Session 2 Basics Of Project Finance

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Mona Iyer CEPT University

Session Outline • Trends in Infrastructure service provision • Distinctive features Infrastructure Project Finance • Basic Components and concepts for financial assessment – Capital cost – Exp and Revenues – Means of financing •

What is Infrastructure – The internal framework structure OR basic facilities, services, and installations needed for the functioning of a community or society, industry or business

• such as transportation and communications systems, water and power lines, and public institutions including schools, post offices, and prisons etc..

– Infrastructure is about delivering essential services that are the foundation for development. (The World Bank) – – The term infrastructure has been used since 1927 – – people now use infrastructure to refer to any substructure or underlying system. Eg. financial infrastructure of business firm, research and development Infrastructure of a pharmaceutical company etc… •

Why is it important • Raise productivity of capital and labour • Essential for economic development of country • Chicken and egg situation: – Does Infrastructure investment cause growth or growth causes infrastructure investment – However, a strong association exists between the two. •

Trends in Infrastructure Service Provision • Historical prominence of public sector • Central Govt: interstate facilities like railways, highways, airports, major ports, telecommunications etc. • State or Local Govt. : Water supply, sewerage, roads, SWM, street lighting etc

• Basing project proposals on – social and political priorities and – budget constraints – NOT commercial considerations •

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Trends in Infrastructure Service Provision Why Public Sector • Assumption that they are natural monopolies •

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(it can only be provided efficiently by one large-scale producer/supplier)

• Considered as social goods to be provided by Govt. free of cost • Externalities linked to the projects •

(positive or negative impacts on nonusers. Private benefits or costs of use are not consistent with the public (social) benefits and costs, and therefore public and private demand are at odds.)

• Funds provided through Govt. Budgetary system

Trends in Infrastructure Service Provision • Wave of privatization and deregulation to achieve improved efficiency and service quality – 1970s- US deregulated natural gas, power and airlines – 1980s- Chile, New Zealand and UK implemented deregulation of almost all infrastructure sectors – Late 1980s more than 30 countries privatized some components of infrastructure – 1990s Govt. of India initiated efforts for commercialization of Infrastructure projects •

Issues in Infrastructure Development • Commercialization/Financing/Privatizatio n • Structuring and risk sharing • Project appraisal • Implementation

How Infrastructure Project Financing Differs?

• Traditional Balance Sheet Financing

• Project proponent raises debt and equity for financing the project • Recourse Debt- (recourse to the existing assets in case of default) • Debt holders rely considerably on balance sheet of the project proponent to decide the risk premium on the debt/loans. • Therefore--Not excessive stress on agreements. •

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How Infrastructure Project Financing Differs? Contd… • Infrastructure Project Financing • New company/corporate entity comprising of sponsor (s) eg. SPV • Sponsor (s) subscribe to equity in SPV • Cash flows of SPV kept separate from individual cash flows of sponsor(s) • debt holders rely on cash flow of SPV • Non-recourse (alternative) or limited recourse debt/financing • Therefore- watertight contracts important

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Project Structure NOIDA

DDA

Govt. of NCT of Delhi

IL & FS

Govt. of UP

Concessio n Agreemen t Support Agreemen t

•Maintenance including road surface overlays NTBCL Share holders Indpt. Engineer •The replacement formation Agreementand maintenance of Indpt. Auditor bridge equipment •Toll collection and management •Salient features •Assured Returns through NTBCL •Leasing of the lands •Concession period extension •Clearances from the •Land development rights Loan •Once the targeted return has Municipal corporation Agreement of Delhi been achieved, the project •Restriction Investors for Banks/ FIs facilities would revert to construction of new NOIDA for a nominal value on competitor bridge Rs 1. Intertoll • •Recovery costs through fees/ tolls Mitsui Marubeni Corp. of Japan South Africa O&M • •Fees Review Mechanism

EPC Contract

Prepared by : URP 0507 Pranjali Deshpande,

URP 2507 ShwetaGupta,

Contra ct

HSG

Roles & Responsibilities

Financing Plan

Equity Debt Ratio is 30 - 70 Measures for Risk Mitigation of NTBCL •Guaranteed returns – 20 % IRR per annum on total project cost •Tariff adjustments

•Exercising development rights •Revision in concession period

Components of Financial Assessment • Project Cost/ Capital cost , Revenues and Expenditure • Means of Financing (Deciding debt equity) • Sensitivity Analysis • Overall Financial Assessment (Cash flow analysis- NPV, IRR, financial ratios) •

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Capital Expenditure

Capital Cost

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– Capital Expenditures (CapEx): Longterm expenditures for property, plant, and equipment. • Physical ( fixed and mobile assets) like – land and site development, – plant and machinery (free on board charges+ transportation+insurance+ta x etc..), Royalty in case of technology transfer, – building and civil works

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Capital Expenditure

Capital Cost

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– Capital Expenditures (CapEx): Long-term expenditures for property, plant, and equipment. •

• Intellectual investments like – technical and engineering fees, – foreign experts and – training of Indian technicians abroad • Preliminary Expenses (Feasibility studies, MoUs, Incorporation of company etc..) • Capital Issue Expenses (Legal, stationary, publicity etc for issue of shares) •

Capital Cost

• – Capital Account: An account stating the amount of funds and assets invested in a business by the owners or stockholders. – Capital Budget: The cost of planned investment projects. – Capital Gains/Loss: The difference between the cost of an asset held for investment and its resale price.

Expenditure and Revenues •

– Expenditure: • Operation and Maintenance • Periodic spare replacements, repairs • Repayment of loans – Revenues: • Revenue from sale of products, • Collection of user fees • From sale of land. • Renting facilities created • Royalty

Equity

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Means of Financing

– In a project financing, the cash or assets contributed by the sponsors. – – In accounting, the difference between total assets and total liabilities. – – Equity finance is difficult to attract, specially in initial stages of project as the risk is high and returns uncertain •

Means of Financing Equity

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– Equity investors are last in the priority of repayment – Lenders look at equity very critically for following reasons : • Lenders want the investors in a position that they cannot walk away easily from the project! They must have enough stake to motivate them to see the project through • • The more burden the debt component puts on project, the greater the lenders risk • •

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(unless sometimes guarantees are provided by very creditworthy guarantors)

Means of Financing Debt

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– Money, owed by one person to another – Commonly called loan ! – The obligation to repay an agreed amount of money •

Means of Financing Subordinated debts/loans (Mezzanine finance) – Quasi-equity, senior to equity and junior to senior debts

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– Often used by sponsor to provide capital to a project which will support senior borrowings from third party lenders •

– Can be advanced by the investor as part of its original investment on project – •

Means of Financing Subordinated debts/loans (Mezzanine finance)

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– The possible sponsors for such loans are • one of the owners (equity holders in the project), • user anxious to get the project operational, or • government interested in getting the project done and is not allowed to take equity position in a project for policy reasons – – Subordinated loan is usually considered as equity by lenders for purpose of computing the proportion of equity and debt –

Means of Financing Senior Debts

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– Debt with the highest ranking for repayment, security, or action – Borrowings from commercial bank lenders – Unsecured Debts • No security except the creditworthiness of the borrower • Project tend to be new enterprises and have no operating histories, lenders rely upon the reputation of project partners • Industry specialist or project financing specialist hired by commercial banks as they are traditional balance sheet lenders • •

Means of Financing •

Senior Debts – Secured Debts • Assets are required to secure the debtcollateral, guarantees by govt. etc • Senior lenders may hold security interest (first right) in key project assets • Security trustee appointed to act on behalf of all secured lenders in case of multiple secured lenders – Distributes the debt service in order of priority.

• Recourse: In the event a project cannot service the financing or achieve completion, the financiers have recourse to either cash from the sponsor or other non–project security. • Non-recourse: The lenders rely on the project's cash flows and security over the project vehicle's assets as the only means to repay debt service. • Risk Premium: The reward for holding a risky investment rather than a riskfree one. • Royalty: A share of revenue or cash flow to the government or grantor of the concession or license. Compensation (i.e., royalty fees) for the use of intellectual property belonging to another party, usually calculated as a percentage of sales. • Collateral: Assets pledged as security under a loan to assure repayment of debt obligations. • •