Financing and investing in infrastructure week 1 slides

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

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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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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.


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

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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%


Ansaldi S.p.A.

Tomo Internazionale

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)


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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.


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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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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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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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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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Example: Metro 5 - Industrial Contracts

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Metro 5

24.6% 23.3% 15.4% 9.4% 7.3% 20%


Ansaldi S.p.A.

Tomo Internazionale

S.p.A.


Ansaldo Ferroviaria

S.p.A.

Banks City of Milan

ATM S.p.A.

METRO 5 S.p.A.


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City of Milan

ATM S.p.A.

METRO 5 S.p.A.



Garbi Linea 5 S.c.r.l.

Alstom Ferroviaria S.p.A.


ATM S.p.A.

CONSTRUCTION CONTRACT

CONCESSION AGREEMENT

OPERATION & MAINTENANCE CONTRACT

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Metro 5: DUAL ROLE



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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Documents

Financing and investing in infrastructure week 1 slides