Week 1
Introduction to project and infrastructure finance
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Index
Who Does What and When? The Contractual Network
Project Finance vs. Corporate Finance
Financial contracts (Shareholders Equity Contribution Agreements)
Financial contracts (Loan/Bond Contracts)
Example: Metro 5 Financial Contracts
Industrial Contracts
Example: Metro 5 Industrial Contracts
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WHO DOES WHAT AND WHEN? THE CONTRACTUAL NETWORK
CLIP 1
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Who Does What and When? The infrastructure can be seen as a network of contracts:
Financial contracts by which: sponsors provide equity capital lenders provide debt capital to the SPV.
Project/Industrial contracts by which the SPV, a 100% outsourced enterprise, gets the assets to design build and operate the project.
Project Finance vs. Corporate Finance
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What is Project Finance?
Project finance: industrial/infrastructure project financed off-balance sheet in a Special Purpose Vehicle (SPV) within a network of contractual agreements with key counterparts (contractors, purchasers, suppliers, operator agents, etc.)
The borrower of funds is a project company set up on an ad hoc basis that is financially and legally independent from the sponsors (separate incorporation) (the SPV)
All economic consequences generated by the initiative are attributed to the SPV that is designated to secure cash receipts and payments (lenders finance a venture, not an operating firm)
The assets of the SPV are the only collateral available to lenders together with the cash flow from the initiative (no-recourse financing)
Approval of the financing is a function of the project's ability to generate cash flows to repay the debt contracted and also remunerate capital invested at a rate consistent with the degree of risk inherent to the venture concerned
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Project Finance and Corporate Finance
Suppose you have the opportunity to realize a new infrastructure with these features:
Large size compared to the assets in place High risk/high return High correlation with the existing assets
Two options are available
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Project Finance and Corporate Finance
Corporate Finance Project Finance
EXISTING FIRM
New venture
Finances
May use
existing balance sheet assets as collateral
Incorporates
EXISTING FIRM
New venture
Finances
Uses
a new dedicated SPV Incorporates
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Project finance is the financing of ONE specific project, within an entity that is created with the sole purpose to design, build and manage that specific infrastructure. On the contrary, in traditional corporate finance one company typically carries out multiple simultaneous initiatives that get financed as a portfolio of projects. How to choose between the two options? See next slides.
Project Finance and Corporate Finance
Corporate Finance Project Finance 1 2
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Why Project Finance?
Incorporating the new venture in the parent firm has these effects:
The outcomes of the project strongly influence the outcomes of the firm Higher risk perceived by shareholders and lenders Effects on the WACC and company value
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Why Project Finance?
Incorporating the new venture in a SPV is the optimal solution for sponsors: Financial flexibility is maintained intact Cost of funding of new financial resources for the initiative can be cheaper than a corporate
loan (trade-off between cost saving and deal structuring/risk mitigation costs)
It avoids contamination risk
Incorporating the new venture in a SPV is the optimal solution for lenders/creditors:
Full control over the project cash flow Easier monitoring Possibility to tie-up management behavior (covenants and restrictions)
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Project Finance: Global Market Trends
SOURCE: Thomson Reuters
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The spectrum of possible application is very large. Though the bulk of financing is related to power generation, oil and gas, and transportation. In addition, telecommunication networks has been an important sector, but less stable from year to year.
Project Finance: Sector Breakdown
39%
SOURCE: Thomson Reuters, full year 2013
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However: out of the total amount of financing that has been committed to project finance in 2012 and 2013 there has been a reallocation of funds from more traditional industrialized countries to fast growing economies. Indeed, Most of the funding has been provided to Asia-Pacific and Middle East areas, where the need to fill the infrastructure gap is particularly relevant
Project Finance: Geographic Breakdown
29%
SOURCE: Thomson Reuters, full year 2013
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Project Finance: Why Infrastructures
What makes infrastructure projects suitable for project finance? Long-term assets with long economic life Low technological risk Provision of key public services Strongly non-elastic demand Natural monopoly or quasi monopoly market contexts High entry barriers Regulated assets Frequent natural hedge against inflation Stable, predictable operating cash flows Low correlation with traditional asset class and overall macroeconomic performance
Financial Contracts Shareholders Equity Contribution Agreements
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Financial Contracts
Sponsors provide equity capital to the SPV with the Equity Contribution Agreement. There are 3 types of sponsors:
Industrial Sponsors who see project financing as an initiative linked to their core business.
o The link can be upstream or downstream of their original core business o They provide not only money but also know how o It is common that they also build or operate or act as suppliers or clients of the
infrastructure (DUAL ROLE)
Public Sponsors who see project financing as the opportunity to realize public works which are economically self-sustaining with limited public investment (Public Private Partnership - PPP)
o The ultimate objectives include growth, job creation and welfare o Their role is typically based on a Concession Agreement.
Pure Financial Sponsors with no industrial rationale who have high propensity for risk and see project financing as an opportunity to get substantial returns on their investments
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Financial Contracts Loan/Bond Contracts
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Financial Contracts
Project finance involves high levels of leverage (i.e. lenders provide the majority of the funding)
Lenders/Investors provide debt capital to the SPV in two forms:
Syndicated Loans by which a group of banks forms a syndicate to jointly provide a certain amount of funds to construct and manage the infrastructure on a mid-to long term basis and fully guaranteed by all the assets of the SPV.
Project Bonds by which investors subscribe debt securities issued by the SPV, which are backed up by the cash flows generated by the cash flows generated by the SPV throughout its life.
o Attractive for institutional investors that seek long-term assets providing a stable stream of cash flows.
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Financial Contracts
Bank Syndicated Loans represent the largest part of total debt financing for infrastructure, although the trend clearly shows a decrease in their size over time, down to an 81% in 2013.
SOURCE: Thomson Reuters, Project Finance InternaBonal - Economoney
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Financial Contracts
Since the financial crisis in 2008, Project Bonds have increasingly gained importance up to a 20%.
SOURCE: Thomson Reuters, Project Finance InternaBonal - Economoney
Example: Metro 5 - Financial Contracts
CLIP 5
Example: Metro 5
The key facts: Financial Contracts singed in 2007 Partial completion of the Violet Line 5 of Milan Underground Light Rail in 2011 Total project cost: about 550 mil
o public grant about 300 mil o private sector:
o 200 mil in LOANS o About 40 mil in EQUITY contribution
Debt/equity ratio: 5.2x
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Metro 5
24.6% 23.3% 15.4% 9.4% 7.3% 20%
Ansaldo Trasporti-Sistemi Ferroviari S.p.A.
Ansaldi S.p.A.
Tomo Internazionale
S.p.A.
Ansaldo Breda S.p.A.
Ansaldo Ferroviaria
S.p.A.
Banks City of Milan
ATM S.p.A.
METRO 5 S.p.A.
Temporary Business Association (TBA)
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24.6% 23.3% 15.4% 9.4% 7.3% 20%
Ansaldo Trasporti-Sistemi Ferroviari S.p.A.
Ansaldi S.p.A.
Tomo Internazionale
S.p.A.
Ansaldo Breda S.p.A.
Ansaldo Ferroviaria
S.p.A.
Banks
ATM S.p.A.
METRO 5 S.p.A.
Financial Contracts INDUSTRIAL SPONSORS PUBLIC SPONSOR
PURE FINANCIAL SPONSORS (LENDERS)
Industrial Contracts
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Industrial Contracts
To design build and operate a facility, the project the SPV enters into 5 main key contracts, in different phases of the lifecycle of the project
Engineering Procuring Construction Contract (EPC)
Operation and Maintenance Agreement (O&MA) Supply Agreement (fuel: FSA; raw material RMSA) Sales Agreement (SA) Concession Agreement (in PPPs)
The same player can take on several different roles (DUAL ROLE).
The same players are NOT found in every project finance deal.
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Engineering Procuring Construction Contract (EPC) The contractor is the company (or consortium of companies) that wins the tender for
the design and construction of a given plant on the basis of a fixed price turnkey contract.
Contract obligations are taken on by the main contractor (who commits directly to the SPV) and are later passed on to consortium members.
The main contractor is normally responsible for damages resulting from delays in completing the facilities.
The contractor is also required to pay penalty fees if the plant does not pass performance tests.
By the same token, the contractor may also receive bonuses if the plant performs at higher than contracted levels or if the project is finished ahead of schedule.
Industrial Contracts
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Operation and Maintenance Agreement (O&MA) The operator is the counterparty who takes over the plant from the contractor after the
construction phase is complete, and handles maintenance for a set number of years, guaranteeing the SPV that the plant is run efficiently in keeping with the pre-established output parameters.
This party plays a key role during the operational phase of the project finance initiative. The operator may be an already-in-place company (perhaps even one of the sponsors) or
a joint venture created to serve as operator by the shareholders of the SPV.
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Industrial Contracts
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Supply Agreement (FSA or RMSA) The suppliers are companies that provide input to the SPV to run the plant on the basis
of long-term contracts which include arrangements for transporting and stocking raw materials.
In practice, there are rarely a large number of suppliers. More often, in fact, the project counterparties prefer a single supplier who is frequently one of the project sponsors.
However, in certain project finance structures there may not be a long-term supply contract.
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Industrial Contracts
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Sales Agreement (SA) The buyers are the counterparties to whom the SPV sells its output. Buyers of goods or services produced by the plant might be generic, which means not
defined ex ante (i.e. a retail market), or a single buyer who commits to buying all the project companys output. In the latter case, these buyers are called offtakers and output is sold wholesale.
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Industrial Contracts
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Concession Agreement (SA) The public administration provides special authorization to the SPV to design, to build
and manage a public project or public service (e.g. hospitals, prison, social housing).
The concession is limited to a certain period of time and typically allows the SPV to operate under the supervision of the public authority and in compliance with a precise set of guidelines.
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Industrial Contracts
Example: Metro 5 - Industrial Contracts
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Metro 5
24.6% 23.3% 15.4% 9.4% 7.3% 20%
Ansaldo Trasporti-Sistemi Ferroviari S.p.A.
Ansaldi S.p.A.
Tomo Internazionale
S.p.A.
Ansaldo Breda S.p.A.
Ansaldo Ferroviaria
S.p.A.
Banks City of Milan
ATM S.p.A.
METRO 5 S.p.A.
Temporary Business Association (TBA)
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Industrial Contracts
City of Milan
ATM S.p.A.
METRO 5 S.p.A.
Temporary Business Association (TBA)
Ansaldo Trasporti-Sistemi Ferroviari S.p.A.
Garbi Linea 5 S.c.r.l.
Alstom Ferroviaria S.p.A.
Ansaldo Breda S.p.A.
ATM S.p.A.
CONSTRUCTION CONTRACT
CONCESSION AGREEMENT
OPERATION & MAINTENANCE CONTRACT
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Metro 5: DUAL ROLE
Ansaldo Trasporti-Sistemi Ferroviari S.p.A.
Ansaldo Breda S.p.A.
ATM S.p.A.
CONSTRUCTION CONTRACTS
INDUSTRIAL SPONSORS PUBLIC SPONSOR
What does it imply to be both SPONSOR & CONTRACTOR? - have strong incentives to do their best - get lot of fees from the construction contract - get lot of money (dividends) as sponsors - consequently cumulate different layers of cash flows
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Metro 5: DUAL ROLE
ATM S.p.A.
O&M AGENT
PUBLIC SPONSOR
What does it imply to be both SPONSOR & O&M AGENT? - have strong incentives to do their best - get fees from the O&M contract - get money (dividends) as sponsor - consequently cumulate different layers of cash flows
Takeaways
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SPV empty shell network of contracts
2 Main Categories of Contracts Financial Industrial
Overlap between Sponsors and Other Counterparties
Agreements permits to:
To share responsibilities with other counterparties To manage risks
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Industrial Contracts
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