Prepared by the students of corporate finance at the MBA program of IE Business School, this presentation provides an introduction to project finance and analyzes two case studies involving project finance.
2-What is project financeDefinitionLifespan of the projectStable cashflowsStructureStakeholdersPeopleLEIDY
3a Why Project FinanceWhy people go for it, comparison with other financial instruments (normally it’s internal financing) (see course material, 5 criteria)DIEGO
5 How is project finance used currently?Historical, statistical, industry overviewIndustry sizeSize of project financingTrends and geographical distribution of project financingAnurag/Alessio
5 Peculiarities of project finance in emerging countriesPRATEEK
The Financial strategy involves access to long term, corporate debt at the Abengoa companies level (Abengoa issues debt mostly through the holding company, but other operational companies may also issue corporate debt). Abengoa parent companies receive cash-flows from project companies both through dividends, through construction contracts and through O&M contracts with parent companies. Infrastructure project companies also issue long term debt, but this debt is non-recourse, project financing debt. Project financing is an important part of the strategy as banks that lend long-term resources to Abengoa parent companies do not consider non-resource debt as part of Abengoa’s net debt.
Abengoa’s higher leverage has not hindered its access to debt markets. Actually, banks do not perceive an increase in total debt as an increase in corporate risk, since a large part of total debt consists in project financing. Abengoa’s long term corporate debt has only one covenant: Net Corporate Debt/Corporate EBITDA. Cash, debts and EBITDA in projects financed by non- recourse debt are not taken into account. Only corporate cash, corporate debt, corporate EBITDA (including project dividends) are considered for its 3.0 Net Corporate Debt/Corporate EBITDA covenant. By this standard, Abengoa still has room for new corporate debt as Net Corporate Debt/Corporate EBITDA has ranged from 1.17 to 1.84 from 2007 to 2009.
However, as a consequence of the greater total financial leverage Abengoa’s ROE has substantially increased, even considering the increase in its interest expenses. On the other hand, higher leverage also brought a higher beta and consequently Abengoa’s cost of equity also increased in the same period, as it can be seen in table 4 and figure 12.
Finally, table 6 and figure 14 point out another interesting effect of Abengoa’s strategy, the huge financial cycle reduction from 2.4 days to –164.8 days between 2001 and 2010, which consequently implied in an increase of cash position caused by working capital reduction.
However, taking into consideration the rise in value created for Abengoa’s stockholders in the last ten years, the final economical result of Abengoa’s financial strategy has been extremely positive. As it can be seen in table 5 and figure 13, Abengoa’s EVA had a substantial growth from 2001 to 2010, which largely explains the performance of Abengoa’s stock in the period. Quite simply, EVA is the profit earned by the firm less the cost of financing the firm's capital.where: , is the Return on Invested Capital (ROIC); is the weighted average cost of capital (WACC); is the economic capital employed;NOPAT is the net operating profit after tax, with adjustments and translations, generally for the amortization of goodwill, the capitalization of brand advertising and others non-cash items.
WHY PROJECT FINANCE? • All flows separated and debt is non recourse Flexibility • Obtains capital while preserving control. Opportunity cost. • Project is spun-off as a separate company Risk • Creditors have no recourse and risk is allocated to shareholders • Lower agency costs and more efficient valuation and risk control Income • Reduced bankruptcy costs and possibly higher debt tax shields • Increased accountability to investors Control • Management remains in control and is accountable • Financing lifetime is finite and highly structured Timing • Slow to put together Other • Failure of parent posses less risk to project • New conflicts of interest can develop
PROJECT FINANCE OR CORPORATE FINANCE?COMPARISON OF STRUCTURAL ATTRIBUTESAttribute Project Finance Corporate FinanceOrganizational Structure -Separated Legal Entity -Secured Debt/Corporate (SPV) Obligation -Facilitate Asset SecuritizationCapital Structure -High Leverage -Median Debt/Total Cap: -Resembles LBO 33%Ownership Structure -Highly concentrated D&E -Recourse to parent ownership -Syndicated Nonrecourse Loans -Equity: 2-3 sponsors, privately heldBoard Structure -Affiliated board members -In large Public firms: 10% -(83%) of sponsor firms affiliated directors -no. of members proportional to size of projectContractual Structure -Large no. of agreements -Limited Contracts
DISADVANTAGES OF PROJECT FINANCE Higher transactions costs involved Contracts can be very complex and allow less managerial flexibility Takes more time to structure and negotiate Project debt can be more expensive Requires greater disclosure of proprietary information
PROJECT FINANCE EVOLUTION • Began in the 80’s to build new power plants • Became the first choice for Governments, NGO’s, and Municipalities to fund new plants • By the 90’s, integrated with the public sector activities: roads, schools, prisons, and roads. • PPP’s- Public Private Partnerships were used to expand the availability of funds. • Today: Used in both developed and developing countries across a broader range of sectors. • Bank loans provide the majority of debt. In 2009 banks financed 461 projects with over $139 Billion while bonds financed 31 projects with $8B.
RECENT TRENDS IN PROJECT FINANCE Geographical Breakdown of Project Finance Volume 12% 21% 33% Western Europe Asia Middle East 16% 18% North America Others
PROJECT FINANCE IN DEVELOPING COUNTRIES GDP is driven by is boosted by Productivity Infrastructureper capita Enables funding for Project Finance
CASE STUDY– DABHOL POWER Electricity D/E Ratio: 70:30 India Dabho l Power Biggest foreign Plant 1993 investment in 1992 $2.9b
WHY THIS EXAMPLE?• To understand the typical risks of a plant set-up in an emerging economy• Review reasons of failure of a project - all parties affected, finally exited• Evaluation of a backup plan
DABHOL – PROJECT STRUCTURE Project Sponsor Enron Corp (65%) Dividends + Capital Banks Interest ANZ, Credit Administration Principal + Interest Suisse First Payment + Cash Project Company boston, ABN- Maharashtra Flows Amro, Citibank. State Electricity Dabhol Power State Bank of Board (15%) Corporation Debt Financing India, ICIC, IFCI, IDBI, Canara Bank Payment Construction and OM Agreements Guarantors Govt. of Operation & Project Maintenance Maharashtra, G Developer ovt. of India Company Enron Corp Bechtel (10%) General Electric (10%) Suppliers
DABHOL – ANALYSIS OF RISKSType of Risk Concerns Stakeholders Inappropriate Conclusion ActionsResource Risk •Contamination of DPC, GOM, -DPC ignored public -Terrible publicity(Water & Land) salt water, used by Enron complaints - Pressure to fishermen -Government severely change practices •Diversion of fresh ignored public -Delay in project water permission and •Land acquisition environmental impact - Enron denialPolitical Risks -Changing state GOM, GOI, - New govt. dismissed -MSEB rescinded govt. DPC, Enron the contract the contract in -Slow moving -MSEB renegotiated 2001 admin. the deal for higher -Enron halted -Conflicts of stake. phase II project, contract terms - Govt. refused for any issued a notice to state owned to buy the sell is stake for stake $1bn. - Enron had to settle for a discountCommercial Risk -Default on MSEB, GOM, -Forced MSEB to buy -An arbitration payments GOI power at higher price notice -payments in US$ - Evoked political Force Majeure
DABHOL – ANALYSIS OF RISKSType of Risk Concerns Stakeholders Inappropriate Actions ConclusionTechnology Risk None DPC, Bechtel - Legal notice from MSEB for inadequate capacity as a counter to DPC’s invocationsLegal Risk None DPC, Enron - MOU includes clauses - Unclear nature of in conflict with Indian PPA, DPC accused law of fraud - Price in USD, against the Indian norms - Allowed ROE of 31% with a limit of 16% for power generating companiesHuman Rights Risk - Protest from local DPC, Enron -Ignored public -Delayed activists/bodies complaints - Damages payable -Protestors harassed threatened the -Political risk finances of the - Insurance from OPIC project
DABHOL – LESSONS LEARNT Reduce dependence on MSEB, by allowing Central Govt. owned utilities to buy power Involve the World Bank or multilateral financing agency, to avoid political risks Detailed study on the financial credibility of the host country Rigid contractual framework, with the right to sell electricity to other customers Financial updates/status reports on the customer Alternate sources of financing Communication and transparency Take local law into account
CASE STUDY– ABENGOA High leverage Expen Size diture Abengoa Time Location
AN INTRODUCTION1940 1970 1990 Founded in Seville The company grew in 1940 as a small in the Spanish engineering From the 1990’s the market and, from company company started to the 1970’s it started specialized in invest in to diversify its electric assembly infrastructure activities projects assets, both in internationally Spain and abroadToday has geographically diversified activities, in 2010 EBITDA of 942 mioEurosAbengoa is a diversified group that focuses on three activities: Require Know-how• Engineering and construction Operational efficiency• Concession-type infrastructures Proprietary assets• Industrial production
GROWTH STRATEGY Non- recourseInfrastructure debt I2 Assets* CF1** Abengoa E&C Infrastructure I1*** Project Activities Assets* CF1** companyInfrastructure Assets* Abengoa I1*** CF1** Abengoa Project Infrastructure E&C Assets*Infrastructure company Activities Assets* I2 Non- recourse debt*Governed by long term sales contracts and hence source of stable revenues.**CF = Dividends + Cash Flows from O&M activities***I1= Equity + Corporate Debt
INVESTMENT STRATEGY New concession-type project assets, built by Abengoa’s Engineering companies.FINANCIAL STRATEGY• Access to long term, corporate debt at the Abengoa companies level• Use of non-recourse debt at SPC (Special Purpose companies, i.e. Project Finance vehicles) level• Stabilization of cash-flows for parent companies
CONCLUSIONS Abengoa successfully evolved from a business strategy focused on heavy engineering to include both construction activities and long term investments in infrastructure assets Abengoa fully explores all synergies between construction business and infrastructure services by: Using project finance for projects with a higher risk profile, thus also reinforcing corporate’s ability to raise more debt. Using corporate financing to finance non-cyclical activities Construction budgets are managed to produce payables with long maturities. As a consequence, working capital is a source of cash in Abengoa’s financial model.Abengoa is able to be very competitive in public auctions through a lowROA (4-6%). This would translate into a low return on investments if thecompany wasn’t able to make use of high leverage, achieving an ROE of 17-26%.