PROJECT REPORT OF INTERNATIONAL FINANCE ON

“The Refinancing of Shanghai General Motors”

........................................................................................................ 3...................... Brief info about the case: ....................................................... 3 Major issues of the Case .............................................. 12 Conclusion & Updates about the case .................................................................................................................. 6............................................................. 14 1 ............................. About Shanghai General Motors ............. Section A Contents 1................................................ 8 Possible Solutions ........................ 3 Questions addressed . 13 References ......... 10 Risks Faced ................................................................ 7 Identification of the Problem ........INTERNATIONAL FINANCE Project Report Group -3................................ 7.................................... 5 Capital Structure of SGM ....................................................................................................................................................................................................................................... 5 Cost of Initial Financing ............................................ 8................................................................................................................................................................................................................................................ 4.......................................................................................................................................... 5....................................... 5 Currency Composition of SGM.................. 4 2..............

1941 This report has been inspired and is the result of ten weeks of hard work and dedication. the process was interesting and motivating.Sir Winston Churchill. Although it was challenging at times. Srinivasan. First and foremost. Lucknow – Noida Campus for his help and guidance throughout the process of this research. we shall not weaken or tire. we would like to take the opportunity to express our gratitude to our mentor.INTERNATIONAL FINANCE Project Report Group -3. would not have been made possible if it had not been for a number of people. This research however. Prof. T... 2 . We would also like to thank those who helped us in gathering the information who took time out of their busy schedules to participate in this study and therefore made this research possible. Section A Acknowledgements “We shall not fail or falter. and provided us with a deeper knowledge in the area “Project Financing” and preferences. professor at the Indian Institute of Management.Give us the tools and we will finish the job” .

It also illustrates how multinational financial decision making--including transfer pricing. The case also touches on elements of foreign governments' attempts to regulate capital markets. who wants to refinance almost $900 million of project finance it rose to begin its operations. and funding decisions must be designed to accommodate governance concerns. financial objectives. Section A 1. Brief info about the case: "This case provides the outcome of "The Refinancing of Shanghai General motors (A)" in which the CFO of General Motors' joint ventured in Shanghai. and how subsidiary management can achieve the most desirable funding terms. the dynamic between domestic and international banks in competing for lending opportunities to multinational subsidiaries. the joint venture partner's captive finance subsidiary. and the potentially divergent interests of joint venture partners. and the conflicting goals of the joint venture partners. The highest priority is improving the terms of the financing with regard to costs and specific covenants. repatriation." Major issues of the Case  Joint ventures-how are organizational form and ownership decisions made within multinational firms and how do recent trends in international trade and finance impact these decisions?  SGM’s refinancing-how should Newman prioritize to his current financing? How can financing decisions interact with business risks?  Financial policy inside the firm-how should GM and multinationals make major financing decisions inside the firm? 3 . the impending entry of China into the World Trade Organization.INTERNATIONAL FINANCE Project Report Group -3. Shanghai General Motors (SGM). including the presence of capital controls. The framework of the ongoing operational and investment decisions that Shanghai General Motors undertakes in its early growth demonstrates the "life cycle" of subsidiary finance. Several factors complicate the CFO's objective. The case illustrates how subsidiary financial decisions must trade off entity-level and parent-level concerns.

Internal capital markets-Can the internal capital markets of multinational firms serve as a competitive advantage to these firms? 4 . For its upcoming SAIL project. Section A  Internal capital markets-Can the internal capital markets of multinational firms serve as a competitive advantage to these firms? Questions addressed Some of the questions we have tried to answer in this report based on our analysis: 1.INTERNATIONAL FINANCE Project Report Group -3. How to address the above problems – What are the options and solution? 5. should SGM use project-financing on existing terms or re-finance its existing debts altogether and start afresh? 3. How to hedge the foreign currency risk of SGM given the restrictive nature of derivative trading in China? 4. Why a joint venture was required? 2. What are the learning’s from the case? 6. Financial policy inside the firm-how should GM and multinationals make major financing decisions inside the firm? 8. SGM’s refinancing-how should Newman prioritize to his current financing? How can financing decisions interact with business risks? 7.

and auto parts centres throughout the country. The company's operations are supported by a network of dealerships. 51%) and General Motors (GM. About Shanghai General Motors Shanghai General Motors is where East meets West in the automotive world. It concentrates on making sedans. manufactures and markets vehicles. 3. and Cadillac brands. The company. Section A 2. Chevrolet. which was established in 1997. Capital Structure of SGM 4. and transmissions from three plants. including models under the Buick. a joint venture between leading Chinese car maker Shanghai Automotive Industry Corporation Group (SAIC. Cost of Initial Financing • • USD Loan was costing Floating LIBOR +105 bps Chinese RMB Loan was costing Floating PBOC rate China was a promising market and GM had the means to do it all alone. Then why did it choose to go for a joint venture? 5 . repair facilities. is one of the fastest-growing car companies in China. 49%).INTERNATIONAL FINANCE Project Report Group -3. Shanghai GM. engines.

This can make it more difficult for an MNC to set transfer prices for intercompany transactions or to structure finances in a way that would minimize its global tax burden since these decisions may affect the profitability of the local venture. If an MNC is serving a global market. then local knowledge becomes less critical and local partners less valuable. SAIC may see SGM as becoming a more global player and even competing directly with GM around the world. Joint ventures and shared ownership make sense when the focus of operations is purely local. for example. it will have to cope with higher tariffs and more competition. they have to structure production across countries in ways that minimize worldwide costs. Now the next question is Why firms may seek full ownership of foreign subsidiaries instead of using joint ventures? Biggest impact of the partnership:  China’s WTO accession poses several challenges for SGM: in the short run. Local partners that are focused on the local market may not have the same priorities. however. Section A As MNCs increasingly serve global markets. Over time. though. especially if GM can restructure its worldwide operations more efficiently. will also change with China’s WTO accession. not in optimizing the overall value of the MNC.  These changes will make it possible for GM to achieve lower costs. giving rise to conflicts over sourcing and selling decision. Let us first understand Project financing and how they are distinctive from general corporate financing? 6 . The broader evidence also suggests that transferring intellectual property can also make joint ventures less desirable. it is likely that the joint venture will become less and less valuable to the respective partners. then outright ownership of foreign affiliates is a more efficient structure for an MNC.  SAIC’s priorities. China’s entry into the WTO will result in low tariffs and more open trade.INTERNATIONAL FINANCE Project Report Group -3. Over the long run. once an industry starts to globalize. Furthermore. local partners have a stake in the profitability of the local venture only.

Although it is in principle different from managerial finance which studies the financial decisions of all firms. which are secured by the project assets and paid entirely from project cash flow. as indicated below: to understand the currency mismatch: all of SGM’s revenues are in RMB while its costs ( including financing) are split between U. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks.S. known as sponsors. as well as a syndicate of banks that provide loans to the operation. How to characterize this investment as a financial play. Usually. the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. a project financing structure involves a number of equity investors. rather than corporations alone. The loans are most commonly non-recourse loans. rather than from the general assets or creditworthiness of the project sponsors. Currency Composition of SGM At its founding. what is SGM naturally long in and short in? 7 . SGM was required to divide its debt equally between U.INTERNATIONAL FINANCE Project Report Group -3. dollars and Chinese renminbi and to pay down its debt evenly in its currency. Section A Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors.S. and are able to assume control of a project if the project company has difficulties complying with the loan terms. 5. This is a problem.$ and RMB. Whereas corporate finance is the finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. a decision in part supported by financial modeling. Project lenders are given a lien on all of these assets. including the revenue-producing contracts. The financing is typically secured by all of the project assets.

there are implications of capital account nonconvertibility. should SGM use projectfinancing on existing terms or re-finance its existing debts altogether and start afresh? And How to hedge the foreign currency risk of SGM given the restrictive nature of derivative trading in China Problems of Existing Financing Terms: High cost of debt due to Asian Crisis.Short selling (often "selling short") is a technique used by trader who wants to profit from the falling price of a currency pair. If it is opposite. If the US$ appreciates against the RMB. she "covers the short position" by buying back the EURUSD. how? 6.INTERNATIONAL FINANCE Project Report Group -3. Situations have improved since then and loans are available at more favorable terms. commodity or currency. But if the price of EURUSD increases the position will create a loss. Restrictive clauses of existing financial terms has caused any finance related decision needed a super-majority 8 . large amount of dollar debt amplify this risk. SGM is naturally long RMB as it has RMB revenues and some dollar operating costs.  In contrast. How should currency decisions on debt respond to these natural exposures?  Borrowing in the local currency would at least not compound that natural exposure. Short . Identification of the Problem Primary problem of the case is: For its upcoming SAIL project. consider an investor who wants to sell short EURUSD. Section A Long . the US Dollar is ready for a rally and EURUSD will fall. The profit is the difference between the price at which the currency pair was sold and the cost to buy it back. For example. this would create significant problems for SGM because it is short in US$. If the price of the currency pair drops.  The US$ component of its debt means that SGM has significant financial risk layered onto its operating risk. believing the Euro is overpriced. Where else in the world currency mismatches between revenues and financing costs have been problematic? That implies the currency mismatch between SGM’s revenues and costs creates financial risk and that may affect its current financing. with the expectation that the asset will rise in value.The buying of a security such as a stock. minus the spread and any interest rollover.

The controlled supply of foreign currency by SAFE made the repayment of USD loan uncertain What does Mark Newman want to change in SGM’s debt? Newman aims to increase the RMB component of SGM’s debt to better match the company’s revenues and lower financial risk. This behavior is usually attributed to informational and agency problems. All existing and future assets of SGM were pledged and Equal use and pro-rata repayment of Chinese and American currency loans. Nonetheless. increasing dividend payouts signal that a firm is profitable and growing and regular dividends reassure investors that managers are not retaining profits for their private benefit.INTERNATIONAL FINANCE Project Report Group -3. He also wants to take advantage of opportunities for lower interest rates on the RMB denominated debt since there appears to be an abundance of local currency and capital controls currently limit investors’ ability to invest RMB abroad. The optimal amount of debt for a firm is a trade-off between tax benefits and the cost of financial distress. Section A approval of the existing bank committee. The super-majority clause was restricting decision making in areas such as expansion. A firm’s dividend policy is also irrelevant in an idealized world. firms generate interest tax shields by taking on debt. but in a world with taxes. USD LIBOR rates at 6. tax costs typically deter dividends as firms could instead repurchase their shares and avoid tax costs. In an idealized world. Recalling . GM and all MNCs face analogous problems inside the firm when they make decisions about capital structure and dividend policy for their subsidiaries 9 . capital expenditure etc.2% were higher than the Chinese RMB rate of 5. If dividends are taxed.Capital structure and dividend policy are two key financial policy decisions for every firm that they will likely consider. yet re-adjustment was not possible due to the proportionate borrowing clause between USD and RMB Use of derivatives for hedging risks was also restricted except for forward contracts. firms do pay regular dividends. Predictable. capital structure is irrelevant.85%.

in contrast. Possible Solutions REFINANCING Interest rates in China has been lower than the 6 month LIBOR rates on which the USD loans were based LIBOR 8 6 4 2 0 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 10 The chart below shows quite a stable exchange rate between USD and CNY during the period under discussion. local firms experience declines in sales and investment. repayments of longterm debt would be made pro-rata. increase their sales and investments in the aftermath of currency crises. . Section A Currency crises provide a good example of how MNCs gain benefits from their internal financial networks when markets are highly distorted.INTERNATIONAL FINANCE Project Report Group -3. drawing down equal amounts in US$ and in RMB. with denominated in each currency being paid down at the same rate. These internal markets provide affiliates with both sales outlets for their products and access to capital when the external capital markets are most distorted. Hence there is not much risk of loss in repatriation of profit due to currency appreciation in U. Similarly. 7. Multinational affiliates. In the aftermath of sharp currency depreciations. The loan agreement also stipulated that long-term borrowings would be made evenly as practicable.S. when the local economy is weakened. They are able to do so because of their access to internal markets.

i.e. Hence the course of action available to SGM is:  Borrow in Chinese currency and repay the old loans  Reduce exposure to foreign exchange as there are not many hedging options available  Become self-sufficient. we feel that even if the interest rate parity and purchasing power parity holds loosely. it will be more profitable to borrow in Chinese currencies. In the face of increased competition. reduce dependency on parent company Other option is to take no action: Continued dependency on the existing banking committee. Decision making will be slow and SGM will not be able to react quickly to the increased competition when China joins WTO. Section A Inflation rates in US have been historically higher than that of China Based on the above three statistics. GM cannot take advantage of the interest rate differentials.INTERNATIONAL FINANCE Project Report Group -3. SGM will not be able to reduce its 11 .

SGM’s tariff costs will actually increase for a period. meaning it will have to pay the same tariffs as all its competitors.  One of Newman’s aims in the refinancing is to gain more flexibility for SGM so it can take advantage of growth opportunities.  SGM’s introduction of a new model required cumbersome negotiations with the lenders’ bank committee and made it difficult for SGM to respond quickly to the market. Since there aren’t any derivatives available. SGM will gain little and may lose somewhat. therefore. Forward Rate Agreements or Interest rate swap if possible 12 . however. Risk of SAFE not supplying enough USD to make payments Mitigating Interest Rate Risk 1. SGM will immediately lose its preferential tariffs based on localization ratios with China’s WTO entry. lower tariffs will lower costs.INTERNATIONAL FINANCE Project Report Group -3. Such restrictions are typical of project finance. Priorities as Newman approaches this refinancing  SGM faced various hurdles in its original financing: it was a start-up venture.Risk of depreciation of Chinese currency and thus dearer imports from US. 8. was both restrictive and expensive. interest rate risk can be mitigated only by an interest rate cap. In the short –run. Since lower tariffs will be phased in gradually.Risk of an increase in 6mnth LIBOR or PBOC rates Currency Exchange Rate Risk . and the host government imposed various requirements on SGM. SGM’s financing.  The initial project was defined in detail and SGM required approval from all its lenders for any changes-and those lenders would demand fees for such changes. the Asian financial crisis meant that debt providers were very cautious. where lenders seek to limit their risks by imposing strict controls on how funds are used. Risks Faced Interest Rate Risk . China’s entry into the WTO means that tariffs will come down and. Section A interest expense. in the long run.  Newman’s goal is to move SGM more toward a corporate finance model based on relationship with a smaller number of banks and loans with restrictive covenants.

” HBS Case No.INTERNATIONAL FINANCE Project Report Group -3. Localization: reducing dependency on US imports and thus reducing USD liability 3. SGM lowered its interest costs on both the USD and RMB components of the debt and the number of banks in the lending syndicate was reduced from 39 to 15. SGM’s robust cash flows allowed Newman to reduce the total debt to $700 million.  In recent years. Export: Export products to US in order to balance out payables and receivables in the same currency Conclusion & Updates about the case  The terms of SGM’s successful refinancing are explained in the follow -up case. engineering and production across its subsidiaries and announced its commitment to global product development—a move towards the vertical model of multinationals described in the case.  SAIC continues to partner with both GM and Volkswagen in the Chinese market while also pursuing new partnerships abroad. a step towards its announced goal of becoming a global player in its own right. GM has tried to minimize the costly duplication of product design. 204 -025. composed of $160 million in USD and $540 million in RMB.  SAIC sold its own passenger car in China by 2007. Refinancing: Change the borrowings from USD loans to Chinese RMB loans to avoid payment in USD 4. The term sheet included only standard financial ratio covenants and thus freed SGM from the many restrictive covenants of the original financing. “The Refinancing of Shanghai General Motors (B). Section A 2.  Newman gained approval from the SGM board for refinancing and the transaction was completed in June 2001. 13 . notably in Korea.

and several other projects in and around the city of Shanghai. One Company..2013 14 . 2012.h tm 10. Reuters. 8. 2011.INTERNATIONAL FINANCE Project Report Group -3. "GM's Shanghai joint venture opens new plant". Cuts the Price On 2 Cars in China". Retrieved 10 January 2013. www. the Buick Regal was being assembled in China for the Chinese market. 7 January 2012. General Motors. Globalization. "1982 -1999. The New York Times. "1995. General Motors Company. The Star.shanghaidaily. Section A References 1. history. January 8.gmheritagecenter. history. marking the Buick brand’s proud return to China.. Retrieved 2011-05-30.M. Srinivasan.wikipedia. Archived from the original on 2011-05-30. 2011. One Team". Retrieved 2011-05-30. "G. "Also in 1995. history. "General Motors Sets Sales Record in China in 2011" (Press release). GM Links with SAIC". 9." 4. The Detroit Free Press.com.." 5. 2012).. "GM signed a milestone agreement with China’s Shanghai Automotive Industry Corporation (SAIC) for a proposed automotive joint venture. gmheritagecenter. Nathan Bomey (April 18. laying the foundation for unprecedented growth over the next few years." 6. 11. a joint venture technical center. Archived from the original on 2011-05-30. com. General Motors Company. "GM says 2006 China vehicle sales up 32 pct". "The General Motors-SAIC joint venture plant in Shanghai began building Buick Regals for the Chinese market. the company entered into a joint venture agreement with Shanghai Automotive Industry Corporation (SAIC) in China. 4 January 2012. 28 May 2005. 2.com/sp/article/2010/201002/20100224/article_429322. 7. 2011. http://www. Cases and Theories discussed in International Finance Class conducted at IIML-Noida Campus by Prof T.02. Buick is Back in Shanghai".com.com 3. Four years later. Archived from the original on 2011-05-30. General Motors Company. "GM regains 50% stake in its largest Chinese partnership". Retrieved 02. "1999. Retrieved 2011-05-30.gmheritagecenter. Retrieved 10 January 2013.

15 . 17. 16. "GM China sales growth slumps to 6% in 2008". Reuters. China Daily. 19 Feb 20103.9 pct on strong Chevy demand". 15. 6 January 2012.M. Retrieved 5 Feb 2013. "GM 2012 global sales rise 2. "G. 10 January 2012. "Summary: Shanghai GM's sales performance from 2002 to 2012". 14. The New York Times. Retrieved 5 January 2013. 4 January 2010. Retrieved 20 January 2013.INTERNATIONAL FINANCE Project Report Group -3. 13. GM Report Record China Sales". Section A 12. Retrieved 5 Feb 2013. "GM's China sales growth slows on VW and Ford competition". Sales in China Rose 67% in 2009". The New York Times. 9 January 2011. The Street. "Ford. 14 January 2012. Retrieved 6 January 2013. Gasgoo.

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