Tianjin Plastics (china)

Tianjin Plastics Case

VU University Amsterdam   [pic 1]

Faculty of Economics and Business Administration

Course:                 Advanced Corporate Financial Management 4.1

Academic Year:        2014-2015

Date:                        29-09-2014

Teacher:                Prof. Dr. lr. H. A. Rijken

Group:                        23

Student name / ID:        Malika el Baktet 2056488

Student name / ID:        Yasmina Adhar  2510294

Student name / ID:        Emirlinda Metalia 2552526

Contents

1. Introduction        3

2. Risks        4

2.1 Construction Risk        4

2.2 Operating Risk        4

2.3 Credit Risk        4

2.4 Political Risk         4

3. Project Financing        5

3.1 Construction Financing        5

3.2 Post-Completion Financing        6

3.3 Using Flow-to-equity method        6

3.4 Risks Associated With Return        7

5. Conclusion        9

Appendix        10

1. Introduction

Maple is the developer of power plant, originating in US which has accomplished many successful projects throughout different emerging economies in Latin America and also projects in United Kingdom. Recently the company is operating in Asian markets and specifically in India and China. The current project is related the construction of a power plant in this important industrial city. Maple has created a joint venture with the Tianjin Plastic (an enterprise owned by the government) and with MOPI (Ministry of Power Industry). Although the cooperation seemed promising, the upcoming restrictions from the government side, would raise the uncertainty on the feasibility of the project. Such restrictions as limiting the profit or currency convertibility would have a great importance on the Maple financing decisions, as will be described below.

This case study is dedicated to the form of financing called project finance. It is a form of financing which depends completely on the cash flows obtained throughout the operational phase of the project and these future cash flows are also the collateral to lenders. The Special Purpose Vehicle is usually the project company whose only business is the specific project. It is separated in financial terms as well as risk indication properties, from its legal owners and investors. The SPV has in its asset side the discounted cash-flows that are going to be attained throughout the project’s life. In the liabilities side there is a small amount of equity (in the specific sector this is usually 15-30%) and the other part of financing which is with debt in the form of loans from foreign and the Bank of China.

Due to the specifics of the project finance, it is a very crucial to match the cash flows with the frequent payments towards the particular investors such as debt-equity holders. From one side the lenders and debt-holders need to be assured that the cash flows will cover the interest expenses and principal payments. In the other side the equity holders are seeking to attain their returns in the expected rate and appropriate risk endurance. The project finance, in the most of sectors, is characterized by a high level of leverage (with debt ratios of nearly 80%-90%). But the predictability of the future cash flows, assured by long term contracts with the government and the cost controlling in the long term agreements can mitigate the business risk and the possibility of financial distress.

2. Risks

There are different types of risks that are related to this project, namely: construction risk, operating risk, credit risk, political risk and exchange rate risk.

2.1 Construction Risk

Construction risk is related to ability of the contractor to complete the project in the pre-agreed conditions and is mostly addressed to engineering, technical features, construction contracts and duration. In this case Maple has the highest responsibility towards this risk. This means that the project will have an interest expense of 7.9 million dollar for every year. As a second risk is that Maple is not able to complete the project with the budgeted costs, which leads to a situation where Maple is forced to acquire new equity. Another construction risk can be a difference in quality of the power plant and the required standard. The Maple Company has taken the responsibility to face with this risk and to make sure that the above conditions are under control and the quality of subcontractors must be of an acceptable position of technical expertise to avoid cost overruns during the project.

2.2 Operating Risk

The project is unlikely to generate revenue until the operations period and so it is going to be key to lenders and other investors that the revenue stream is certain and that forecasts of revenues are accurate. Operating risk is the risk that exist in the way a company deals with the key factors during the operating phase which are related to maintenance, efficiency, performance so that the assets maintain their quality to sufficiently generate cash flows throughout the project. Lenders and investors want to make sure that the assets remain productive throughout the life of the project. So the lenders will seek for protection to the extent that affects the revenue stream. In our case this risk may be low, because Maple has a reputational expertise in other countries and has dealt with similar projects in the past.

2.3 Credit Risk

This is the risk that a borrower will fail to complete its debt obligations in time. This risk is higher in the case of the borrower who expects to use future cash-flow to make his payment. For this case the cash flows are guaranteed by the government in the contract, but as is indicated in the case Chinese government often refused to fulfil project contract such as this, hence raising the concerns of the lenders on the potential failure on meeting the debt payment obligations. The debt on this project is arranged in tranches which are limited/non-recourse, thus in the case of o probable failure, they will only seek the assets of the project (project company’s contracts, licenses, rights on natural resources) and not the assets of individual equity holders.