Introduction to Project and
Infrastructure Finance
Week 1
Table of Contents
1 Who Does What & When: The Contractual Network
2 Project Finance vs. Corporate Finance
3 Financial Contracts: Shareholders’ Equity Contribution Agreements
4 Financial Contracts: Loan/Bond Contracts
5 Example: Metro 5 – Financial Contracts
6 Industrial Contracts
7 Example: Metro 5 – Industrial Contracts
LEGEND:
Additional content 2
CLIP 1
WHO DOES WHAT & WHEN?
THE CONTRACTUAL NETWORK
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Who Does What & When?
Infrastructure can be seen as a network of contracts:
Financial contracts in which: Project/Industrial contracts in which the SPV, a
• Sponsors provide equity capital; 100% outsourced enterprise, receives the assets
• And lenders provide debt capital to the SPV to design, build, and operate the project
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CLIP 2
Project Finance vs. Corporate Finance
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What Is Project Finance?
Project finance is an industrial/infrastructural 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 flow, to
repay the debt contracted, and also pay capital invested at a rate consistent with the
degree of risk inherent to the venture concerned.
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Project Finance & Corporate Finance
Suppose you have the opportunity to implement a new infrastructure with
these features:
• A large size compared to the assets in place;
• A high risk/high return;
• And a high correlation with the existing assets
Two options are available…
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Project Finance & Corporate Finance
1 Corporate Finance 2 Project Finance
EXISTING FIRM
EXISTING FIRM
May use
Uses
Finances Finances
existing balance sheet a new
New venture New venture
assets as collateral Incorporates dedicated SPV
Incorporates
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Project Finance & Corporate Finance
1 Corporate Finance 2 Project Finance
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.
Whereas in traditional corporate finance one company typically carries out multiple simultaneous
initiatives that get financed as a portfolio of projects.
How can you choose between these two options? (See the next slides.)
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Why Project Finance?
Incorporating the new venture in the parent firm has these effects:
• The outcomes of the project strongly influences the outcomes of the firm.
• There is a higher risk perceived by shareholders and lenders.
• It effects the WACC (weighted average cost of capital) and company’s value.
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Why Project Finance?
Incorporating the new venture in a SPV is SPONSOR SIDE
the optimal solution for sponsors:
Avoid Limit
• Financial flexibility is maintained intact. responsibilities
contamination
• There is a possibly cheaper cost of funding risk
of new financial resources for the initiative Limit losses
if compared to corporate loans (trade-off
between cost saving and deal Avoid negative
structuring/risk mitigation costs).
effect of an
• There is also an avoidance of increased
contamination risk. weighted average
cost of capital
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Why Project Finance?
Incorporating the new venture in a SPV
is the optimal solution for
lenders/creditors:
• There is full control over the project cash
flow.
• Monitoring is easier (focus on one
initiative).
• A possible tie-up of management behavior
(covenants and restrictions) exsists.
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Project Finance: Global Market Trends
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SOURCE: Thomson Reuters
Project Finance: Sector Breakdown
The spectrum of possible applications is very large, though the bulk of financing is in power
generation, transportation, and oil and gas.
In addition, telecommunication networks have been an important sector but less stable from year to
year.
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SOURCE: Thomson Reuters, full year 2015
Project Finance: Geographic Breakdown
However, out of the total amount of financing that has been committed to project finance in 2014
and 2015 there has been a reallocation of funds from more traditional industrialized countries to
fast growing economies. Most of the funding has been provided to Asia, the Pacific, and the Middle
East areas, where the need to fill the infrastructure gap is particularly relevant.
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SOURCE: Thomson Reuters, full year 2015
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 an near-monopoly of market contexts,
– High entry barriers,
– Regulated assets,
– Frequent natural hedge against inflation,
– Stable and predictable operating cash flows,
– And a low correlation with traditional asset classes and overall macroeconomic
performance.
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CLIP 3
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 three types of sponsors:
1 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 also common that they build, operate, and/or act as suppliers or clients of the
infrastructure (DUAL ROLE).
2 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.
3 Pure Financial Sponsors with no industrial rationale who have a high tendency to make risks
and see project financing as an opportunity to get substantial returns on their investments.
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CLIP 4
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:
1 Syndicated Loans in 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
to fully guarantee all the assets of the SPV.
2 Project Bonds in which investors underwrite debt securities issued by the SPV, which are
backed up by the cash flow generated by the SPV throughout its life.
o It is attractive for institutional investors that seek long-term assets providing a
stable stream of cash flow.
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Financial Contracts
Bank Syndicated Loans represent the largest part of total debt financing for infrastructure, although the
trend had shown a decrease in their size over time (down to an 81% in 2013) which has started to recover in
the past few years. 21
SOURCE: Thomson Reuters, Project Finance International - Economoney
Financial Contracts
Since the financial crisis in 2008, Project Bonds have increasingly gained importance up to 20% until
2013, but from that time onwards they have decreased in importance.
22
SOURCE: Thomson Reuters, Project Finance International - Economoney
CLIP 5
Example: Metro 5 - Financial Contracts
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Example: Metro 5
The key facts:
• Financial Contracts were signed in 2007,
• Partial completion of the Milan Metro Light Rail’s Lilac Line 5 of the in 2011,
• Total project cost: about 550 million Euro
o public grant about 300 million Euro
o private sector:
o 200 million Euro in LOANS
o About 40 million Euro in EQUITY contribution
• Debt/equity ratio: 5.2 to 1 (5.2x)
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Metro 5
Ansaldo Tomo Ansaldo Ansaldo
Ansaldi ATM
Trasporti-Sistemi Internazionale Ferroviaria Breda S.p.A.
Ferroviari S.p.A. S.p.A. S.p.A. S.p.A. S.p.A.
24.6% 23.3% 15.4% 9.4% 7.3% 20%
METRO 5
S.p.A.
Banks Temporary Business Association (TBA) City of Milan
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Financial Contracts
INDUSTRIAL SPONSORS PUBLIC SPONSOR
Ansaldo Tomo Ansaldo Ansaldo
Ansaldi ATM
Trasporti-Sistemi Internazionale Ferroviaria Breda S.p.A.
Ferroviari S.p.A. S.p.A. S.p.A. S.p.A. S.p.A.
24.6% 23.3% 15.4% 9.4% 7.3% 20%
METRO 5
LENDERS
S.p.A.
Banks
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CLIP 6
Industrial Contracts
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Industrial Contracts
To design, build, and operate a facility the SPV Take part in five key contracts, in
different phases of the project’s lifecycle.
1• Engineering Procuring Construction 2• Operation and Maintenance Agreement (O&MA)
Contract (EPC)
3• Supply Agreement (fuel: FSA; raw material RMSA)
4• Sales Agreement (SA)
5• 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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Dual Role
What does “the same player can take on several different roles” mean?
In this context it is common to have some counterparts playing multiple roles: DUAL
ROLE.
This means a sponsor (either industrial or public) is also linked to the SPV through one
or more industrial contracts. Lenders (or Pure Financial Sponsors), instead, provide
exclusive equity, so it is unlikely to find them in a dual role situation.
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Industrial Contracts
1 Engineering Procuring Construction Contract (EPC)
– The contractor is the company (or consortium of companies) that is chosen to design
and construct a given plant on the basis of a fixed price turnkey contract.
– Contract obligations are taken on by the main contractor (who directly commits to the
SPV) and are later passed on to the 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 expected levels or if the project is finished ahead of schedule.
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Industrial Contracts
2 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 a company that is already in place (perhaps even one of the
sponsors) or a joint venture created to serve as operator by the SPV shareholders.
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Industrial Contracts
3 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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Industrial Contracts
4 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 of the
project company’s output. In the latter case, these buyers are called offtakers and
output is sold wholesale.
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Industrial Contracts
5 Concession Agreement (SA)
– The public administration provides special authorization to the SPV to design, 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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CLIP 7
Example: Metro 5 - Industrial Contracts
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Metro 5
Ansaldo Tomo Ansaldo Ansaldo
Ansaldi ATM
Trasporti-Sistemi Internazionale Ferroviaria Breda S.p.A.
Ferroviari S.p.A. S.p.A. S.p.A. S.p.A. S.p.A.
24.6% 23.3% 15.4% 9.4% 7.3% 20%
METRO 5
S.p.A.
Banks Temporary Business Association (TBA) City of Milan
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Industrial Contracts
ATM
S.p.A.
OPERATION & MAINTENANCE
METRO 5 CONTRACT
S.p.A.
CONCESSION
CONSTRUCTION CONTRACT AGREEMENT
Temporary Business Association (TBA) City of Milan
Ansaldo Garbi Alstom Ansaldo
ATM
Trasporti-Sistemi Linea 5 Ferroviar Breda
S.p.A.
Ferroviari S.p.A. S.c.r.l. ia S.p.A. S.p.A.
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Metro 5: DUAL ROLE
INDUSTRIAL SPONSORS PUBLIC SPONSOR
Ansaldo Ansaldo
ATM
Trasporti-Sistemi Breda
Ferroviari S.p.A. S.p.A.
S.p.A.
CONSTRUCTION CONTRACTS
What does being both a SPONSOR & CONTRACTOR imply?
- Having strong incentives to do their best,
- Getting lot of fees from the construction contract,
- Getting lot of money (dividends) as sponsors,
- Consequently accumulating different layers of cash flows.
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Metro 5: DUAL ROLE
PUBLIC SPONSOR
ATM
S.p.A.
O&M AGENT
What does being both a SPONSOR & O&M AGENT imply?
- Having strong incentives to do their best,
- Getting fees from the O&M contract,
- Getting money (dividends) as sponsor,
- And consequently accumulating different layers of cash flows.
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CLIP 8
Takeaways
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Industrial Contracts
1 SPV
– Empty shell
– Network of contracts
2 2 Main Categories of Contracts
– Financial
– Industrial
3 Overlap between Sponsors and Other Counterparties
4 Agreements permits to:
– Sharing responsibilities with other counterparties
– Managing risks
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