Project Finance and PPP Software - ppmportal.com

1 Rev 1 5 Aug 2010 Copyright 2010 Project planning and Management Ltd Page - 1 - Project Finance and PPP Models By John Macgillivray CEng, MIChemE, BA (Hons) Managing Director - Project planning and Management Ltd. Developing models for Project Finance (PF) and Public Private Partnerships (PPPs) presents some critical challenges. In this article we review some of the issues faced and make comment on how they should be handled. Why use a financial model? The basis for a Project financing or a PPP is that the ring-fenced projected cash flows are strong enough to interest an investor and warrant a bank loan, and the repayments and returns will be based on the Project cash flows alone. A model is therefore needed by the investors and the lenders to assess the cash flows under different scenarios throughout the life of the Project .

2 Differences between PF and PPP models PPPs use a private sector funding mechanism approach for public utilities and services. They cover many types of transactions some of which, such as pure management contracts, may not need a separate financial model. If a model is required, such as in concession-style contracts, the models differ little from private sector PF models except in the basis for calculating the revenue. PPP models will often have a reimbursement formula which is based on the capital and operating costs and may be affected by service availability and other external environmental factors. Differences between PF/PPP and corporate models PF/PPP models are similar to corporate planning models but are usually limited to a single plant or Project and will include the following items not normally found in a corporate model: Cash sweeps Cash traps Waterfall of accounts Sinking funds Loans, often in more than one currency Two bank accounts (operating and escrow) Financing parties may also insist upon the minimum ratios to protect the Project financial strength.

3 These items are discussed further in this article. The Model in Different Phases of the Project A simple model can be used in the pre- planning phases to compare the viability of different Project designs. This financial model does not need the accounting, funding or fiscal calculations to determine the optimum Project design though these are vital for fuding decisions. Models are most extensively used during the planning phases and before the financial close . Such models have extensive what-if analyses and will calculate the draw-down for the construction contract and the injection of equity and loan Finance during the construction phase. The user can change, say, the construction schedule and the model will recalculate the draw-downs.

4 A somewhat different model is needed once the design has been agreed. During the bidding and evaluation phase, the model should include the proposed contractor s payment schedule and the corresponding loan and equity draw-down schedules as part of its inputs. During the construction and subsequent phases the model should also accept the actual accounting statements for previous periods as inputs. These are needed in order to use up-to-date figures in calculating cash flows and ratios linked to loan covenants. Design of the model The model should be as flexible as possible. If it is a planning phase model, it should allow for a change in the start date, the construction schedule, the design, the capital and operating costs, etc.

5 There should be no hard coded figures. In the operating phase there will be less flexibility to change design inputs since these will be finalised at the end of the construction phase. The model should be laid out clearly with separate sheets for input and output. Colour coding will help the user understand which figures are inputs and which are calculated. Correct technical conversion factors are a crucial part of the model. This can be a crucial part of the model and it is very important to get them right. For instance, on a power Project , the difference between a lower and a Rev 1 5 Aug 2010 Copyright 2010 Project planning and Management Ltd Page - 2 - higher heating value (LHV and HHV) and when to use each variable is essential Revenues The revenues will be based on the market price and the market demand or a combination of capacity and operating cost payments as in a concession.

6 This may come from an external expert. Operating Costs The operating costs are typically divided into fixed and variable. The fixed costs are incurred irrespective of output whilst the variable costs depend on the output. Again these may be provided by experts. Maintenance Most projects are shut down once a year for annual maintenance. Some industries require additional maintenance at longer intervals. For instance, ships are dry-docked at two or three year intervals. Under these circumstances the model should take into account the additional costs and the loss of earnings and include a sinking fund for these costs for these items. Working Capital Inclusion of the working capital is an essential (and often forgotten) item in any model.

7 It should consist of both current assets and current liabilities. The initial working capital needs to be calculated and included in the funding. Multiple Currencies Almost all PF and most PPP models have to address multiple currencies. Whilst there will be a fixed exchange rate specified at some date, the model should calculate future exchange rates based on relative price indices assuming some form of purchasing power parity. The balances on loans, bank accounts, sinking funds and the accounting balance sheet will require an exchange adjustment entry in each period. Funding Funding typically consists of a blend of loans and equity. On some projects there may also be mezzanine loans.

8 Funding may be supplemented by government grants, either during the construction phase, the operating phase or both. Existing Project revenues may also be used. For instance, in a toll road, the net operating revenues from early operation of part of the Project may fund later phases. Where there is a significant element of foreign equipment and materials it may be possible to obtain export credits. The model may need to include some short term loans during the operating phase, such as a stand-by loan, working capital loan or feedstock supplier credit for periods when there is a shortfall in available cash. Cash Traps and Cash Sweeps It is quite common for lenders to request cash traps and cash sweeps from the Project accounts and the model must include these constraints on cash disbursements and availability.

9 The Waterfall of Accounts The loan documentation will contain a description of the sequence of disbursements from the escrow account. This sequence should be included in the model. Similarly, the documentation should describe how shortfalls in the net operating cash flows are made good by a combination of additional equity and/or loans. The Accounting Currency The Project documentation will state the currency in which the accounts will be prepared, usually the local currency. The formula for the calculation of the undepreciated assets needs to be carefully considered. If the calculations are done and displayed in another currency, say US Dollars, it needs to recognize the currency exchange differences.

10 Otherwise if the local currency depreciates against the US Dollar the Rev 1 5 Aug 2010 Copyright 2010 Project planning and Management Ltd Page - 3 - undepreciated assets will be overstated and the corresponding corporate taxes will be understated. Legal Structures Most projects are set up as corporate entities in the form of special purpose vehicles. Some Project financings can adopt different forms, such as a joint ventures or partnerships. These may impose additional expectations in the design of the model. Other types of projects, such as a privatised railway or a lease or a service agreement for an oil field, will inevitably gain from a model which looks at the cash flows for both parties.