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Private and confidential

Oil & Gas Conference


Joint Venture Financing Discussion Materials
11 July 2013

Contents

Section

Page

1.

Understanding Joint Ventures

2.

Funding Options

3.

Case Study

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Private and confidential

1. Understanding Joint Ventures

Understanding Joint Ventures

Definition of a Joint Venture

The Term joint venture (JV) is one of art, not law. The term itself is very vague and does not describe the actual structure
adopted or even the objectives. It merely suggests that each of the investors are to a greater or lesser extent active rather than passive participants

Likewise, there is no law of joint ventures as such and this area usually involves a mix of contract and corporate law
and in some cases concepts from partnership, equity or agency law.

Examples of joint venture relationships include mining or exploration agreements (involving an investor and an operator),
investment arrangements (i.e. involving a capital investor and an existing trading company), co-suppliers which require greater size to be competitive and gain economies of scale etc.

Rationale for a Joint Venture:

Allows international investors to acquire local knowledge and contacts by entering a joint venture with a local entity.

Newrest and Uganda Inflight Services

It is a means of implementing changes to a companys strategic position and spreading its financial risk - i.e. by
allowing it to concentrate on its areas of relative competence while diversifying into unfamiliar business areas.

MTN Uganda and American Towers Joint venture

Allows a company to deal with business opportunities in its core area of competence which are too big for it. Therefore
joint venture entities can cope with large contracts and gain economies of scale.

Very Common in Construction sector (primarily roads & bridges) where local company does not have balance sheet

In contrast to using a company or partnership structure, a joint venture is seen as having advantages in terms of greater
flexibility. Parties are free from many of the restrictions under the partnerships and companies acts. Also, as opposed to a partnership, a joint venture structure gives each party a limited liability in the sense that each party is severally liable (and not jointly liable) for its share of monies owing to third parties

Understanding Joint Ventures

Joint Ventures

Un-Incorporated Joint Ventures Incorporated Joint Ventures


Equity Joint Ventures Corporate Merger Holding Company Structure

The Relationship is managed solely by a shareholders agreement

Contractual JV

Governed by JV agreement
Unregistered arrangement

All Corporate law protections

Incorporated JVs function like a stand alone Company

Unit Trusts

Partnerships

Key considerations of Incorporated Vs Unincorporated Joint Venture

Privacy

An unincorporated joint venture agreement is a private arrangement and therefore is not subject to public scrutiny like the articles of an incorporated company. The nature of the business or the sophistication of one the parties may lead to a choice of incorporated entity. The framework provided by corporate law and additional protection available to shareholders may be preferred as an incremental safeguard to contractual rights.

Legal Protection

Accounting Treatment

Partners may prefer an unincorporated venture allowing them to keep separate accounts and maintain their own accounting policies It is easier to transfer shares to incoming parties which is a big advantage of an incorporated joint venture. Because it tends to be specific as to the parties needs, a transfer of shares is unusual once JV agreement has been reached If the parties want to use collective financing and grant security over the joint venture assets, a company is necessary. Additional shares can be issued as a way of securing further capital

Transfer of Interests

Financing

Fiduciary Relationships

Easier to manage under an incorporated JV

Joint Venture Agreement Check List


Joint Venture Objectives

Should provide some detail on objectives of the JV

Conditions to Agreement

Will include Items such as: Regulatory consents Licenses required Approval of business plans Parents Board approvals Can be set up to be dependent on: Investors equity falling below a certain threshold Listing on an exchange Completion of a specific project or a specifies date

Term of Venture

Financing

Start-up Capital typically would be Equity (subscription for shares); agreement will set out the number, class, price Can be complemented with debt financing Subsequent capital raising to be set out in share holders agreement In an unincorporated JV property is beneficially owned in proportion to their interest Profits and losses also shared in proportion to these respective interests Under an Incorporated JV, the Company itself owns the assets and JV shareholders own the shares Need to specify independent auditors who will act as experts and not arbitrators Critical to separate Management from shareholders or board oversight Contracting a management company which provides indemnity to JV in case it breaches its contracts can be useful Also useful in allowing for knowledge transfer when Management is delineated

Ownership of Interests

Auditors

Management

Joint Venture Agreement Check List

Management Committee & Board Representation

Mandate and structure of Management Co (Un incoporated) and Board of Directors (Incorporated) are similar Each party will have representatives proportionate to their shareholding Certain decisions can be majority and others unanimous allowing minority some veto power Matters such as issue of new shares; acquisitions or divestments, dividend payments and major amendments should require unanimous consent Key to define confidential information and obligations of each party

Confidentiality

Certain experts believe remaining silent on this point will force parties to reach commercial solution
Alternative could be to appoint an expert or arbitrator. Time consuming but better than relying on courts Other Alternatives include; Swing man Director; shot gun provisions (forcing either party to buy or sell from other party); auction system (sell shares to highest bidder) Difficult to enforce unless there is a proprietary aspect to the JV Should have an expiry period and cannot be open ended Most critical provision of an incorporated JV Issue of new shares will require consent of all and offered on a pro-rata (rights) basis Transfer of shares should have pre-emptive right Management Contracts Financing Agreements Technical Services Agreement Brand Licence Agreement

Dispute Resolution

Non-Compete

Pre-emptive rights

Additional Agreements

Private and confidential

Funding Options

Trade-off between Capital Structure and Risk


Several Corporate Finance Tools at your disposal
Expected and Required After-Tax Rate of Return (%)

Seniority

Common Stock PIK Preferred Stock Holding Company

Cash Pay Preferred Stock


Risk Premium

Subordinated Notes Senior Notes (Unsecured) Senior Secured Notes/Mortgage Notes Common Stock PIK Preferred Stock Subordinated Notes Senior Notes (Unsecured) Senior Secured Notes/Mortgage Notes Credit Facilities Short-Term U.S. Treasury Bill Operating Company

Risk-Free Rate of Return

Risk to Investors

Indigenous Financing A Case Study on the Busingye Catering Dilemma


Project Overview
Busingye wants 48% ownership of the JV but only has US$ 1m at his disposal and needs to find funding for the balance

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Project Sponsor CNOOC Project Term 10 years Project Winner - Busingye Catering Partner New York Global Catering Project Capital Cost US$ 50m

Debt Financing Available US$ 20m


Equity Required US$ 30m Promoter (Busingye) provides:

Cash US$ 0.5m Kisassi Land US$ 0.5m

Dilemma:

Busingye only has US$ 1m available for equity funding but wants 48% ownership of the JV. This implies Busingye has a funding gap of US$ 14m

Indigenous Financing Busingye Catering


Financial Projections 2013 Revenues Gross Profit EBIT Interest Expense PAT
PAT to Busingye - 48%

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2014 30

2015 60

2016 90

2017 104

2018 155

2019 163

2020 171

2021 180

2022 189

Total 1 141

11
8 -2 5
2.2 2.3

21
15 -2 9
4.3 4.7

32
23 -2 14
6.5 7.0

36
26 -2 16
7.5 8.1

54
39 -1 23
11.2 12.1

57
41 -1 24
11.7 12.7

60
43 -1 26
12.3 13.4

63
45 -1 27
12.9 14.0

66
47 -1 28
13.6 14.7

399
285 -12 171
82.2 89.0

PAT to NY Global Catering - 52%

2013 Calculating IRR Net Cash Flow IRR


2014 9

2015 13

2016 18

2017 20

2018 28

2019 29

2020 30

2021 31

2022 32

Total 209

(50) 33%

Busingyes Cash flows improve dramatically by 2018 when his annual portion of PAT reaches US$11.2m An IRR of 33% is achieved

Indigenous Financing A case Study on the Busingye Catering Dilemma


Solutions

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Shareholder loan with Payment-In-Kind (PIK) component

Pay interest and dividends with additional debt or equity instead of cash. Busingyes debt obligation will grow with interest being added to principal every year. He
pays out at the most convenient time based on his cash flows.

Illustration Borrows $14 million at 10% a year; in year 2 will owe $15.4, year 3; $16.9
million; year 4 $18.5 million

Major advantage is that it matches with Busingyes cash flow. He has a 33% return and
has no issue paying a 10% PIK cost.

Equity participation rights triggered in year 3

Gives Busingye an option to buy-into equity when his cash flows improves in year 3 at
pre-determined valuation.

Keeps option to purchase 48% for $15 mm with modest escalator

Convertible loan (initially take on debt financing) coverts to equity in year 3

Gives Busingye embedded option to convert his loan to equity in year 3


Preferred Stock Sweat Equity

Contribution to a JV in the form of effort

Funding Options
Key points The subject is a key debate in many mining sectors and has become increasingly relevant in the O&G sector

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Maximising Domestic Benefit

Arguments for Indigenisation:

Broadening of economic wealth


Increased local ownership and participation in the assets A programme that allows employees /communities to own shares within the organisation A flexible Government approach to the application of the Indigenisation policy is key. If an immediate transfer of ownership to
locals would jeopardize profits, the company can submit a plan to equip locals with necessary skills to take over in the future

Financing Options
There are multiple funding options that can be utilized to facilitate this transfer of shares in an Indigenization scheme

Ultimately, the company needs to be paid for the equity stake in the business that will pass on to employees/management
There are multiple funding options that can be utilised to facilitate this transfer

Is it deductible from cost oil? If so, the State is implicitly paying for the bulk of it Paid for by tax rates of beneficiaries?

Other alternatives include:

Simple to implement Funding rate determined with reference to vendor cost Existing shareholders remain in control of the transaction and structure Gives rise to a direct cash flow impact on the business Commercial funding rate for indigenous partners Existing shareholders debt subordinated in terms of redemption and security Reduces flexibility to sustain structure but promotes independence State development banks Brazil (BNDES); South Africa (DBSA/IDC)

Vendor/Partner Finance

External Finance

Progressing Indigenisation - Financing


Key points BEE has become highly sophisticated over time

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The evolution of BEE transaction structuring (South Africa)


1994 2000 2006 Current

Individuals

Consortium members

Individuals

Staff Communities

Staff + Communities + Commercial

SABMiller, Vodacom

Market conditions

Strong performing equity markets supports success of BBBEE transactions

Volatile markets expose structural weaknesses

Funding

Bank funded
7 10 years

Vendor financed

Tenor

SABMiller, Assore, AECI

Emergence of perpetual community structures

Limited dividend flows to participants during transaction, largely option pay-off structures Cash flow
Tiger Brands, Mediclinic

Emergence of structures incorporating trickle dividends

SABMiller, Assore

Focus on meaningful cash flow for participant groupings

Private and confidential

Case Studies

Partner Funding
Key points

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Case Study - Ghana National Petroleum Corporation (GNPC)

Industry development records were achieved after the Jubilee discovery which made Ghana a net oil exporter

Ghana National Petroleum Corporation (GNPC) was established in 1983 and is responsible for the exploration, development, production and disposal of petroleum activities in Ghana Ghanas most successful oil story is the Jubilee field with Tullow, Anadarko, Sabre, Kosmos and GNPC (10%) having an interest in the field, with associated fields in operation (e.g. Tano, West Cape Three Points) Ghanas fiscus earns 5% royalties; a 10% free carry, an additional, paying interest of 3.75% and an income tax of 35%. Note that prior to the payment of income tax, the oil companies who incurred the expenditure are allowed a full cost recovery upon eligible development expenditure

Jubilees output has ramped up more slowly than expected. Revenues for Ghana have built up slower than expected , with various reasons cited for the cause

Jubilees development was accelerated (around 50 months from discovery to operations) with targeted production at 120,000 bpd. However, since the start of commercial operations, production has at times been as low as 63,000 bpd which has reduced revenues relative to projections
In addition to this, Ghanas Petroleum Law that allows for development costs incurred to be recovered before profits are declared, with a reported 20% return being allowed on eligible expenditure. Note that in the case of Jubilee etc, total costs are reported to amount to US$4.2 billion. Note that one of the factors behind this is that GNPC did not fund itself, but borrowed the money from its development partners (at a cost of 20% p.a.) which has to be repaid. Note that this choice has implications for control, influence and relative independence/autonomy of GNPC regarding the investment. This cost recovery has led to a P&L loss-making situation which means the government has not been able to levy an income tax (despite the field producing oil since December 2010) This notwithstanding, in 2012, the fiscus generated US$ 542 million from oil revenues of which royalties amounted to US$ 151 million and US$ 390million came from the States free carry

Government generated US$542 million from oil revenues in 2012

Partner Funding
Key points State has the right to participate in petroleum activities, bilaterally negotiated upfront

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Case Study - Empresa Nacional de Hidrocaronetos de Mocambique (ENH)

Mozambiques petroleum law stipulates that the state has the right to participate in any petroleum activities, which is negotiated on an ad hoc basis. Practice is the State is carried during exploration and funds its participation during production. As with Ghana, there will be access to royalties and an ability to receive income tax (post cost recovery) Since 2004, Mozambique has had operational upstream and midstream gas projects:

Upstream Pande-Temane gas fields (ENH - through CMH - owns a 30% stake)
ENH has participated in onshore upstream production and infrastructure developments since 2004

Midstream ROMPCO gas pipeline (ENH - through CMG - owns a 25% stake)

ENH funded its investments in these projects through a mixture of DFI funding and partner funding. For different reasons, for example, the financing structure, ENH has similarly not seen large dividends resulting from the investments
Since 2010, the Area 1 (led by Anadarko) and Area 4 (led by Eni) consortia have made material offshore discoveries (175 Tcf gas in place to date) which are likely to mean that Mozambique will become a major natural gas producer (starting with a 10 MTPA 2 train LNG export project) Whilst the Area 1 and Area 4 transactions are still under development and will not close until 2014, there are signs Mozambique and ENH may be approaching these transactions differently:

Subsequently, ENH has partnered in world-class offshore gas discoveries (Areas 1 and 4) which will require it to make funding choices in 2013/2014

ENH is appointing independent advisers to determine how it should fund its participation in the LNG transaction (which requires the raising of up to USD 3 billion) and refinance existing deals; Mozambique has carried out a very careful fact-finding process to broadly determine its partnering and financing options, with sovereign wealth entities strongly interested in Areas 1 and 4 The Government has ensured a running yield from securing a capital gains tax take of disposals of interests in the blocks (for example, the sale of Cove Energy)

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