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Financing Mega-Projects

Prof. Azhar M. Khan PhD(USA), PE, PMPAlumnus of Georgia Tech and Harvard University

CEO Business Masters and Consultants LLC, Connecticut USA

CEO Institute of Project Management and Emotional Intelligence

Adjunct Professor SKEMA and Center for Advanced Studies

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Mega Project• A megaproject is an extremely large- scale investment project. Airbus A-380 ($ 13 Bn), Caspian Oil Fields, BP Amoco ($ 10 Bn), Three Gorges Dam ($ 26 Bn)

• Costing more than US$ 500 Million

• Attracting a lot of public attention and have Great Impacts on Communities and Nations

• They can Generate Financial, Developmental and Social Returns

What is Project Finance?

Raising of funds to finance an economically separable capital investment project in which fund provider looks at cash flows from the project as the sources of funds to service their loans and provide return of and return on their equity invested on the project.

A financing of economic unit in which lender is satisfied to look at cash flows (earnings) of the unit for repayment of loan

Project Finance Contd.

Project finance involves creation of a legally independent project company financed with non-recourse debt.

Thus, non-recourse debt is typically limited to 50% or 60% loan-to-value ratios.

Dates back to 1299 when English Crown Established Leading Florentine Merchant Bank to Aid Development of Devon Silver Mines

Key Aspects of Project Finance

1. Investment decision involving industrial asset (Including infrastructure)

2. Stock type projects: Oil/gas or other ores (proceeds used to service debt and generate equity return)

3. Flow type projects: toll roads, telecomm, pipelines, power plants (rely on asset use)

4. Project finance is off-balance sheet finance5. Project companies have highly leveraged

capital structures

Means of Project Finance Share Capital: Comprises Equity capital and

preference capitalEquity funds: through ownership capital or cash that is

debt free. The use of such funds incurs an opportunity cost. Being a risk capital carries no fix rate of dividend.

Preference Capital: Contribution made by preference shareholders

Term Loans Borrowing money from banks or other financial organizations (e.g., insurance companies and pension funds). It is a secured borrowing.

Issuing bonds. These debt obligations are normally long-term, as opposed to short- term, obligations for the purchase of supplies and raw materials.

Financing projects through issuing bonds is a method of obtaining capital funds that is probably less popular than borrowing money from a bank at a stated interest rate.  

Debenture Capital

Deferred Credit: Payment of plant or machinery can be made over a period of time.

Incentive Sources: Financial support (subsidy) provided by the government to have industrial estates, eco-conservation parks etc, in the form ofSeed moneyTax breaks/ deferment etc.

Miscellaneous Sources:Unsecured loans/ Bridge financingPublic depositsLeasing and hire purchase finance

PPP

Financing of Govt. ProjectsTaxation like income tax, property tax, sales

tax and road user tax etc.Issuance of bondsResource mobilization (Income generation):

Toll Road, Municipally owned power plant, charge for service performed

Loans, subsidies and grantsMoney is passed from one government authority to anotherLow or No interest loansInsured loans

Use of Federal funds entail no monetary returns to the government but benefits to the society (Consumer surplus)

Cost-sharing agreements with States and Provinces

International Donor funding

Implications - Capital Market Imperfections

• Agency conflicts• Asymmetric information• Financial Distress

• Cause Deadweight Financing Costs on Firms• Small relative costs become large absolute costs

• 5 % of asset value for $ 20 million investment is only 1 million and is $ 100 million for a $ 2 billion investment

Empirical Studies on Performance of Large Projects

1. Miller and Lessard (2000) studied large engineering projects ($ 1 Billion average). They found 40 % of projects were abandoned or restructured for financial distress.

2. Merrow et al (1988) studied 47 Megaprojects and found that only 4 of them came on budget and 26 failed to achieve profit objectives. They concluded that megaprojects with greater public ownership showed worse performance.

3. Flyvberg, Bruzelius and Rothengatter concluded that “over-optimistic forecasts of viability are the rules for major investments rather than the exception.

Second Dimension of Investment

Financial Analysis of Mega-Projects

Conclusion1. The Most Comprehensive Study on Performance of Project Loans Conducted by Leading Project Finance Banks & S&P Risk Solutions Showed that Project Loans have Lower Default Rates and Higher Recovery Rates than Corporate Loans.2. There Exists a Direct Relationship between Project Finance and Project Management

Conclusion Contd.3. To make optimal investing,

financing and operating decisions, senior executives must possess functional expertise across a broad range of disciplines. They must understand issues related to Competitive Strategy, Business-Government Relations, Marketing/ Sales.

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