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Project Finance

Project Finance

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Published by Kshitij Shah

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Published by: Kshitij Shah on Aug 28, 2010
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10/20/2010

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Project Finance

By S.CLEMENT

Project Finance -features
‡ To finance ± New, Expansion, Modernization, Diversification etc ‡ High value investment ‡ Longer Gestation period ± break even period is longer ‡ High risk ± spread over longer time horizon and future is full of uncertainty ‡ Irreversible decision ± difficult to come out or quit

Project Finance
‡ A funding structure that relies on future cash flow from a specific development as the primary source of repayment, with that development¶s assets, rights and interest legally held as collateral security ‡ It looks in to cash flow as compared to conventional corporate lending which looks to the balance sheet and income statement.

Project finance . exp. Building Machinery Other assets Pre op.C Contingencies ‡ ‡ ‡ ‡ ‡ Means of finance Capital Bank loans Un sec.structure ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Cost of project Land & site dev. Margin for W. loans Subsidy .

Project finance involves ‡ ‡ ‡ ‡ ‡ ‡ MANGERIAL FINANCIAL TECHNICAL COMMERCIAL LEGAL ECONOMICAL .

Managerial Appraisal ‡ Most subjective aspect ‡ Types of promoters ± Existing companies ± RIL/Bajaj Auto ± First generation ± E. Narayana Murthy of Infosys ± Government/ PSUs ± SAIL. ONGC etc ± Foreign promoters ± Pepsi/Coke/Ford motors.g. . Covered under FDI. Mr.

‡ Qualification ± technical or otherwise ‡ Composition of board .% of independent /professional directors ‡ Management structure ± centralized /decentralized/ reporting systems ‡ Corporate governance ± ethics/ /transparency/disclosure ‡ Stake in the business ± high or low .Managerial Appraisal ‡ Managerial ‡ Promoters¶ track record ± individual /group/ how group companies are managed.

Sales realization -.Cash realization . cash-flow and balance sheet ‡ More emphasize on cash flows ‡ Assumptions underlying profitability projections ‡ Critical assumptions ± ± ± ± Installed capacity Capacity utilization ± 1st/2nd/3rd year etc Product mix Consumption of inputs & prices -.Financial appraisal ‡ Estimates of profitability.

FINANCIAL APPRAISAL ‡ Debt Equity ‡ Cash flows ±realistic vis-à-vis to loan repayment ‡ Breakeven/ cash BE ‡ profitability ‡ DSCR ‡ NPV/IRR ‡ Sensitivity analysis .

particularly the PBIDT margin.Financial appraisal ‡ Compare profitability with that of existing firms in similar line. ‡ It takes into account time value of money ‡ The sum of money received in future is less valuable than it is today. Re 100 today may not have the same value after one year. ‡ With Passage of time present value of rupee to be received in future will go on decreasing ‡ Technique of finding present value of money through discounting is NPV/IRR method . Present value of rupee to be received is less than one. E. ‡ NPV/(net present value) IRR (internal rate of return) method: Considered to be best method for evaluating the capital investment proposals.g.

Financial appraisal ± Sensitivity analysis ‡ Effect of adverse variance of critical elements on viability is examined ‡ Typical tests are ‡ Reducing sales vol. ./ Price ‡ Increasing cost of inputs ‡ Increase in project cost ‡ Effect of FE fluctuation ‡ Reduction in capacity utilization.

Technical appraisal ‡ Various areas covered are ± ± ± ± ± ± ± ± Locational aspects Process Technical arrangements Raw materials Utilities Environmental factors Manpower Implementation schedule .

g. Stand by arrangement for power.g.g. water etc].Location ± Proximity to markets [e. perishable products] ± Proximity to raw material supplies [resource based. Cement/Sugar ± Proximity to market ± E. Electronics ± Availability of labour [quality. quantity. water etc ± Governmental Policies [restrictions and sops] . transportation. imported raw material] E. cost. relations] ± Effluent disposal ± Other infrastructure [power.

Technical arrangements ‡ ‡ ‡ ‡ ‡ Technical collaboration Licensor of know-how/ basic engineering Patents/ updation clause Plant & machinery Guarantees/ warrantees ± Collaborator/ P&M supplier/ Details of engineering contractor ‡ Approach to ³force majeure´ conditions ± earthquake/storm etc ‡ Termination .

Technical arrangements ‡ Technical know-how agreement ± Supply/ vetting of basic engineering ± Guarantees ± Liquidated damages for non-performance ± Training of personnel ± Royalty ± Indemnity .

oil ± Past trends in growth ± Duties ± customs/excise ‡ Arrangements for supply .Raw Material ‡ Raw materials & quantity ‡ Sustained availability ± Imported/ indigenous ± Major suppliers ‡ Prices of raw material ± Price volatility ± E.g.

IMPLEMENTATION SCHEDULE ‡ Consequences of delay ± Increase in project cost ± Funding overrun ± Effect on viability ± Loss of market ± Confidence level of FIs .

Policy ± budget/foreign trade policy /FDI .inventions ‡ Customer profile ± high or low end/corproates/government/overseas etc ‡ Competitors profile ± local/international ‡ Demand & supply/market share ‡ Import threat.Commercial ‡ Product profile ± substitutes.WTO/ Trade block or CECA (comprehensive economic cooperation agreement) ‡ Pricing ± compatible with market/elasticity of price change ‡ Marketing/Selling arrangements ‡ Govt.

Legal ‡ Title to the property ‡ Object clause in Memorandam ‡ Powers to borrow & create charge .

PROJECT STRUCTURE Shareholder·s Agreement Sponsor 1 Sponsor 2 Construction and O&M Contractors O&M Contract Equity Insurance Policy Loan & Security Documents EPC Contract Insurance Company Project SPV LENDERS Lenders TRA Agreement Concession Agreement Lenders Engineer TRA Bank Government .

Risks Analysis ±Why? ‡ Many projects have: ± Large investment outlays ± Long periods of project payout ± Incomplete sharing of information and technology especially with foreign investors ± Differences in the ability of the parties to bear risks ± Unstable contracts ± Projects may be attractive in aggregate. . but are unattractive to one or more parties due to uncertainties about sharing risks and returns.

Risk analysis ‡ Strategic Risks ± Market demand [more often than not the demand projections have little credibility]. ± Unexpected/ unanticipated capital costs. ‡ Financial Risks ± Interest rate changes. ± Currency/ foreign exchange fluctuations. ± Operating costs [often underestimated]. ± Liquidity ± cashs flow mismatch .

Risk analysis ‡ Operational Risks ± Supply chain management ± Information systems ± Key managers ‡ Hazard Risks ± ± ± ± Property damage Legal risks Workers' compensation Natural disasters .

Risk control ‡ Within Company¶s Control ‡ Outside Company¶s Control ‡ Within Lender¶s Control .

WITHIN COMPANY¶S CONTROL ‡ Operating Risk ± Technical ± Cost ± Management ‡ Participant Risk ‡ Engineering Risk or Design Risk ‡ Completion Risk .

OUTSIDE COMPANY¶S CONTROL ‡ ‡ ‡ ‡ ‡ ‡ Supply Risk Market Risk Infrastructure Risk Environmental Risk Political Risk Force Majeure Risk ± Temporary ± Permanent ‡ Foreign Exchange Risk .

RISK SHARING SPONSORS SHAREHOLDERS¶ AGREEMENT BANKS CREDIT ENHANCEMENT SUPPLIERS SUPPLY AGREEMENTS PROJECT COMPANY OPERATOR LOCAL LAWS O&M AGREEMENT GOVERNMENT AGREEMENTS EPC CONTRACTOR EPC CONTRACT .

FC .Risk and risk mitigation ‡ ‡ ‡ ‡ ‡ ‡ Risks Political Interest rate Liquidity Force Majeure Exchange rate ‡ ‡ ‡ ‡ Risk mitigation Arbitration clause Hedging Cash flow arrangement/ standby * Insurance * Hedging .

‡ What is the strategy? What is secret of success ? .Strategy of Reliance Petroleum ‡ Why RPL is the most profitable refinery in the world? ‡ How RPL can achieve a refining margin of $ 9-10/barrel which is one and half times higher than the global players ? ‡ Singapore refineries can achieve just $3/barrel.

Strategy of Reliance Petroleum ‡ Ability to build larger projects cheaply(37% less than in US) ‡ Most other refineries sign long term contracts covering all their needs and tailor made refinery technology. ‡ RPL opted for highly complex refinery (out of 2300 different configurations) for a) to crack all low-value fractions (as fuel oil) into higher value products and b) complex refinery could refine a wide variety of crude. . It assures supply security but not price security.

? ‡ RPL took huge bet on composition of future oil supplies i. ‡ How did RPL justify such an expensive and complex compared to others.e. expected that supply low quality crude will outstrip that of high quality crude creating widening price discount for low quality varieties. .Strategy of Reliance Petroleum ‡ Of course. this flexibility came at a price since complex refinery cost is much more than stand alone.

RPL could spot opportunities continuously to buy cheap crude variety. the prices of different crude and products. ‡ RPL bet that this flexibility would justify high cost of complex refinery. ‡ Simple refinery lacked the flexibility to switch from one to another crude.Strategy of Reliance Petroleum ‡ This will make it profitable to buy low quality crude which could not be processed in efficiently in simple refinery but in complex refinery. ‡ By tracking. .

‡ Insecurity of supply can translate in to security of high profits. For the rest. it scans the market for short term bargains. .Strategy of Reliance Petroleum ‡ RPL strategy is based on opportunism in selecting profitable crude to import at any point of time ‡ It does not assure supply security. RPL has firm contracts for only half its capacity .

allocation and mitigation ... ‡ Identification of proper project ‡ Right transaction structure ‡ Proper risk identification.Successful project finance entails .

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