- March 3, 2018
- Posted by: OLC Learning
- Category: Blog
Key Aspects of Project Finance
I will highlight some of the other key aspects of Project finance.
- Separate Entity (Parent) and SPV Status – Risk of the transaction is generally measured by the creditworthiness of the project itself rather than that of its owners (Sponsors).
- Project Finance debt is often termed as “non-recourse”– That means the financial institutions cannot go to the parent level to get their money back. The money has to be generated at the SPV level. Typically these loans are secured by the project assets and the core project contracts.
- Timing of Cash Flow: The cash flows from the project comes only after the project is fully complete (takes more than a single financial year for completion) and are usually the sole means of repayment of the borrowed funds
- Multiple parties involved
- Global financiers
- Long Gestation: From inception of an idea to Financial Close, a Project Finance deal can take years to negotiate
- Identifying Risks: The success of the project depends a lot on identifying risks, allocating them appropriately and ensuring that the responsible parties are adequately incentivized to manage their risks efficiently
- Construction time, costs & specification
- Operational cost, reliability
- Supply reliability, quality, cost
- Off-take volume, price
- Political environment, war, local hostility, currency in-convertibility
- Socio-environmental responsibilities
Modeling a Key Risk – Delay in Project Implementation
Because of the structure of the project one of the key risks in the project is the risk of delay. Delay in project can significantly reduce the IRR (what is it?) of the project and completely take it off track! There are multiple ways in which projects can be delayed and each would have its own repercussions on the return. These can be (The list is not exhaustive):
- There is an implementation risk (Delay because you could not execute the project in time)
- Delay in start of project (Could be because of regulatory approvals – Regulatory Risk)
- Delay in project because no funds were available (or delay in arranging the funds)
- Delay in collection of revenues (You built at the right time, but could not sell – Selling risk)
Typically each of these delays would have different affect on the cash flows. For example, if you are implementing a real estate residential project and you are not able to sell the homes – you have incurred all your cash outflows and your inflows are delayed. This would spell doom for the returns. On the other hand, if there is a delay in staring the implementation because of non acquisition of land, typically your cash outflow is not there so the affect would not be that large.
Why are delays more relevant for certain kind of investments?
Typically for long gestation projects – Roads, Real Estate, Power, Telecom, etc. there is a huge upfront investment. Even if there is a small delay in getting back the cash flows, it makes your project financials look very bad.
The Case of ABC Housing Co.
ABC housing company is planning to start the project on 1 Jan 2002 and is expecting to complete the construction over a period of 3 years. The construction cost is expected to be USD 1000 Mn. It is expecting to hold the property for a period of 5 years, in which it would get a lease rental of USD 100 Mn each year. After 5 years, it would sell the property at a value of USD 2000 Mn.