCampbellR.HarveyAdityaAgarwalSandeepKaulDukeUniversityContents•TheMMProposition•WhatisaProject?•WhatisProjectFinance?•ProjectStructure•Financingchoices•RealWorldCases•ProjectFinance:ValuationIssuesTheMMProposition“TheCapitalStructureisirrelevantaslongasthefirm’sinvestmentdecisionsaretakenasgiven”Thenwhydocorporations:•Setupindependentcompaniestoundertakemegaprojectsandincursubstantialtransactioncosts,e.g.Motorola-Iridium.•Financethesecompanieswithover70%debteventhoughtheprojectstypicallyhavesubstantialrisksandminimaltaxshields,e.g.Iridium:veryhightechnologyriskand15%marginaltaxrate.Contents•TheMMProposition•WhatisaProject?•WhatisProjectFinance?•ProjectStructure•Financingchoices•RealWorldCases•ProjectFinance:ValuationIssuesWhatisaProject?•Highoperatingmargins.•Lowtomediumreturnoncapital.•LimitedLife.•Significantfreecashflows.•Fewdiversificationopportunities.Assetspecificity.WhatisaProject?•Projectshaveuniquerisks:–Symmetricrisks:•Demand,price.•Input/supply.•Currency,interestrate,inflation.•Reserve(stock)orthroughput(flow).–Asymmetricdownsiderisks:•Environmental.•Creepingexpropriation.–Binaryrisks•Technologyfailure.•Directexpropriation.•Counterpartyfailure•Forcemajeure•RegulatoryriskWhatDoesaProjectNeed?Customizedcapitalstructure/assetspecificgovernancesystemstominimizecashflowvolatilityandmaximizefirmvalue.Contents•TheMMProposition•WhatisaProject?•WhatisProjectFinance?•ProjectStructure•Financingchoices•RealWorldCases•ProjectFinance:ValuationIssuesWhatisProjectFinance?ProjectFinanceinvolvesacorporatesponsorinvestinginandowningasinglepurpose,industrialassetthroughalegallyindependententityfinancedwithnon-recoursedebt.ProjectFinance–AnOverview•OutstandingStatistics–Over$220bnofcapitalexpenditureusingprojectfinancein2001–$68bninUScapitalexpenditure–Smallerthanthe$434bncorporatebondsmarket,$354bnassetbackedsecuritiesmarketand$242bnleasingmarket,butlargerthanthe$38bnIPOand$38bnVenturecapitalmarket•Somemajordeals:–$4bnChad-Cameroonpipelineproject–$6bnIridiumglobalsatelliteproject–$1.4bnaluminumsmelterinMozambique–€900mA2RoadprojectinPolandTotalProjectFinanceInvestment050100150200250MillionUSD19971998199920002001YearsTotalProjectFinanceInvestmentEquityFinanceMLA/BLABondsBankloans•Overall5-YearCAGRof18%forprivatesectorinvestment.•ProjectLending5-YearCAGRof23%.NumberofProjects0100200300400500600700NumberofProjects19971998199920002001YearsNumberofProjectsProjectwithBondFinanceProjectswithBankLoanFinanceLendingbyTypeofDebtPercentLendingbytypeofdebt0%10%20%30%40%50%60%70%80%90%100%19971998199920002001YearsPercentageBondsBankLoansProjectFinanceLendingbySector$-$20.00$40.00$60.00$80.00$100.00$120.00AmountUSD19971998199920002001YearsAmountofProjectLendingbySectorIndustrialLeisurePetrochemicalMiningTelecomOilandGasInfrastructurePower•37%ofoveralllendinginPowerProjects,27%intelecom.•5-YearCAGRforPowerProjects:25%,Oil&Gas:21%andInfrastructure:22%.Contents•TheMMProposition•WhatisaProject?•WhatisProjectFinance?•ProjectStructure•Financingchoices•RealWorldCases•ProjectFinance:ValuationIssuesProjectStructure•Structurehighlights•ComparisonwithotherFinancingVehicles•Disadvantages•Motivations•AlternativeapproachtoRiskMitigationStructureHighlights•Independent,singlepurposecompanyformedtobuildandoperatetheproject.•Extensivecontracting–Asmanyas15partiesinupto1000contracts.–Contractsgoverninputs,offtake,constructionandoperation.–Governmentcontracts/concessions:oneofforoperate-transfer.–Ancillarycontractsincludefinancialhedges,insuranceforForceMajeure,etc.StructureHighlights•Highlyconcentratedequityanddebtownership–Onetothreeequitysponsors.–Syndicateofbanksand/orfinancialinstitutionsprovidecredit.–GoverningBoardcomprisedofmainlyaffiliateddirectorsfromsponsoringfirms.•Extremelyhighdebtlevels–Meandebtof70%andashighasnearly100%.–Balanceofcapitalprovidedbysponsorsintheformofequityorquasiequity(subordinateddebt).–Debtisnon-recoursetothesponsors.–Debtservicedependsexclusivelyonprojectrevenues.–Hashigherspreadsthancorporatedebt.ComparisonwithOtherVehiclesFinancingvehicleSimilarityDis-similaritySecureddebtCollaterizedwithaspecificassetRecoursetocorporateassetsSubsidiarydebtPossiblerecoursetocorporatebalancesheetAssetbackedsecuritiesCollaterizedandnon-recourseHoldfinancial,notsinglepurposeindustrialassetLBO/MBOHighdebtlevelsNocorporatesponsorVenturebackedcompaniesConcentratedequityownershipLowerdebtlevels;managersareequityholdersDisadvantagesofProjectFinancing•Oftentakeslongertostructurethanequivalentsizecorporatefinance.•Highertransactioncostsduetocreationofanindependententity.Canbeupto60bp•Projectdebtissubstantiallymoreexpensive(50-400basispoints)duetoitsnon-recoursenature.•Extensivecontractingrestrictsmanagerialdecisionmaking.•Projectfinancerequiresgreaterdisclosureofproprietaryinformationandstrategicdeals.Motivations:AgencyCostsProblems:•Highlevelsoffreecashflow.Possiblemanagerialmismanagementthroughwastefulexpendituresandsub-optimalinvestments.Structuralsolutions:•Traditionalmonitoringmechanismssuchastakeovermarkets,stagedfinancin