Project Finance M&A Case Study
Michael Bennon
Global Project Finance
Stanford University
Spring 2025
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You and your colleagues work on the energy sector mergers and acquisitions desk at a midsized investment bank. One of your Managing Director’s regular clients is a senior
executive at XYZ Renewable Energy Partners, a fund manager with a mandate to take
controlling equity positions in both greenfield and operating renewable energy project
companies. XYZ Renewables has engaged your team to conduct investment due diligence
on a potential investment in the Island Energy Company. Your task is to review the project
agreements, contracts and other current documents, assess the energy market the project
plans to service, develop a financial model to analyze the proposed transaction, complete a
risk assessment and sensitivity analysis of the proposed project, and make a presentation
to the investment committee at XYZ Renewables to either recommend or not recommend
the opportunity for investment. If recommended, your team is asked to identify key risks,
propose actions to mitigate them, and propose the appropriate terms of investment.
Island Energy
The Island Energy Company was formed to develop a High Voltage Direct Current (HVDC)
undersea transmission system to take advantage of supply and demand imbalances
between two energy markets. The company was initially financed in a “friends and family”
round of local community investors, but is now prepared to take on significant additional
investment to develop the project. The company has completed initial design work and
environmental review, and has a draft Engineering, Procurement, and Construction (EPC)
with a major construction firm. The company has also negotiated Power Purchase
Agreements (PPAs) in each of the energy markets in which it plans to operate.
The Energy Markets
ABCSO is a large Independent System Operator (ISO), or interconnected energy market, in
the United States. In recent years, independent power investments, primarily in the
renewable energy sectors, have increased supply relative to demand in the market and
spot prices have accordingly reduced. The market borders a large body of water in Lake
Smith. Across the lake is the island city of Hampton, with a municipal utility: the Hampton
Island Power Utility (HIPU). The population and local economy of Hampton have
experienced significant growth over the last decade. In servicing the island city, however,
HIPU has experienced difficulty in adding energy supply due to a lack of space for new
generation facilities and difficulty in obtaining fuel supply. More recently, the island has
experienced sporadic brown outs and HIPU has needed to implement significant energy
conservation measures. The total installed capacity on Hampton Island is 4825 MW’s.
Two years ago, HIPU issued a Request for Proposals (RFP) for additional energy generation
capacity. Several on-island generation proposals were made, but high land prices, high fuel
prices and a difficult permitting process made all on-island generation proposals expensive
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and uncertain. Island Energy responded with a novel solution to develop an HVDC cable
system that would go primarily under Lake Smith to service the Hampton energy market.
Ultimately, HIPU selected Island Energy’s proposal and the parties have been working
together to finalize the necessary agreements and permits to implement the project.
The Project
The HVDC system would have a total contracted capacity of 660 MW. The proposed HVDC
system will be 65 miles from end to end, and the undersea cables will be buried at
minimum depths of 4 and 17 feet below the seabed in Lake Smith. The subsea cables will
connect two to-be-built converter stations, one on Hampton Island and one adjacent to a
substation owned and managed by ABCSO. Island Energy will lease the land for the
converter stations from HIPU and ABSCO as part of their respective Interconnection
Agreements described below.
Conceptually, the operation of an HVDC system is quite simple. Energy is withdrawn from
the power grid as conventional alternating current (AC); within the converter station, the
power it is stepped up to very high voltage (500 kV) then converted to direct current (DC).
The energy then flows over the cables with relatively low electrical losses. At the other end
of the DC line there is a second converter station where the voltage is reconverted to AC
and stepped down to local transmission system levels and re-injected into the grid.
AC magnitude varies as a sine wave function of time, 60 times per second, whereas DC
magnitude does not vary as a function of time. DC circuits thus have an advantage over AC
circuits when power needs to be transmitted over long differences. While DC cables only
need to be charged once when they are energized, AC cables experience a continuous
charging current by virtue of their voltage and current changing from maximum in one
direction to a maximum in the other direction 60 times per second. This limits the amount
of useful power that can be transmitted by AC cables. It also makes DC cables very efficient
in transmitting useful power. The energy efficiency of the cable system proposed by Island
Energy and the excess renewable energy capacity readily available in ABCSO makes the
project very attractive to both environmental and economic interests.
Island Energy has negotiated a PPA with HIPU for 660 MW of capacity with a 20-year term.
It has also negotiated interconnection agreements with HIPU and ABCSO for the converter
stations and tie-ins at each end of the cable. It has completed or plans to complete
numerous environmental permits and conducted engineering studies for the project. It has
a lender term sheet from one of your firm’s competitors for a loan to cover the majority of
project costs, and is seeking $100mm-$150mm in additional equity investment to complete
the project financing. Island Energy is in talks with several funds but would like to limit the
number of investors in the company to the extent possible to avoid complications and
possible alignment issues between investors. Given your client’s close personal
relationship with the founders at Island Energy, they think they could take a portion of the
round or take the full round and, possibly, a controlling interest in the company.
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The EPC Contract
Island Energy has negotiated a turnkey EPC contract with BuildCo, a large engineering and
construction firm from Europe with a history of constructing similar subsea HVDC
transmission projects globally. Under the contract terms, BuildCo will be responsible for
delivering the construction of the cable as well as all of the necessary tie-in and converter
station construction, all remaining design work, and providing all necessary materials.
The EPC contract is for all services to provide an operational project between the two
interconnection points. The contractor will design, construct, procure, manufacture and
install all necessary equipment in accordance with the agreed specifications which have
been reviewed and approved by ABCSO and HIPU. As discussed below, the EPC contract
includes liquidated damages (LDs), warranties, and other guaranties to provide a system
ready for operation.
Price. The EPC contract has a total contracted price of $455,000,000. However, this is based
on an assumed euro to dollar exchange rate of $1.30, which is the current exchange rate.
The final EPC contract amount will be fixed at the Financial Close date to allow for
fluctuations in the exchange rate. For every increase or decrease of $0.01 in the exchange
rate between now and Financial Close, the total EPC contract price will increase or
decrease by $1,670,000.
Schedule and Payment Timing. The EPC contract has an aggressive 24-month construction
timeline. Deviation from the planned schedule, if the fault of the EPC, will be subject to
liquidated damages. Island Energy is obligated to pay BuildCo monthly construction
payments during the construction period, which will begin immediately following financial
close. The monthly payments will be a function of the total EPC contract price. The EPC
service payments will be the lesser of the actual costs incurred that month and maximum
payment schedule specified below, which is a function of the final EPC contract price.
EPC
Contract
Month
FC + 1-3
FC + 4-8
FC + 9-14
FC + 15-18
FC + 19-24
Total
Maximum
Payment; as
percentage of
total EPC Price
2%
4%
6%
5%
3%
100%
Warranty. BuildCo has provided a warranty for all work free from deficiencies. Island
Energy and BuildCo have agreed to share the risk of geotechnical risk if undersea soil
conditions differ from the geotechnical surveys conducted during planning. If BuidCo is
unable to install a portion of the HVDC cable to a burial depth of a least four feet due to
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differences between actual conditions and the subsea conditions as described in the
current surveys, then the excess installation costs will be allocated between Island Energy
and BuildCo as follows:
•
•
The first $10 million in excess costs will be paid equally by BuildCo and Island
Energy.
Thereafter excess costs will be paid by Island Energy.
BuildCo has provided a warranty that the completed project will be capable of transmitting
660 MW by the completion date. If the completed project is incapable of transmitting at
least 630 MW on the completion date, Island may exercise its option to terminate for cause.
If the project has a continuous power transfer rate of greater than 630 MW and less than
660 MW at completion, BuildCo may elect to pay LDs equal to $1.5 million for each MW less
than the contracted agreement for capacity with HIPU.
The designed capacity of the cable will be 750 MW, though operating requirements if the
project meets design specifications will be to operate at 750 MW for no more than four
hours continuously, and followed by a 15 hour cool-down period of operations at no more
than 600 MW to prevent overheating and deterioration.
BuildCo also warrants that system losses for the completed project will not exceed 2.7% of
transmitted load. If system losses exceed 2.68% on commissioning, BuildCo may elect to
pay LDs equal to $950,000 for each 0.1% of excess losses.
The maximum aggregate LD liability payable by BuildCo in reference to all warranties is
$130 million.
The EPC contract required cable burial depth is in accordance with federal permits and
shipping channel requirements. The contract stipulates that the cable will be buried 17 feet
deep in the main shipping channel,12 feet in areas identified as sand wave areas, and 6 feet
in all other parts of the lake. The technologies used for cable burial include a hydroplow for
the areas authorized in addition to manual dredging. Horizontal Directional Drilling will be
used for cable burial near shore to minimize soil disturbance in those areas, per the project
environmental permits. The build depths are based on minimizing the risk of cable damage
due to channel shipping traffic, which is a primary risk for the company.
Soil studies performed over the route identified some areas where the ability of native soils
to dissipate heat generated by the power flow may be limited, and the specification for the
cable return was adjusted accordingly to ensure that it can operate within heat limits.
Power Purchase Agreement
Island Energy has signed a long term PPA with HIPU which is based upon the availability of
the HVDC system and certain performance requirements. The PPA has a 20-year term from
the beginning of system operation, with HIPU retaining an option to extend for an
additional term of the lesser of 20 years or the assessed remaining useful life of the asset.
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Any such extension would be on then fair market value terms to be negotiated. The target
operational date is July 1, 2025.
The PPA will remunerate Island Energy based on a 660 MW capacity and the percentage
availability of the system to provide power for the island. The base capacity charge rate
starts at $10.52/kW-month and is adjusted for inflation at a rate of 0.50% per annum.
Each monthly payment during operations will be adjusted for availability by multiplying
the base rate by the ratio of the average availability for the 12 months prior to the current
month divided by the average target availability for the 12 months prior to the current
month. The target availability for each month of the year is given below, per the HIPU PPA
requirements.
Target
Availability
January
95%
February
95%
March
95%
April
95%
May
95%
June
100%
July
100%
August
100%
September
100%
October
95%
November
95%
December
95%
Month
The contracted base rate for the PPA is based on a July 1, 2025 start date and a July 1, 2023
Financial Close for the deal. If the financial close is delayed the contracted base rate will be
adjusted based on fluctuations in the US treasury rate and the US dollar to Euro exchange
rate. If financial close is delayed by HIPU and the dollar / Euro exchange rate fluctuates by
more than .05/1 from the current rate the contracted base rate will fluctuate by $120/MW
for each .05/1 change. If the US 10-year treasury interest rate fluctuates by more than 10
basis points due to a delay, then the contract rate will be increased or decreased by
$50/MW for each 10 basis points of fluctuation.
Island Energy will pay HIPU an interconnection service fee during operations. The fee will
be $110,000 per month for the first 120 months of operation. After that period the fee will
increase to $220,000 per month for the remainder of operations.
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Island Energy has agreed to post security for its obligations under the PPA with HIPU. At
financial close, Island Energy will put $7 million in escrow as security. At the start of
operations, the escrow security will be increased to $22.5 million. Every five years during
operation, the escrow requirement will be reduced by 5%.
The HIPU PPA is priced based on the designed system efficiency of Island Energy’s cable. It
specifies that system losses between the ABCSO market and the HIPU converter station will
be no more than 2.7% of the contracted capacity. If system losses exceed 2.7% in any given
period, Island Energy will be required to pay an annual excess system loss amount to HIPU
calculated as the gross percentage of system losses during that period multiplied by the
base contract rate.
Additional Revenue. The planned PPA should use the full contracted capacity of the HVDC
system, to the extent the operating capacity of the completed project is greater than the
contracted capacity of the PPA, Island Energy will have the option to sell electricity to HIPU
at spot prices. Annual average spot prices on the HIPU ISO are currently $0.60/kW, though
they vary seasonally and with broader changes in energy supply and demand on the island.
There is also a military base on Hampton Island which may require secure
telecommunications services off of the island, which the Island Energy system may be able
to provide as a potential opportunity for supplemental revenue in the future.
The Operations and Maintenance Agreement
Island Energy has signed an Operations and Maintenance (O&M) Agreement with MaintCo,
a major industrial power services provider. The agreement requires MaintCo to operate
and dispatch the cable project and to scope, plan and execute all maintenance services
associated with the cable and each of the converter stations. MaintCo will provide technical
support and advisory services, routine preventative and scheduled maintenance, repair
services, and spare parts management, procurement and delivery. MaintCo will keep
operations and maintenance staff on site 24 hours per day, 365 days per year. MaintCo will
be required to remedy faults designated Urgent (impacting project operation) within 2
hours and faults designated Routine (which do not immediately impact operations) within
24 hours. MaintCo will warranty all work for 12 months and will remedy all defective work
at no cost to Island Energy, up to an aggregate liability of $15 million.
The term for MaintCo’s O&M contract is five years, with the option to extend an additional
5 years from the start of operations. Under the agreement, Island Energy will pay MaintCo a
quarterly fee of $690,000 during the term of the agreement.
While MaintCo will be responsible for O&M and repairs to keep the system functional,
Island Energy will be responsible for all capital expenditures during operations. The
manufacturer of the cable system advertises that HVDC cable systems require minimum
capital expenditures during operations, though more significant capex may be required for
converter stations or if major repairs are needed for the cable itself. Such major repairs
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should be covered under Island Energy’s extensive insurance coverages, including business
interruption insurance, less per incident deductibles of $250,000.
Interconnection Agreements
Island Energy has signed Interconnection Agreements with both ABCSO and HIPU. These
agreements authorize them to tie into each network and to build all necessary
infrastructure for their converter stations and on-shore cable components.
ABCSO has authorized Island Energy to build a converter station with a nominal capacity of
up to 800 MW. The agreement also grants Island Energy withdrawal rights from the
interconnection of up to 690 MW firm and another 110 MW non-firm. On commissioning,
Island Energy is required to pay ABCSO a fee of $2.5 million for the interconnection and
another $5.2 million for a network upgrades fee. Island Energy is required to demonstrate
to an ABCSO inspection team the commercial operation of the interconnection facility no
later than 2 months prior to the start of operations for the project.
On commissioning, Island Energy is required to pay HIPU a $2 million interconnection fee
for the interconnection at that facility.
Environmental Permitting
Island Energy has obtained most of the required environmental permits to complete the
project, which contain numerous mitigation requirements. Island Energy is responsible for
obtaining all required permits before BuildCo is able to begin construction. Current permits
include the federal water construction permit, a waterfront development permit, water
quality certificates, and local permits based upon detailed site plans for both converter
stations and related interconnection facilities.
As one of the interconnection sites is near a wetland, Island Energy is also required to
receive a federal wetland construction permit, which is currently under review. Island
Energy believes an additional $3 million in consulting fees and surveys will be required to
obtain that permit.
The state environmental permitting agency conducts regular monitoring of all construction
projects that impact the lakebed of Lake Smith for water quality and particulate
exceedances and for contaminated material. The project’s water construction permit
authorizes them to halt construction temporarily in the event of an exceedance. State law
also prohibits construction on the lakebed from March – June every year due to biological
activity during that season. That prohibition is currently accounted for in the EPC project
schedule, but may exacerbate delays if there is a project construction delay for any reason.
The state environmental permitting agency requires an $800,000 fee at the start of
construction for all of its monitoring activities. Additional fees may be levied if construction
is delayed and additional monitoring is required.
The federal water construction permit includes a provision for fisheries mitigation which is
expected to cost the project approximately $130,000 per year.
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Other Project Costs
The EPC contract will cover the majority of the total costs to build all aspects of the HVDC
system. Island Energy has identified additional project implementation costs in the table
below.
Other Project Costs
Land Acquisition
Development Expenses
Development Fees
Management and
Oversight
Insurance
Interest and Fees
During Construction
Closing Costs
Contingency
Cost
12,500,000
28,500,000
14,700,000
8,150,000
25,000,000
56,853,000
14,392,000
30,754,000
The above project costs are expected to be paid during the construction phase of the
project. Interest during construction, insurance, and management and oversight costs will
be distribute evenly over the 24-month construction period. All other costs will be paid at
Financial Close.
Corporate Costs
Island Energy has also estimated their annual corporate costs in addition to the O&M
contract. Those costs, which commence at the start of construction, are listed in the table
below.
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Item
Cost
Corporate Resources 1,900,000
Outside Resources
Engineering
220,000
Legal
315,000
Accounting
180,000
Community Relations
80,000
Industry Relations
20,000
Misc.
50,000
Overhead
Station Power Service
285,000
Utilities
65,000
Rent
82,000
Telecommunications
50,000
Travel / Office
260,000
Misc.
200,000
Contingency
120,000
Other Annual Costs
Insurance
2,500,000
Property Taxes
2,550,000
Cable Easement
700,000
Contribution to Stanford
25,000
Global Projects Center
All annual operating costs are anticipated to escalate at an annual rate of inflation of 2.5%
during project operations. Operating costs are assumed to begin when construction is
complete and commercial operations begin. Other corporate costs during construction are
assumed to be accounted for in Project Costs.
Property Taxes. Cables and pipelines in the state are considered exempt from property
taxes, so the property tax estimate for Island Energy is based on the substation properties,
which are assumed to be taxed at 1% of the assessed value of the property. Rather than
increase at inflation they will thus increase at the rate of property values in the region.
Corporate Taxes. In addition to the costs listed in the table above, Island Energy will pay
corporate taxes at a rate of 30% of Net Income each fiscal year. Island Energy has received
a tax exemption during the construction phase of the development and will thus pay no
taxes until the system is operational. For the purposes of tax calculations, assume that
losses may not be carried forward. Depreciation will be calculated on all assets and capital
expenditures using the straight-line method and assuming a 20-year useful life.
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Project Loan
The team at Island Energy has arranged for a bank loan with a 20-year repayment period
for the majority of the costs to develop the cable project. The loan amount is $550,062,792,
and will be made available at the start of the construction period. The loan will charge a
commitment fee of 10 basis points per year. The repayment schedule offered by the bank
includes a $75 million balance outstanding at the end of the 20-year loan term, and a 6.3%
annual interest rate. Island Energy would have the option of retiring debt early as well and
no prepayment fee.
Island Energy plans to refinance $75 million of the loan principal that will remain
outstanding at the end of the 20-year loan term depending on debt markets, the current
operating performance of the cable at that time, and the terms of a PPA extension or new
PPA that the company is able to negotiate when the current PPA term nears its end. The
loan requires a Minimum Debt Service Coverage Ratio of 1.3.
Liquidated Damages Information and Other Risk Factors
The BuildCo EPC contract includes several types of LDs payable to Island Energy in the
event of non-owner caused construction delays and system underperformance. Island
Energy has also agreed to several LD provisions with HIPU as part of their PPA with the
utility in case of system underperformance.
As noted in the PPA section, if system losses are greater than the specified amount Island
Energy will pay remunerate HIPU for the system losses in exceedance of the maximum
allowable.
If Island Energy does not meet financial close by the planned date it will be liable to HIPU
for LDs of $10,000 per day up to a maximum of $2.2 million. If Island Energy does not start
construction within 3 months of financial close it will be liable for LDs of $20,000 per day
up to a maximum of $7.2 million.
If the facility is not fully operational by the planned completion date, Island Energy will pay
LDs of $50,000 per day for the first 60 days, and $40,000 per day for the next 240 days. If
the facility is not fully operational after 300 days HIPU will have the right to terminate the
PPA. The EPC contractor will pay Island Energy LDs of $60,000 per day if completion is
delayed due to no fault of Island Energy. The LD limit for the EPC contractor for schedule
delays is $80 million.
Construction is currently underway to renovate and repair a bridge over Lake Smith. This
includes the use of spud barges for positioning equipment near the planned cable route.
Currently construction is scheduled to be completed before construction of the cable
project begins, but if the project is delayed special coordination between the projects may
be required, and may delay the cable construction.
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