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Project Finance. Tim Thompson Corporate Restructuring. How is most corporate investment organized?. In corporations Debt is usually recourse to entire organization’s assets Leverage is usually modest (obvious exceptions). What is project finance?.

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project finance

Project Finance

Tim Thompson

Corporate Restructuring

how is most corporate investment organized
How is most corporate investment organized?
  • In corporations
    • Debt is usually recourse to entire organization’s assets
    • Leverage is usually modest (obvious exceptions)
what is project finance
What is project finance?
  • Refers to a wide range of financing structures. These financing structures usually have one thing in common --- the financing is not primarily dependent on the credit support (credit quality) of the sponsors or the value of the assets involved. Instead, debtholders (banks, public lenders) place a substantial degree of reliance on the performance (I.e., cash flows) of the project itself…
  • Non-recourse (or at least limited resource) financing
  • Project finance is both a financial structure and a corporate governance structure aimed at resolving capital market imperfections and efficiently allocating risk.
what types of projects
What types of projects?
  • Somewhat arbitrary, but
    • Single purpose capital investment
    • Stand alone entity
    • Finite and long life
    • Large in size
project finance versus conventional financing
Project finance versus conventional financing
  • Modigliani Miller still holds if its assumptions are true
    • if there were no taxes or transactions costs
    • no costs of financial distress
    • no agency conflicts
    • no information costs
    • THEN PROJECT FINANCE WOULD ADD NO VALUE RELATIVE TO CONV. FIN.
project finance is very costly
Project finance is very costly
  • Transactions costs very large
  • Contracts: very complex organizational structure, not much flexibility
  • Long negotiations, long time to close
  • Fees (0.6% of deal size, similar to M&A)
  • DISADVANTAGE RELATIVE TO CONVENTIONAL FINANCE
costs of distress bankruptcy
Costs of distress/bankruptcy
  • Risk of default and allocation of this risk very different than conventional debt
  • Less risk contamination with other parts of firm
  • Less co-insurance benefit
  • Rearranges “states” in which default occurs
  • Trade-off, clearly
agency costs
Agency costs
  • High leverage, dedicated cash flows, very specific contractual terms for repayment and contingencies
    • May limit opportunities for risk shifting
    • May limit cross subsidization incentives
    • May replace managerial incentives of a public-sector project with a for-profit venture, contracts used to enhance incentives
may improve economics
May improve economics
  • MM theorem assumes the investment is fixed
    • It may be that the investment itself is improved by the structure
      • Walt Disney got huge tax and governmental relief by setting up EuroDisney as a project structure rather than owning outright
    • Tax, gov’t. reg.’s may be reduced
outside guarantees
Outside guarantees
  • Project finance is usually high leverage and non recourse to project sponsors
    • even with its possible benefits, this usually leads to high risk debt, which is often illiquid, costly and sometimes simply not available
  • Often a guarantee or credit support is offered by
    • Governments/international agency (IFC/World Bank)/Sponsors/etc.
different contractual relationships
Different contractual relationships
  • Contracts needed:
    • Management/shareholder agency relationship
    • Intercorporate agency relationship
    • Government/corporate agency relationship
    • Bondholder stockholder relationship
  • Definition of the organization (corporation) is a nexus of these contracts
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