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Agenda
1) Introduction to Risk Management for outsourcing
projects.
2) Project Finance
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Financing choices
Real World Cases
Project Finance: Valuation Issues
The MM Proposition
Prof. Vincenzo Sanguigni
Rome - May 29th
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Purpose:
management process
To describe specific risks and what its
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Objectives of RM
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What is a Risk?
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Project Predictability
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Project Predictability
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Customer
End-user
Project team
Management
Product management
Related Projects
Suppliers
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When?
RM is a continuous process
Prof. Vincenzo Sanguigni
Rome - May 29th
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Generic RM process
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Likelihood
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Consequence
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Agenda
1) Introduction to Risk Management for outsourcing
projects.
2) Project Finance
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Financing choices
Real World Cases
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The MM Proposition
The Capital Structure is irrelevant as long as the firms
investment decisions are taken as given
Then why do corporations:
Set up independent companies to undertake mega
projects and incur substantial transaction costs, e.g.
Motorola-Iridium.
Finance these companies with over 70% debt inspite
of the projects typically having substantial risks and
minimal tax shields, e.g. Iridium: very high technology
risk and 15% marginal tax rate.
Prof. Vincenzo Sanguigni
Rome - May 29th
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Agenda
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Operating aspects
Financing choices
Real World Cases
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What is a project?
High operating margins.
Low to medium return on capital.
Limited Life.
Significant free cash flows.
Few diversification opportunities. Asset
specificity.
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What is a project?
Projects have unique risks:
Symmetric risks:
Demand, price.
Input/supply.
Currency, interest rate, inflation.
Reserve (stock) or throughput (flow).
Environmental.
Creeping expropriation.
Binary risks
Technology failure.
Direct expropriation.
Counterparty failure
Force majeure
Regulatory risk
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Agenda
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Financing choices
Real World Cases
Project Finance: Valuation Issues
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150
MLA/ BLA
Million USD
Bonds
100
Bank loans
50
0
1997 1998 1999 2000 2001
Years
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Number of Projects
Number of Projects
700
600
500
Number of 400
Projects 300
200
100
0
1997 1998 1999 2000 2001
Years
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Percentage
Bonds
Bank Loans
1997
1998
1999
2000
2001
Years
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$120.00
$100.00
$80.00
Amount USD
$60.00
$40.00
$20.00
$1997 1998 1999 2000 2001
Industrial
Leisure
Petrochemical
Mining
Telecom
Oil and Gas
Infrastructure
Power
Years
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Agenda
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Operating aspects
Real World Cases
Project Finance: Valuation Issues
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Project Structure
Structure highlights
Comparison with other Financing Vehicles
Disadvantages
Motivations
Alternative approach to Risk Mitigation
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Structure Highlights
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Structure Highlights
Highly concentrated equity and debt ownership
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Similarity
Dis-similarity
Secured debt
Collaterized with a
specific asset
Recourse to
corporate assets
Subsidiary debt
Possible recourse to
corporate balance
sheet
Asset backed
securities
LBO / MBO
No corporate sponsor
Venture backed
companies
Concentrated equity
ownership
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corporate finance.
Higher transaction costs due to creation of an
independent entity. Can be up to 60bp
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.
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Problems:
Structural solutions:
High levels of
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Problems:
Structural solutions:
monitoring.
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Structural Solutions:
Opportunistic
behavior by
trading partners:
hold up. Ex-ante
reduction in
expected returns.
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Structural Solutions:
Opportunistic
behavior by
trading partners:
hold up. Ex-ante
reduction in
expected returns.
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Structural Solutions:
Opportunistic
behavior by host
governments:
expropriation.
Either direct
through asset
seizure or
creeping through
increased
tax/royalty. Exante increase in
risk and required
return.
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Structural Solutions:
Opportunistic
behavior by host
governments:
expropriation.
Either direct
through asset
seizure or
creeping through
increased
tax/royalty. Exante increase in
risk and required
return.
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Debt/Equity holder
conflict in distribution
of cash flows, reinvestment and
restructuring during
distress.
Structural Solutions:
Cash flow waterfall reduces managerial
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Structural Solutions:
Debt/Equity holder
conflict in distribution
of cash flows, reinvestment and
restructuring during
distress.
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default.
Creeping expropriation is difficult to detect and
highlight.
Multi lateral lenders which help mitigate sovereign
risk lend only to project companies.
Non-recourse debt had tougher covenants than
corporate debt and therefore enforces greater
discipline.
In the absence of a corporate safety net, the
incentive to generate free cash is higher.
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Structural Solutions:
Under investment in
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Structural Solutions:
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Structural Solutions:
Co-insurance benefits are negative
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Motivations: Other
Tax: An independent company can avail of tax holidays.
Location: Large projects in emerging markets cannot be financed
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Risk
Solution
Completion Risk
Price Risk
hedging
Resource Risk
Operating Risk
Environmental Risk
Insurance
Technology Risk
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Insolvency Risk
Currency Risk
Hedging
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Agenda
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Operating aspects
Real World Cases
Project Finance: Valuation Issues
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functions
Analysis and risks managing/sharing
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Applicability fields
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Players
Proposers or sponsors
Public granter
Project Company o Special Purpose Vehicle)
Institutional investors and financers
Project managers
Contractors
Suppliers
Consumers or output projects users
Guarantors
Consultants
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Involved parties
Public
administrations
Banks
se
cu
r
Suppliers
f in
an
iti
ci n
g
es
SPECIAL
PURPOSE
VEHICLE
Supply
contracts
Plant
Managing
subject
Prof. Vincenzo Sanguigni
Rome - May 29th
Project
sponsors
ion
t
p
i
sc r
Sub
Purchase
contracts
cks
o
t
s
of
Product
Off-taker
Plant
Constructor
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Steps:
A) Project focusing and feasibility analysis
Proposal
Feasibility studies
a) technical feasibility
b) financial feasibility
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B) Operating phase
Creation of a project
company
Planning
Grants allotment
General contract,
supply contract,
Permissions,
environmental impact
test
Monitoring
Completion
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C) Managing phase
Start-p
Workability
Grants end
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Risks
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A) General risks
B) Specific risks:
planning risks, project testing risks
Workability risks (risks of the operational
phase)
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A) General risks
Subjective risks
Financial risks
interest rate fluctuations
currency rate fluctuations
inflation
Refinancing risk
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Country risk
currency unconvertibility
transfer risk
market deregulation
restrictions, law limitations
Legal risk
certainly of the law system
difficulties in conciliate different foreign
law techniques
Prof. Vincenzo Sanguigni
Rome - May 29th
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Environmental risk
Related costs to: Environmental Due
Diligence; taxes; sustainable technologies;
insurances; legal costs; reimbursements;
assets value decreasing; etc..
Technological risk
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Fulfillment risk
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Market risk
Risks related to the operating costs of the
project
Supply risk
Unexpected capital disbursement
Prof. Vincenzo Sanguigni
Rome - May 29th
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2 main strategies
stipulating insurance contracts
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Guaranties
In the Security package it is possible to
do, not to do
to give, not to give
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Issues:
fulfillment (costs, quantity, quality)
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Foreign Country
Country choice
Local counsel
Local government involvement
financial resources
guaranties on the future political stability
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Pattern
shareholders
PROJECT
COMPANY
GOVERNMENT
/
AUTHORITY
GRANT
PROJECT
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Building contract
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Completion Guarantee
(required by banks)
if the building cost exceeds the budgeted
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Contract (SOP)
Put And Pay Contract (PAP) or Supply And
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Contents
The MM Proposition
What is a Project?
What is Project Finance?
Project Structure
Operating aspects
Real World Cases
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Case : BP Amoco
Background: In 1999, BP-Amoco, the largest shareholder in AIOC,
the 11 firm consortium formed to develop the Caspian oilfields in
Azerbaijan had to decide the mode of financing for its share of the
$8bn 2nd phase of the project. The first phase cost $1.9bn.
Issues:
Size of the project: $10bn.
Political risk of investing in Azerbaijan, a new country.
Risk of transporting the oil through unstable and hostile countries.
Industry risks: price of oil and estimation of reserves.
Financial risk: Asian crisis and Russian default.
Prof. Vincenzo Sanguigni
Rome - May 29th
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Case: BP Amoco
Structural highlights:
Risk sharing: Increase the number of participants to 11 and
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Key Issues:
limited growth potential
Market risk from fast changing telecom market
Risk from project delay
Specialized use asset: Need to get buy in from
landing stations and pre-sell capacity to address
issue of Hold Up
Significant Free Cash Flow
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Structural highlights:
Avoid Hold up Problem through governance structure:
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Key Issues:
Assessment of project risk and allocation of risks.
How can project risk best be managed?
Developing a structuring solution given the time pressure.
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Operating Risk:
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Key Issues:
What should be the final capital structure to keep the project viable?
What is the optimum debt instrument and will the debt remain
investment grade?
How can the project structure best address the associated risk?
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Sovereign Risk
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Equity returns:
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Key Issues:
Chad is a very poor country ruled by President Deby, a warlord.
Expropriation risk.
Possibility of hold up by Cameroon.
Allocation of proceeds World Banks role and Revenue Management
Plan.
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Field System
Export System
Total
Investment
$1521m
$322m+$1881m=$2203
m
$3723m
40%*
$1521m = &608m
40%*($2203m) =
$881m
$1489m
Corp. Finance
40%*
$1521m = $608m
Project Finance
40%*(123+680)=
$321m
$929m
16%*$1521m = $243m
16% * ($2203)
=$352m
$596m
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Key Issues:
Seizing the initiative and exploiting first movers advantage.
Possible alternative sources for finance.
Limited corporate debt capacity.
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Project Finance :
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Project Finance:
Hybrid Finance:
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Issues:
Scope of the project: 66 satellites, 12 ground stations around the world
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Cannot be explained by trade off theory since tax rate is 15% only.
Pecking order theory and Signaling theory also do not explain the high
D/V ratio.
Agency theory best explains the D/V: Management holds only 1% of
equity and the project has projected EBITDA of $5bn resulting in high
agency cost of equity. Also, since Iridium has no other investment
options, risk shifting and debt overhang do not increase agency costs of
debt.
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Sequencing of financing:
Started with equity during the riskiest stage (research) since debt would
be mispriced due to asymmetric information and risk.
In development, brought in more equity, convertible debt and high yield
debt. This portfolio matches the risk profile then.
For commercial launch, got bank loans: agency motivations emerge.
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Issues:
Concentrated and weak equity ownership: Preston Resources.
Cash flows very close to debt service.
Processing technology is unproven.
The output faces severe market risk and currency risk.
The company has exposure to currency risk through forward
contracts.
Prof. Vincenzo Sanguigni
Rome - May 29th
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Acknowledgements
The content of this presentation has been derived primarily from
the:
Imperatori G, La finanza di progetto, Il Sole24Ore, 2003.
Project Finance course taught by Benjamin Esty at the
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