Long Term Project Finance & Valuations

Hemlata Bharech 08BS0001182 Hetal Ghia 08BS0001184 Hiren Mota 08BS0001205 Kanchan Dhankar 08BS0001350

What is a Project?
A project is a temporary endeavor, having a defined beginning and end (usually constrained by date, but can be by funding or deliverables), undertaken to meet particular goals and objectives, usually to bring about beneficial change or added value.

Project Finance
Raising of funds to finance an economically separable capital investment project in which the providers of funds look primarily to cash flow from the project to service their debt and provide returns on their equity

Emergence of Project Finance

Appropriate techniques for projects with high capital requirements and a complex risk profile Payouts are based only on the projects own assets and cash flows stream Creditors rely on the ability of the project for repayment of related debt obligations, non-recourse debt Multi-source financing: syndicated commercial banks, bonds, multilaterals

Features
Special Project Vehicle (SPV) Non-recourse or limited recourse funding Off-balance sheet transaction Sound income stream of the project as the predominant basis for financing Variety of financial instruments Variety of participants

Comparison with Other Vehicles

Financing vehicle Secured debt Similarity Collaterized with a specific asset Involve Single purpose indusrial assets Collaterized and nonrecourse Dis-similarity Recourse to corporate assets Does not involve

Privatization

Asset backed securities

Hold financial, not single purpose industrial asset No corporate sponsor Lower debt levels; managers are equity holders

LBO / MBO Venture backed companies

High debt levels Concentrated equity ownership

Project Finance v/s Corporate Finance

Organization
Control and Monitoring Risk Allocation Financing Arrangements

Flip side
Takes longer to structure than equivalent size corporate finance. Higher transaction costs due to complexity of the transactions involved Project debt is substantially more expensive (50-400 basis points) due to its non-recourse nature. Extensive contracting restricts managerial decision making. Project finance requires greater disclosure of proprietary information and strategic deals.

Trends
Resilient market! 5 of the top 10 deals in 2009 in India Immense financial market depth, but challenges remain on attracting more state owned banks, insurance companies and pension funds. PF market to continue to be dominated by Banks/ FIs, with bonds market still in nascent stages. Equity markets not receptive to Project listings. Dominated by power and transportation projects in the private sector Sectors like mining to follow in the footpaths of Transportation and Power in increasing transparency. Urban infra to rise on the back of governmental support. Government push on cost recovery to improve social infrastructure viability. USD 100bn/ year of infrastructure capex unlikely to be met, but expect this region to be one of the most active in the world for the next few years

Top 10 PF deals in 2009

Project
Sasan Power Vodafone Essar

Country
India India

Sector
Power Telecom

Deal size (USD m) 2,887 2,006

Jubilee Field Tullow Oil

Ghana UK

Petrochem O&G
Petrochem Transport-ation Power Power Power Telecom

2,000 2,000
1,814 1,756 1,482 1,341 1,302 1,200

ONGC Petro India M25 road widening UK Adani Power India

Al Dur Bahrain Sterlite Energy Ltd India Yahsat Project UAE

Structural Attributes
Organizational Capital Ownership Board Contractual

Models in Project Structure

Build-Operate-Transfer (BOT) Build-Transfer-Operate (BTO) Buy-Build-Operate(BBO) Lease-Develop-Operate Wraparound Addition Temporary Privatization Speculative Development

On Balance Sheet Financing Model

Loan FINANCING INSTITUTION Construction Payment Heat/Power FACILITY SITE OWNER Biomass fuel supply EPC CONTRACTOR Construction Services ENERGY PLANT Other Power Off-takers

Project Finance Model

Other Fuel Supply Sources Fuel Supply Power Payment Power Sales Fuel Payment Biomass Fuel Supply Fuel Payment Energy Payment Heat/Power Equity Power Sales to the Grid

Equity
Dividends

Other Investors

Construction Services
Construction Payment EPC CONTRACTOR

FACILITY SITE OWNER

Dividend

ENERGY PLANT COMPANY Loan PPA Assignment Repayment Loan Funding

Completion Guarantee FINANCING INSTITUTION

Construction Guarantee
19

Non-recourse Project Finance

Non-recourse debt a fundamental building block for current business integral part of investment decisions Projects are levered from 50% to 85% on the basis of security and visibility of cash flow All project debt is non-recourse complete isolation from the parent no facilities (parent or project) have ratings trigger funding consequences Minimal parent level debt provides: financial security at the parent level option to raise corporate capital for right opportunities

Project Funding Alternatives

Long
Common Equity

Short
Construction Financing

Preferred Equity

Bridging Finance

Convertible Debt

Line of Credit

Unsecured Debt

Secured Debt

Lease Financing

Associated Risks
Completion Risk Technology Risk Raw Material Supply & Pricing Risk Economic and Financial Risk Currency Risk Political Risk Environmental Risk

Project Valuations

DCF v/s Real Options

TRADITIONAL METHODS: NON-TRADITIONALMETHODS:

Traditionally DCF Methods (NPV &IRR) were used to value a project but it had problems in the selection of the discount rate and the treatment of risks.

The Method of Real Options Analysis is the new one which incorporates the flexibility in projects.

Real Options
REAL OPTION is not a derivative instrument, but an actual option that a business may gain by undertaking certain endeavors . In simple words , this model places a present value on the real options available to a company. Types of Real Options:
Investment Timing Options Growth Options Abandonment Options

Flexibility options

Valuation Approaches of real options

1) Using a standard model for financial options like: Black Scholes Model Binomial option Pricing Model 2) Using Decision Tree Analysis Example of valuation of an option through Black Scholes Model: Black-Scholes Model : C(S, ; E) = SN(d1) Ee- rN(d2)
d1 = (ln(S/E) + (r + 1/22) )/ ( 1/2) d2 = d1 - 1/2

Key Elements of the Model:

rate of return

S: Underlying asset value E: Exercise price : Standard deviation of the : Expiration time r: Risk free interest rate C: Option premium/option

price

Example: Non-Phased Development vs. Phased Development

Project Business Case:
Five years Total Investment: $11 Million Expected Cash Flow in year 5: $21 Million NPV computed by Traditional DCF (worst case): $1mm Phase 1 First year: I1=$5 Million The expected Net Cash flow from Local Distribution: V1 = $5 Million NPV of phase 1 is 0 Phase 2 The second outlay in 3rd year: I2=$6 Million The expected Net Cash flow from expanding Distribution: V2 = $15 Million The Uncertainty of V2: = 0.5
Value of the Option: $10 Million

Non-phased development: Phased Development:

Expanded NPV = NPV of phase 1 + option premium of phase 2 = 10 Million

Drawbacks of ROA
Using ROA when one should not. Using the wrong real option model Miscalculation in the data inputs

Getting both the models & the data right, but mistakes in the solution.

G Power Ltd.

ABOUT G Power Ltd.

It is a Private power producing company. It wanted to expand its power producing capacity from 3000 MW to 15000 MW. The company needed about USD 6bn for this revamp. It had a debt to capitalization ratio of 79%. In 2007, there was an aggressive growth required for Power generation in India. GOI was looking to increase the power generation capacity from 132 GW to 210 GW and also reducing its investment in this sector. As per the estimates by 2010, total investment of USD 19bn was expected.

How to raise funds???

The finance experts at G Power Ltd. had 3 options to raise financethey were: Corporate Finance Project Finance Revolving Facility

Corporate Finance G Power Ltd. Debt/Value Ratio Borrowers Debt/Value Ratio Maturity 79%

Project Finance

Revolving Facility 60%

60%

79%

50%

70%

10 years

50% in 2 years and rest 50% in 5 years USD 120mn

4 years

Financing Cost

USD 70mn

USD 27.8mn

Refinancing Cost Nil

USD 44mn

USD 81mn