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Tianjin Plastics/ Maple Energy

China Project Joint Venture


Generally speaking, Maple has been ready to take the China MOPI project. Although different

from the U.S., Tianjin is directly administered by Chinese central government, the political

factor would not affect the revenue-generating ability of the project. As a newly-emerging

industrial and port city of China, Tianjin carries out a series of a more open and more foreign

capital favored policies, attracting numerous outstanding foreign investment during a decade.

Tianjin Plastics was a government-owned enterprise relying on intensive energy input to produce

a wide range of raw industrial plastic products, which supports the company provide an attractive

policy of its contract with Maple -- Tianjin Plastics would provide free coal feedstock for the life

of the power plant, that is more than 20 years. Among various investing methods, Maple

intended to adapt project finance venture to settle financing needs of the deal. The method came

with some nature concern, for instance, is there any Chinese government approval required? Or,

is there any regulations restricting the investment? One issue, besides currency exchange issue,

had already exposed is that the Ex-Im Bank refused to lend money to Chinese Three Gorges

Dam Project, given the consideration of environmental factors, and it could be the same reason

for the bankers to reject Maples request. Even though Maple successfully borrow money, there

would be a relatively higher interest rate to satisfy lenders risk expectation of Chinese market.

Some of the benefits are pretty clear for current stage: the contract date would start after the

power plant construction and testing. In other words, Maple could expect a flow-in gross revenue
by the summer of 2000 and consider the projects life ended in the year 2020, regardless the

economic life of the project and the coal storage problem during the 20 years. However, once the

project starts to generate gross profit, it would face a tax rate of 40% after corporate income, and

Chinese government particularly required that 25% of annual depreciation charges be

reinvested in operations. That means there would be no recapture of depreciation at the end of

the investment and a higher tax amount in total.

Another favored item for Maple is that the joint venture structure would split as 49% by Maple,

46% by Tianjin Plastics, and 5% by MOPI. Consequently, Maple could control the operation of

the project with an absolutely majority percentage of investment; on the other hand, it didnt

have to worry too much about financing pressure, because Tianjin Plastics, its local partner,

would share the burden as much as Maple would take. Whats more, the second biggest

shareholder position would positively motivate Tianjin Plastic to make full use of local

resources: lower the price of raw material, keep a steady sales and gain a strong voice to

negotiate with local banks. But all of the investor's equity world equity would make up only

15% of the total $110 million in capital needed in this case. In order to lower the financing risk,

it became a crucial chain for the project to succeed that diversify the fund resources, not only in

equity part, also in debt part.

Despite all the difficulties Maple was facing, it still eagerly wanted to reach the deal, it believed

there would be a huge increase in Chinese electricity market and the project is a perfect timing

and opportunity to step into the Chinese market.

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Some investors may think it is always riskier to invest in a foreign country. To some extent, it is.

There would be more unfamiliar administrations and regulations, cultural gap between

government and between local investors, different working habits and even time differences. All

of these will bring uncertainty to the project, but one of the most dangerous factor should be

currency risk. The renminbi was not freely convertible at that time, leading to an issue that any

cash flows back to the U.S. would have to require a government approval process. The long

procedure of approving expanded the investment payback periods, and the unsure ending date of

each procedure also brought more troubles for Maple to manage currency risk, regarding the

surprising performance of Renminbi in recent years.

Although the macroeconomic environment in China was substantial and sustainable, there are

still something not fit in Maples situation. Chinese government increased the limitation of return

on investment (ROI), still lower than Maples expectation. Another major concern was that he

Chinese government often refused to guarantee fulfillment of the similar contracts. Finally,

according to the central authority, Maple would only return the profit of project back to the

parent company, instead of all the investment.

Corporate finance is the area of finance dealing with the sources of funding and the capital

structure of corporation, the actions that managers take to increase the value of the firm to the

shareholders, and the tools and analysis used to allocate financial resources. In conventional

corporate finance, the sponsoring company typically raise capital by borrowing money from

lenders that is has sufficient assets on its balance sheet, to use as collateral in the case of default.

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The lender will be able to foreclose on the sponsors companys asset, sell them, and use the

proceeds to recover its investment. But in project finance, the project must be backed by a strong

credit, the repayment of debt is not based on the asset reflected on the sponsoring companys

balance sheet, but on the revenue that the project will generate once it is completed. For lenders,

it is riskier. So, the sponsor should be financially healthy to assure lenders that the sponsor will

be around to build it and operate over its lifespan. And sponsor company should demonstrate that

revenue streams from the completed project will be sufficient to repay the loan.

In this case, equity would make up 15% of the total $110 million in capital needed. The majority

of the capitalization would come from bank financing- local banks, foreign banks and

international lending institution. And the joint venture would be split 49% Maple, 46% Tianjin

Plastics, 5% MOPL. Maples equity financing is close to Tianjin Plastics, but Maple could hold

the controlling interest and maintain actual control of operation. This is advantageous for Maple.

First, Maple contributes $8.085 million to get the controlling interest. Holding the controlling

interest means holding the decision-making power. If there is conflict of companys operation,

Maple has the power to make a decision. Second, this structure helps the joint venture raise

money more quickly. But at the same time, this structure also has some difficulties to overcome.

First, bearing more benefit means bearing more risk. If this project fail, Maple will loss more.

Second, debt capitalization makes up 85% of the total $110 million in capital needed, so the cost

of debt is very high, which means you should pay for money to the lenders not the equity

stakeholders although joint venture earns the profit. Third, debt financing makes up a large

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percentage in the whole capitalization. However, several major U.S.-based firms had openly

campaigned for the U.S. Export-Import Bank support, so its hard to raise the enough loan from

the U.S. Export-Import Bank.

Amount(million Currency Rat Drawdown

) e

Equipment vendor $22 Dollar 9% At the beginning of

Y4

Tianjin Plastics $7.59 Renminb 14 Guarantee

i % s

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Maple $8.085 Dollar 9% Guarantee At the beginning of

s Y1

West Coast U.S. $55 Dollar 9% Equally at Y2 and

Bank Y3

MOPI $0.825 Renminb 14

i %

From the above table, we can see that total construction financing of $93.5 million was provided

through a combination of loans from the equipment vendors ($22.0 million), Tianjin Plastics

($7.59 million), Maple Energy ($8.085 million) and a bridge loan from a West Coast U.S. bank

($55.0 million). This diversified debt structure finance the debt in U.S. dollar and Renminbi at

the same time. This strategy helps this project more convenient to operate. But the debt from

West Coast U.S. Bank is more than 50% of all debt. And the debt is bride loan. More bridge

loan, more interest rate. There is a modification that can enhance the structure. This project

should finance more debt in U.S. dollar because of the less interest. And it should decrease the

debt from West Coast U.S. Bank, because the West Coast U.S. Bank provide the bridge loan,

which has a higher interest rate.

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Consider the big amount of money they would lend, participating banks would play an important

role in the project. For those banks, their risks would be adequately covered and they would earn

a sufficient return. The West Coast U.S. bank would provide a $55.0 million bridge loan, which

is a short term loan with high interest rate (9.0%) as a part of construction financing. Out of that,

the bank required completion guarantees from both Tianjin Plastics and Maple Energy. The

post-completion financing of $117.4 million was arranged through a club syndication consisting

of three banks which had experience with project financing in China, and by the Bank of China.

The Bank of China loan was provided at a fixed rate of 13% for 12 years. Repayments of loan

principal on the Bank of China loan and on the club syndication loan were to be made in equal

annual installments.

Why those foreign bank were interested in funding this project? Actually all three foreign banks

had an indirect interest in the project: Maple was a good customer of the West Coast bank; a

number of the vendors to the project were Japanese; and the Canadian bank was actively

pursuing business in the PRC.

Before funding the project, one of the most critical problem was currency controls in China. The

renminbi was not currently freely convertible, so that any cash flows for either profit repatriation

or debt-service repatriation would have to go through a government approval process. Requests

for hard currency exchange and the opening of foreign exchange accounts must be submitted to

the State Administration of Exchange Control (SAEC). Even with a reduction in actual

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restrictions in recent years, foreign investors in China must still obtain SEAC approval to buy or

sell foreign currencies, as well as submit documentation evidence for each individual transaction.

Although it was not always successful, Chinese government made effort to ensure the stability of

Rmb. The Chinese government continued to control the amount of renminbi converted to hard

currency with an iron fist in an attempt to manage the currencys value and the external impacts

on the domestic financial economy through volatile exchange rates or imported inflation. It was

reasonable since the domestic market and financial economy was vulnerable during this period.

They would easy to affected by foreign market and economy without such kind of control. But

for the parties that were involved in the project, the risk would increase since the government

only allowed the profit to be repatriated. So it would be more different to take back investments.

A partially convertible currency posed special problems for the financing plan of Tianjin plastic

project. Pat thought about to make a deal with Wintel, another western company by a

back-to-back loan. However, even governmental approval would be obtained for the conversion,

the currency risk for such an extended period of time was unacceptable. The reason was lack of

financial derivatives to hedge renminbi cash flows. All risk management derivative products

relied upon access to money and capital market instruments in the subject currency, and those

financial markets simply did not yet exist in China or in Chinese renminbi anywhere. Pat also

thought about another solution, financing the majority of the project in renminbi locally. This

would simply match the local currency inflows with local currency outflows insulating the

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majority of the firms cash flows from currency risk. However, the renminbi loan from the Bank

of China would require 100% dollar-denominated collateral: the lenders for the Tianjin power

plant project would put up a $101.5 million deposit with the bank. This plan would be a rather

expensive alternative. It was hard to find an available method both sufficient in terms of risk and

cost.

After considering the currency exposure, we examine the barriers in China to the foreign

investors. One of the reasons why Maple has the limitations on the return on investment is the

barriers of the Chinese government. The Chinese government was attempting to limit the return

on investment (ROI) on projects of this type to 12%. After most power plant developers like

Maple balked at such low rates of return, the Chinese government revised the target ROI to

between 15% and 17% if the plant demonstrated outstanding efficiency. And then, the Chinese

government refused to guarantee fulfillment of a contract. Finally, the Chinese government did

not allow registered capital, the equity capital initially invested under the agreements of the

project, to be repatriated. To deal with the situation in China, Maple and Wintel discussed a

back-to-back loan transaction. Back-to-back loans are a financial move used by companies to

curb foreign exchange rate risk or currency risk. They are loan arrangements where companies

loan each other money in their own currency. The back to back loan was essentially a currency

swap. Maple would be the fixed rate payer that borrows RMB from Wintel for six years at

10.5%; Wintel would be the float rate payer that borrows USD from Maple for six years at

LIBOR+1.45%. Both parties would be better off in this back to back loan structure. Maples

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discount rate would be only 10.5%, rather than 18% (the hurdle rate). In addition, Maple also

locked in an exchange rate of 8.32RMB/$. Therefore, for Maple, cash inflows in U.S. dollars,

and outflows in local currency (RMB), this was a satisfactory deal for Maple to avoid the risk,

the currency valuation risk was borne by Wintel, and Maple insulated from currency exchange

risk. Also, there was limited interest rate due to variable loan rate. However, the cost was high

for Maple, there was initial capital loan to Wintel, and Immediately converted to current

currency exchange rate (Rmb$8.32/$). More than these, Wintel will charge 10.5% for six year

loan. Therefore, the back-to-back loans is the best solution to solve repatriation issues.

There is no equality of apparent benefits and of the inherent risks in this case. Maple wanted to

avoid the currency risk and solve repatriation issues, so back-to-back loan was the best choice.

However, when one party got the benefits, the other one would take the lost. There were

different choices for Maple, if the company want to invest directly with US dollar, the company

would suffer of the exchange rate risk and the restriction of the Chinese government. If Maple

invested in China by borrowing local currency (RMB), the bank of China will take the most

benefits for the high exchange rate, Bank of China will charge 13% interest for 10 year loan, and

the Initial collateral was in 100% dollar-denominated deposit. Therefore, there is no win-win

solution in this case. The negotiation skill and results for government is better than Tianjin and

Maple. However, Maple finally could find a better solution (back-to-back loan), which showed

that this would be a good result.

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