Introduction to Project Finance Project Appraisal Financing and

Introduction to Project Finance Project Appraisal, Financing and Management CRISIL CERTIFIED ANALYST PROGRAMME SEMESTER III Dr. A. B. Rastogi NMIMS

Slide 2 What is a Project? • • • High operating margins. Low to medium return on capital. Limited Life. Significant free cash flows. Few diversification opportunities. Asset specificity. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 3 What is a Project? (cont. ) • Projects have unique risks: – Symmetric risks: • • Demand, price. Input/supply. Currency, interest rate, inflation. Reserve (stock) or throughput (flow). – Asymmetric downside risks: • Environmental. • Creeping expropriation. – Binary risks • • • Technology failure. Direct expropriation. Counterparty failure Force majeure Regulatory risk ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 4 What Does a Project Need? • Customized capital structure • Asset specific governance systems – to minimize cash flow volatility and – to maximize firm value. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 5 “Project finance” is not the same thing as “financing projects”. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 6 What is Project Finance? Project Finance involves a corporate sponsor investing in and owning a single purpose, industrial asset through a legally independent entity financed with nonrecourse debt. Cash flow is security to lenders. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 7 Project Structure • Structure highlights • Disadvantages • Motivations ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 8 Structure Highlights • SPV - Independent, single purpose company formed to build and operate the project. • Extensive contracting – As many as 15 parties in up to 1000 contracts. – Contracts govern inputs, off take, construction and operation. – Government contracts/concessions: one off or operate-transfer. – Ancillary contracts include financial hedges, insurance for Force Majeure, etc. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 9 Structure Highlights (cont. ) • Highly concentrated equity and debt ownership – One to three equity sponsors. – Syndicate of banks and/or financial institutions provide credit. – Governing Board comprised of mainly affiliated directors from sponsoring firms/ independent directors • Extremely high debt levels – Mean debt of 70% and as high as nearly 95%. – Balance of capital provided by sponsors in the form of equity or quasi equity (subordinated debt). – Debt is non-recourse to the sponsors. – Debt service depends exclusively on project revenues. – Has higher spreads than corporate debt. ABR class ppt-PAFM-CRISIL-1 -Introduction

Disadvantages of Project Financing Slide 10 • Often takes longer to structure than equivalent size corporate finance. • Higher transaction costs (~60 bp) due to creation of an independent entity. • Project debt is substantially more expensive (50400 bp) due to its non-recourse nature. • Extensive contracting restricts managerial decision making. • Project finance requires greater disclosure of proprietary information and strategic deals. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 11 Type of Projects • BOT - Build Operate Transfer • BOOT - Build Own Operate Transfer • BOO - Build Own Operate • BOOST - Build Own Operate Share Transfer • BOLT - Build Own Lease Transfer • DBFO - Design Build Finance Operate • OMT - Operate Maintain Transfer ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 12 Means of Finance • Equity Capital • Mezzanine Finance – Convertibles – Preference Capital – Sub-ordinated Debt • Senior Debt – Rupee Term Loan – Bonds – Foreign Currency Loan – Export Credit – Supplier’s Credit ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 13 Deal Diagram Sponsors Advisers Government Invt. Bankers, Technical & Legal Advisers Equity Concession / Licence Agreement Financial Investors Equity / Sub-Debt Users TRA Agent Off-take Contracts Insurance Companies Insurance Policies Project SPV O&M Contract TRA/Escrow Agreement O&M Operator EPC Contract Debt Lenders ABR class ppt-PAFM-CRISIL-1 -Introduction Substitution Agreement EPC Contractor Financing Infrastructure Projects

Slide 14 Key Components • Cash flow projections based on technical, market and financial analysis • Risk allocation through project contracts and financing agreements • Structured financing • Security and documentation • Project monitoring and compliance ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 15 Base case analysis shows adequate debt servicing capacity of the enterprise. 200 100 0 2002 2004 2006 2008 2010 2012 2014 2016 -100 -200 -300 -400 -500 ABR class ppt-PAFM-CRISIL-1 -Introduction Capital Expenditure Operating Cash Flow Debt Service

Slide 16 Why Investors Use Project Finance • • • High leverage Tax benefits Off-balance sheet financing Borrowing capacity Risk limitation Risk spreading Long-term finance Enhanced credit Unequal partnerships ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 17 Benefits of Project Finance to Third Parties • Lower product or service cost • Additional investment in public infrastructure • Risk transfer • Lower project cost • Third-party due diligence • Transparency • Additional inward investment • Technology transfer ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 18 Case Study - 1 • Project : 4 -laning of 59 km on NH 5 on annuity basis • Concession Period : 17. 5 years (incl construction period) • Promoter : GMR Group • Project Cost: Rs 315 crore • Financed in a Debt-Equity Ratio of 3: 1 by way of: – Equity: Rs 1 crore – Preference Capital: Rs 78 crore – Debt: Rs 236 crore ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 19 Case Study - 2 NHAI Annuity Concession Agreement UEM Financing Agreements Lenders Project SPV Shhldr’s Agmnt Equity Debt LE Scott Wilson ABR class ppt-PAFM-CRISIL-1 -Introduction O &M Agemnt EPC Agmnt UEM Indep Eng GMR Group Dorsch Engineers

Slide 20 INFRASTRUCTURE • Transport – road including toll road, a bridge, rail system, a highway project, a port, airport, inland port. • Telecommunication – basic or cellular, radio paging, domestic satellite services, broadband network, internet services. • Energy – generation, distribution, transmission, gas supply • C&I – a water project, irrigation project, water treatment system, industrial park, SEZ, education and hospitals. ABR class ppt-PAFM-CRISIL-1 -Introduction

Slide 21 Thank you ABR class ppt-PAFM-CRISIL-1 -Introduction