Case 2 – Tianjin Plastics
Although business risk is low due to contractual obligations, and so is financing risk (despite high debt levels), Tianjin Plastics project carries material currency risk, both for its cash flows as well as dollar-profitability of Maple, the main sponsor. However, this should not turn the project unprofitable. Broadly defined political/country risk must be considered and accepted by Maple, if project is to happen. Hedge possibilities for those two risk categories are limited. We recommend going on with the investment – NPV for Maple is around $ 12 Mio assuming constant RMB/USD rate, and remains positive under all plausible FX scenarios. On the basis of profitability considerations, we reject full Rmb financing option. With some reservations, we support back-to-back deal with Wintel. Introduction. Project’s Risk Assessment.
While analyzing Tianjin Plastics project, we were mainly using capital budgeting tools, in particular the Net Present Value concept, applying it from the equityholder (Maple Energy) point of view. In short, we obtained cashflows for each year as Operating Margin net Interest Expenses net Taxes, corrected for formerly deducted depreciation (non-cash expense) and not included so far principal debt repayments (cash outflows, although no income statement event). The cash flows are discounted at the rate of 17%, which is explicitly mentioned by Maple as expected return and as such approximates the cost of equity. It exceeds Maple’s hurdle rate by 2 p.p., which should already be perceived as adjustment for general projects risk (see section: Conutry/Political Risk). We account for Maple’s initial outlay of $8,085Mio. The project has no salvation value – at the end of operating it is passed to Chinese authorities and no equity can be repatriated. -5759451062355We use the risk matrix approach to assess the materiality of various risks associated with the project, with both business and financing side in mind. It visualizes risk types as products of two measures: probability of a risk occurrence and severity of harm it can do to the project. The full risk matrix and description of main risk types, can be found in Appendix 1. The risk matrix is the effect of qualitative analysis, which points out to those hazards that are of greatest importance for the project. Then, we go on to quantitatively evaluate the impact of major risk types (red and orange fields in the matrix) on the projects profitability. -32804101938020Chart 1: Scenarios for future Renminbi depreciation. 00Chart 1: Scenarios for future Renminbi depreciation.
We want to stress that currency risk (risk of unfavorable changes of RMB/USD rate) is imminent in the project and appears both on the project level (financing risk) and well as Maple’s level (profitability in dollar terms). Therefore, we account for FX risk in all further analyses, most frequently applying selected scenarios. FX rate prediction 24 years ahead is cumbersome, but we identify 4 representative scenarios for possible RMB/USD developments (see Chart 1):(1) the depreciation trend continues at an annual average rate (1969 – 1996) of 1.15%, (2) the exchange rate remains constant following the improvement of the current account balance showed in the 90’s (3) the currency appreciates at a rate of 1.15%, (4) a worst case in which the currency depreciates at an annual rate of 4%. Capital Structure. Financing Risk Focus.
There are two financing options available for post-completion phase of the project: (1) dollar-denominated syndication loans + Rmb loan, and (2) 100% dollar-collateralized Renminbi loan from Bank of China. The choice has significant implications for project CFs sensitivity to Rmb depreciation. Under dollar-denominated debt from syndiaction loans, interest expenses and principal payments are subject to FX risk, caused by Rmb depreciation. Weaker inflows currency, increases dollar-fixed outflows (although...
References: Dailami, M., & Leipziger, D., Infrastructure Project Finance and Capital Flows: A new perspective. Economic Development Institute, 1997.
Fight A., Introduction to Project Finance, Elsevier, 2005, Ch. 2 - Understanding Key Project Risks, (pp. 45-80).
Lessard Donald R., Incorporating Country Risk in the Valuation of Offshore Projects, Journal of Applied Corporate Finance, 9 (Fall), pp. 52-63, 1996.
Resnick B., Eun Ch., International Financial Management, Third Edition, The McGraw-Hill, 2004, ch. 17.
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