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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
reinvested in operations. That means there would be no recapture of depreciation at the end of
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
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
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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
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
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
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Y4
i % s
4
Maple $8.085 Dollar 9% Guarantee At the beginning of
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Bank Y3
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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,
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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
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
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
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