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FINANCING THE MOZAL PROJECTCASE ANALYSIS

CORPORATE FINANCE

BY-VIVEK KUMAR

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CASE BRIEF

• Time period- 1997

• Location- Mozambique

• Project- $1.4 billion Aluminium Smelter

• Joint Venture between- Alusaf and Industrical Development Corporation(IDC)

• Born out of common interest among Eskom, Alusaf and Mozambican Govt.

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ALUSAF

• Aluminium subsidiary of Gencor Group.

• Gencore acquired Billiton from Royal Dutch Shell in 1994.

• Gencor- 4th largest Aluminium producer.

• $1.8 billion dollar Hillside Smelter in Richards Bay, South Africa.

• Build Aluminium smelter in Mozambique using hydroelectric power.

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INDUSTRICAL DEVELOPMENT CORPORATION(IDC)

• $3.6 billion Govt. Owned bank in South Africa.

• Mission- contribute to sustainable growth in South Africa by promoting entrepreneurship and financing private sector enterprises.

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ESKOM

• South Africa Power- 95% of country 50% of continent

• Saw opportunity in Mozambique to generate Hydroelectricity on Zamberi River.

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LONDON METAL EXCHANGE(LME)

• The world centre for industrial metals trading.

• The prices discovered on its trading platforms are used as the global reference price for both the metal and investment communities.

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HISTORY OF MOZAMBIQUE• Gained freedom from Protugese in 1974.

• Civil war broke out between Frelimo & Renamo

• The two sides signed peace treaty in 1992.

• Govt. Made constant efforts to improve macroeconomic conditions & encourage private sector investments.

• GDP was increasing and inflation reducing.

• Yet still remained poor and under-developed.

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THE MOZAL PROJECT• Aluminium Smelter • Provide Mozambique with electrical and industrial

infrastructure.• 34 months to complete.• Additional 6 months to reach full capacity.• Smelting technology from France.• Skilled labour from South Africa• Unskilled labour from Mozambique at low cost.• Raw materials from current suppliers at Hillside.

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NEGOTIATIONS

BILLITON’S AUSTRATIAN OPERATIONS

ESKOM & EdM

PECHINEY OF FRANCE

SKILLED LABOUR

UNSKILLED LABOUR

SUPPLIERS AT HILLSIDE SMELTER

TAXES & FEES

Smelting Technology

Electricity under 25yr contract

Alumina imports under 25 yr contract

South Africa

Mozambique at cheap cost Raw materials

Industrial Free ZoneNo Custom duties1% sales tax

MOZAL PROJECT

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PROJECT POTENTIAL

• A Low cost producer, among lowest 5% of the industry.

• World average cost of production & financing- $1510 per ton.

• Mozal project- $ 1493 per ton in 4th yr, declining to $1070 in 11th yr.

• Cost of Capital $4750 per ton, compared to the recent average of $4850.

• Mozambique GDP growth rate- 0.5% (1980-91) to 6.5%(1992-96)

• Attractive Power tariffs, favourable investment incentives.

• Labour cost 1/5th of western world smelter.

• Risk rating from 7.6 to 14.0

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CHALLENGES OF PROJECT

• Legal and Approval system- Mozambique followed civil law based system with contrasted with common law system of South Africa.

• Pessimistic picture of Economist Intelligent Unit(EIU)

• Pessimistic approach of investors.

• No existing infrastructure.

• Logistical challenges.

• Unskilled labour.

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FINANCING

ALUSAF$125

IDC$125

EQUITY PARTNERS

$250

START-UP CASH$35

SUBORDINATE DEBT$150

SENIOR DEBT$680

$ - In million

THE MOZAL PROJECT$1365

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INTERNATIONAL FINANCE CORPORATION (IFC)• A member or world bank group.• Founded in 1956.• 172 member countries.• Rich experience in emerging markets.• Invested in private sector in poor countries with the aim to reduce

poverty and improve standard of living.• Projects must have- private ownership, commercial viability,

environmentally sound and provide developmental benefits.• Provided long term multilateral source of debt and equity.• Valued developmental benefits.• Provided lower financial rate of return for same risk.• Appraisal of Mozal project took 3 months (Jan-Mar 1997)

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OUTCOMES

• Increase exports by $430 million.

• Increase GDP by $157 million (6.5% to 9%).

• Increase net foreign exchange by $161 million.

• 5873 jobs for Mozambicans.• jobs for Mozambicans.

• Job training, AIDs awareness, housing.

• Provide critical infrastructure and spur future investments.

• Social and environmental impact.

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Q.1 a) Should Alusaf/Gencor invest in the Mozal project

Market Opportunityo To rebuild Mozambique’s damaged infrastructure

They already have a strong footing in South Africa, where they completed Hill Side smelter, $360 million under budget and four months ahead of schedule, Mozal can access the same resourcesSupport from Government of Mozambique

o Offered to create an Industrial Free Zone and exempted from custom duties and income tax, levying a sales tax of just 1%

Competitive and Reliable Suppliers networko Eskom’s offered long term and attractive electricity prices and also the availability of

cheap hydroelectric powero The key elements of production was internationally sourced from reputed companies

Low Production Costso Very low Labor and overall production costs compared to the rest of the industry

Financial benefitso The current ratio for all the projected years is comfortably above 1.33o DSCR of the company for the following years is falling within comfortable limits.

Exhibit 6

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Q. 1 b)What are the greatest risk? Have they been adequately addressed?

• Technology:Risk of handling construction of a project that require technology and skills.Alusaf had already used the smelter technology in hillside smelter project that turned out to be a

meaningful decision.

• Timely Completion of the project:Since government is directly involved in this project, therefore it would involve bureaucratic procedure to comply all the legal and legislative requirement of the state.Company is seeking prior permission of the state to grant construction permit. Thus an agreement has been signed with the South African government to address risk associated with delays.

• Operation:Cost of production heavily depend on cost of raw material(Alumina)Agreement by which rate of Alumina is the function of final product.

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Q.2 Will the sponsors be able to finance the deal?

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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

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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

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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

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3.1 How does IFC involvement affect the deal?• It would generate interest among banks to finance the project.• Outcomes appraisal would generate confidence in the project.• Will ensure the project is fair to all parties.• It would be a catalyst and increase the likelihood that others would

participate in the deal and generate future investments.

3.2 Will IFC and sponsors(Alusaf & IDC) share similar objectives?• Yes, going by the mission of IDC, it is similar to the ideology of IFC. • Alusaf will be benefited as IFC will provide comfort to potential

lenders.• IFC will reconcile the different legat system of Mozambique & south

Africa into a single set to simplify dispute resolutios.• Specify sponsor’s completion guarantees- What kind of political

events would release the sponsors from contractual obligations.

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3.3 Should the IFC play an advisory role only or should it also invest in the Mozal project?

• IFC should also invest in the Mozal project.• It was willing to make loans with longer maturity for long lived

asset.• Could offer lower financial rate of return for same risk.• IFC involvement could help change the country’s risk rating as

evident in history.• Would lead to overall development and growth of Mozambique and

could be a good opertunity of them get over hard times of war and move towards a better future.

• It would help IFC live out it’s mission.

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4. As an IFC board member, would you approve the recommended investments in Mozal?

• Yes, Selling price of metal is higher than the Mozal cost, thus their is the potential for Profitability.

• Investment in the project would generate valuable social, economic and financial benefits.

• Mitsubishi Corporation, worth $78 billion is a participant to join the deal.• Industry demand for aluminium is 20 million tons is expected to grow by

2-3% each year.• Projected growth of 5million tons of primary capacity for the next 10 yrs.• Outcomes of the project appraisal depict a positive potential of the project

towards Mozambique’s growth and development as well as profitable for the sponsors.

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Q.5) What is the IFC`s competitive advantage?

• Good governance.• Better Accountability. • Increased lender liability are relevant to

financial institutions.

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To what extent does the IFC do something that is unique, valuable, and sustainable?

Longer maturity period loans given •Senior debt for 7-12 years•Subordinated debt for 8-15 years

Presence of IFC increases the likelihood

of other lenders to finance the project

IFC was willing to lend on subordinate basis

thereby exposing itself to higher risks

As compared to commercial banks, IFC was willing to

accept lower returns for the same level of risk because of

the development policy

IFC structured deals in such a manner that

sovereign risk is mitigated

IFC helps the sponsors in improving the corporate

governance and make them more sustainable

IFC also makes the companies adopt

better environmental practices

IFC’s association with the World Bank

helped in reducing the political risk

IFC helps in developing human capital among

the Mozambicans through skills training