Mozal Case

Financing the Mozal Project

Group 1 – Team 3Prashant Gupta 25Vaibhav Gupta 27Vinayak Harer 28Uday Jaipuria 32Deepak Kidiyoor 38Saran Markan 39

Agenda

• About the Project• Objectives of IFC & other sponsors• Risk Assessment• IFC involvement• Financial analysis • Current status of Mozal

Mozal Project

• Eskom – South African Power utility– 95% of country’s & 50% of Africa’s power

• Mozambique govt.– Build damaged electricity infrastructure

• Alusaf– Industrial and electrical infrastructure – Access to competitively-priced power

• $1.4 billion aluminium smelter • Takes upto 18 months to finalize the deal

About Mozambique

• 1975 – 1992: Civil war broke out• Post 1992 : Socialism to Capitalism; Economic

reforms; Privatization ; Removed price control• Comparisons– Sub – Saharan : Indebtedness, Country Risk– World Economic Forum : Road infrastructure,

Legal effectiveness, Time to complete, Trade• Mozal through country’s Byzantine

administrative and regulatory procedures

Aluminium Production

• Industry demand 20 mn tons/year• Demand growth 2-3% increase/year• Aluminum Prices– Low : $1040/ton – Nov.1993– High: $ 3645/ton – June 1988– Average : $1500/ton

• Major inputs for Aluminum– Alumina- Billiton– Electricity – EdM– Labor and other raw materials

Mozal – Execution and Implementation

• Maputo -> Capital of Mozambique• 34 month + 6 month Full capacity• Annual capacity 250000 capacity• Overall capital cost:$ 4750/ton (others:$4850)• Taxes – Free from custom duties and income taxes– 1% sales tax applicable

• Currency Exposure– All denominations in $ Less risk

• Low cost producer(lowest 5% costs)

Objectives of IFC and other Sponsors – Will the IFC and the sponsors share similar objectives

OBJECTIVESOf

stakeholders

IDCSustainable development of

SA by promoting private enterprises

IFCPromotion of private sector investments in developing

countries as a way to reduce poverty and improve

people’s lives

AlusafReturns from the project,

proximity to Hillside smelter, inputs at attractive

rates

EskomWanted to expand its

operations outside SA and utilize its excess capacity

French Export Credit Agency

Supporting the use of Pechiney technology

MitsubishiEquity provider and will share

the output (large metal group)

Govt. of MozWas actively trying to improve climate for private sector

investment

Objectives of IFC•Mission statement – promoting private sector investments in

developing countries as a way to reduce poverty and improve

people’s life.

• High risk projects – invest in those projects which nobody else

wants to finance.

•Developing human capital among Mozambicans through

managerial , health and other skills training.

•Providing critical infrastructure and spur investments along the

Maputo corridor.

•Generate future investments in other private sector ventures.

Objectives of Planned sponsors

•Sustainable growth – in South Africa by promoting entrepreneurship .

• e.g. Hillside smelter and financing private sector enterprises.

•Economic stability – maintaining economic stability in the South African region

Objectives of IDC -

Objectives of Alusaf -

•New Smelter – at competitively priced power.

•Profit motive – cheap availability of inputs like alumina, raw materials, electricity

and labor.

•Risks mitigation – risks had been identified and had been dealt with

appropriately.

•Establishing commercial ties with local businesses.

Risk Assessment – What are the greatest risks and have they been

adequately discussed?

Risks for the Project

• Country Risk –– Political instability.– High indebtedness and legal ineffectiveness.– Poor and under-developed country and a risk of civil war.– Risk of expropriation.

• Mitigation by government• Investment Protection and Promotion Agreement.• Government has applied for entry into HIPC debt initiative.• Exempt from custom duties and income taxes.• External debt and inflation has decreased and FDI has increased.

From “Financial” to “Structural” approach in Risk Management

• The sponsors assembled a group of international lenders comprised of – IFC as major financial institution– Industrial Development Bank – Export Credit Agencies (Coface and CGIC).

• South African power supply, alumina from Australia, technology from France, and holding of sales proceeds in foreign bank account.

• Highly leveraged capital structure to discourage expropriation.• The project is set up as an independent entity.• The establishment of infrastructure, training of local human

resource, awareness camps for AID/HIV, school, hospitals or any such social/humanitarian activities will be attached to the entity.

Risks for the Project

• Timing and completion risk – – Complex bureaucratic processes that may delay getting the necessary

permits to proceed with the construction– The conditions of the basic infrastructure may slow down the

construction efforts

• Mitigation • Government established a special liaison committee.• Infrastructure development for electricity supply by Eskom and

EdM.• Will employee the same project management team under similar

agreements.

Risks for the Project

• Operational risk – – Fluctuation in aluminum prices.– Labor issues.– Demand and supply uncertainty.– Currency exposure.

• Mitigation• Input prices are function of LME aluminum prices.• 25 year supply contract for alumina and electricity.• Long term purchase contract with sponsors.• Initial skilled labor and management expertise from South Africa.• Major inputs and all outputs would be denominated in U.S.

dollars.

Other Risks

• Diverse legal systems and Completion guarantees.– Expertise and experience of IFC in these areas.

• Interest rate risk– Subordinated debt interest risk is mitigated by linking them to the

amount of sales.

Risks adequately discussed?

• Labor issues.• Government may withdraw the privileges given to the project. • If IFC backs out of the project then it would be difficult to find

other bank or financial institution will finance the project.• Road infrastructure.• Local Suppliers• Input prices are not totally hedged.

IFC involvement – How does IFC involvement affect the deal?

About IFC

• A member of World bank group founded in the year 1956 and owned by more than 170 member countries

• Promoted private sector investment in developing countries for social cause

• World’s largest multilateral source of debt and equity financing for private sector projects

• The loans provided by IFC aren’t backed by the sovereign funds

How Does IFC Involvement Affect The Deal?

IFC participation had a catalytic effect on other lenders. IFC brings credibility to the project and provides

reassurance to potential lenders.• Project Appraisal• Environment and Social Impact Assessment• Due diligence – high risk projects

‘Honest Broker’ – IFC had a reputation for being fair to all parties in the deal. Reducing the incentive for short term opportunistic behaviour

Help in other aspects of the deal like the integration of the diverse legal system followed in Mozambique and other countries.

How Does IFC Involvement Affect The Deal?

Completion guarantees: They could also help to structure the contractual terms to define financial and technical performance.

From the financing angle:IFC provided loans with longer maturities

matching the long project lives.It was willing to lend on subordinated basis.IFC gave greater emphasis to development

benefits.IFC played a big role in preventing adverse sovereign

action and its involvement reduces political risk.

Financial Analysis

Mozal : Costs and Pricing

• Avg. prod. Costs (excluding depr and financing) – $ 1510/ton

• Mozal’s prod cost( including depr and financing) – $ 1493 ton in 4th year– $1070 by 11th year

• 67% of production cost was variable • 47% of production cost varied with LME prices• Aluminum Prices– Aluminum price assumed - $1750/ton– Existing aluminum price - $1560/ton – Average Aluminum price - $1500/ton

Sensitivity analysis

• Fluctuation in aluminum prices– Due to speculations

• Cost components– 33% alumina (function of LME aluminum prices)– 25% electricity (function of LME aluminum prices

in later years)– Remaining labor + other raw material + admin

Should Alusaf/Gencor invest in the Mozal Project?

Strategic Benefits

• Market opportunity– To rebuild some of Mozambique’s damaged infrastructure

• Well positioned in Southern Africa– Hillside smelter

• $350m under budget• 5 months ahead of schedule• Mozal will access the same resources• Useful parallels

• Competitive and reliable electricity supply– Power drawn from Eskom’s SA grid– Long-term and attractive electricity prices– Availability of hydroelectric power– Flexible power supply options over and above contract

Strategic Benefits

• Support from Government of Mozambique– Investment incentives– Industrial Free Zone:

• tax at 1% of turnover• exempt from custom duties, sales and circulation tax

• Liberal foreign exchange regime:– Can repatriate dividends & loan repayments– Can hold foreign exchange offshore

• Rare mix of key elements in Aluminium Production– Alumina import on a long term deal– Labor costs– Hillside suppliers

Strategic Benefits

• Reliable transport– Port and Maputo Corridor

• Enhance reputation for technical excellence• Group synergy– IDC, IFC funding

• Indirect benefits

Financial Motivation

• Increase shareholder value• LME exposure of roughly 75%, decreasing toroughly 60% after 2012• IRR – $1,500/tonne to earn weighted average cost of

capital

Financial Motivation

• Current Ratio

• DSCR

Reality

Mozal is a big project in a poor country withweak legal rules, lots of bureaucracy, and ahistory of civil war

Will the sponsors be able to finance the deal?

Deal Structure

Equity

IDC(Industrial Development Corporation)• $3.6bn government owned development bank• Longstanding relation with AlusafMitsubishi• $78bn Japanese industrial conglomerate with large

metals group• Synergy/ Shared interests

Quasi Equity

IFC• World bank group promoting private sector

development in developing countries• Net income of $400mn in 1997• 10% of all finance deals in countries with rating less

than 25• Mozal project was viable and had acceptable

financial and economic rates of return

Senior Debt

IDC• Discussion with CGIC, South African ECA to provide

insurance for $400mn of senior debt• Protect creditors against losses from commercial

insolvency and political risksLoans• 85% cover for loans made by french banks• Loans arranged by IFC and other development

financial institutions

Current Status of the Project

Highlights

• Completed near Maputo, Mozambique in 2000• Project Management Institute's 2001 "Project of the

Year" Award• $100M under budget• 6 months ahead of schedule• Phase II construction project at Mozal• Mozal is owned by BHP Billiton, 47.11%; Mitsubishi,

25%; the Industrial Development Corp. of South Africa, 24.04%; and the government of Mozambique, 3.85%.

Problems

• In Mozambique, there has been an imbalance of trade

• The price of Aluminium fell from US$2,621 per ton (2008) to US$1,383 per ton (2009)

• Fall in tax revenue received from Mozal• Mozal uses a lot of energy

References

List of Websites• http://www.allbusiness.com/africa/1028751-

1.html• http://findarticles.com/p/articles/

mi_qa5382/is_200112/ai_n21465687/• http://internationalbusiness.wikia.com/

wiki/Mozal:_Aluminium_Export

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