Project Finance
Tim Thompson
Corporate Restructuring
How is most corporate
investment organized?
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In corporations
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Debt is usually recourse to entire
organization’s assets
Leverage is usually modest (obvious
exceptions)
What is project finance?
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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?
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Somewhat arbitrary, but
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Single purpose capital investment
Stand alone entity
Finite and long life
Large in size
Project finance versus
conventional financing
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Modigliani Miller still holds if its
assumptions are true
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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
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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
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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
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High leverage, dedicated cash flows,
very specific contractual terms for
repayment and contingencies
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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
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MM theorem assumes the investment is
fixed
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It may be that the investment itself is
improved by the structure
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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
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Project finance is usually high leverage and
non recourse to project sponsors
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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
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Governments/international agency (IFC/World
Bank)/Sponsors/etc.
Different contractual
relationships
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Contracts needed:
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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