Project Appraisal & Finance
1
Need for private capital in Infrastructure
Key Drivers of change
• Pressure on the fiscal position of
governments coupled with need for
massive investments in infrastructure
• Globalization and breakdown of
trade barriers which is compelling • Role of public sector/state shifting from
local industry and services to become that of a financier, owner and
more competitive manager of facilities to that of a
facilitator and enabler of efficient
• Emergence of successful models for infrastructure creation and provision by
engaging the private sector and multiple players with an independent
increased access to capital across regulator
borders in providing infrastructure
services
• Changing economic models leading
to breakdown of erstwhile infrastructure
natural monopolies, that have made
possible the creation of competitive
market structures
2
WHAT IS PPP?
PPP covers a wide variety of arrangements for the participation of
private organisations in public projects.
Transportation facilities, water and waste-water services,
telecommunications systems, energy generation and distribution and
waste management facilities.
Can be financed mainly by user charges.
Private participation can cover design, construction, financing and
operation.
3
While there are a wide range of forms of Public Private
Partnerships (PPPs) in infrastructure…
• Range of infrastructure delivery options: Each type differs in terms of government
participation levels, risk allocation, investment responsibilities, operational requirements and
incentives for operators
Ownership and Management / Concessions* Privatization** Divestiture By
Risk O & M contract (BOT) (BOO) License /Sale
Asset Ownership State State Private Private
Investment State Private Private Private
Responsibility
Primary State Private Private Private
Commercial Risk
It may would be better to start at the management contract end of the spectrum
and moving forward to deferred payment structures.
Project Finance Structures
Special Project Vehicle
Provides limited recourse
BOT, BOOT, BOLT, BOO etc.
Essentially a public project. Private finance
is resorted
Should ownership with Private sector be
temporary or permanent?
5
Concession Agreement
An Agreement between Government (Grantor
of Concession or Permission) and Project
Company (Grantee or beneficiary) giving
permission to execute a Project.
Government Project Company
Lender
6
Common Forms of PPP Models
in India
BOT Models Performance-based
Management / Maintenance
User-fee based BOT model: contracts
Commonly used in medium- to
large-scale PPPs for the energy PPP models that lead to
and transport sub-sectors improved efficiency are
(road, ports & airports) encouraged in an environment
that is constrained by the
Annuity-based BOT model: availability of economic
Commonly used in resources.
sectors/projects not meant for Sectors meant for such form of
cost recovery through user PPP models include water
charges such as rural, urban, supply, sanitation, solid waste
health and education sectors management, road
maintenance
7
Sectors have a varying degree of maturity in policy and
regulatory frameworks for PPPs in India
Increasing Commercial Attractiveness
Telecom Telecom and Electricity
Generation may not be strict
PPPs as defined in India but
Ports & Power account for a major share of
Airports Generation PPIs
Toll Roads
“Commercial Attractiveness”
defined as a function of
market structure, cost
Water and Urban
recovery and demand
Infrastructure
potential
Increasing Policy and Regulatory Clarity
8
PPP Assessment Model
Effectiveness
Ability to meet program objectives
Efficiency
Financial efficiency in transfer of ownership & associated
risks
Equity
Ability to accrue benefits of program to the poor people
Financial sustainability
Financial viability of the model
9
Project Finance
10
Project Financing is like a chameleon;
It always finds a way to take advantages
of changes in the business.
Project Financing
Economically separable capital investment
project which operates under a concession
from the host government
Project cash flows as source of funds
to service the loans
to provide the return of &
return on the equity invested in the project
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Project Financing
Non-recourse or Limited- recourse to
the promoter.
Project is very big compared to firm’s
present size.
The Project has unacceptable risk to be
brought to the balance sheet. (So,
quarantine the risk by forming a separate
company called Special Purpose Vehicle)
risk does not attach, but return does!
13
Project Financing
Comprehensive contractual
arrangements with suppliers &
customers
High ratio of debt to equity with limited-
recourse / non-recourse
Cash waterfall / escrow mechanism
14
Project Financing
An agreement by financially responsible
parties
to complete the project
to purchase the project output
to supply the project inputs
to make available necessary funds in the
event of disruption in operation occurs
15
Contractual Structure for Project
Finance
Insurers/
Off-taker Surety companies Government
Export Credit
Agencies Sales
contract Suppliers
Delays/
Guarantee Insurance
Arrangers/ Debt Special Purpose Vehicle/ EPC Contract EPC
Lead funders Project Company Contractor
Independent
Escrow agent/ experts/lawyers
Trustee
Sponsors Lessors O&M
Contractor
Cash Waterfall
*
Customers Offshore Proceeds
Account
($ Denominated
Payments) (Banker’s Trust)
2. Debt Obligations
1. 90 Day Operating
Service ( 1 year 1.35x
Expense Account coverage ratio)
3. Debt Service Res. 4. Distribution to
Account (6 m. worth of Equity
principal & interest)
Holders
Project Finance
When firm does not want to do balance
sheet financing because of higher
informational requirements.
When raising finance in domestic (developed)
market means giving out more information; so
finance these internal projects through internal
resources and mobilize additional resources
through project finance.
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Risks in PPP Projects
Regulatory Political
Commercial
Operational &
Maintenance
Financial Risk
RISKS
Force Majeure
Risk
Market Risk
Cost Overrun
Risk
Land Acquisition
Risk
Technology Risk
Construction
Risk
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Project Choice
Efficiency in Resource Allocation
Bankable Projects / Profitable Projects
Cost-Benefit Analysis
Project Cost (t0 to t3)
Land & Site Development
Building & Civil Works
Plant & Machinery
Furniture & Fixtures
Technical Know-how Fees
IT Infrastructure
Preliminary & Pre-Operative expenses
Margin Money for Working Capital
Cost-Benefit Analysis
Benefits (t4 to t15), FCFF (Free Cash Flows to
Firm)
Toll Revenues
(-) Operating & Maintenance expenses
= Operating Profit
(-) Income Tax
= Net Operating Profits After Tax (NOPAT)
Salvage Value / Terminal Value (t15)
Analysis of Individual Cash Flows
Free
Cash Year
FCF used for NPV (IRR)
Flow
analysis
(FCF)
Sales
revenue
Anatomy of FCF Year
for project finance
Input cost
Operating cost
Construciton
costs Taxes
Net investment
(in maintenance)
Analysis of Individual Cash Flows
Free
Cash Year
FCF used for NPV (IRR)
Flow
analysis
(FCF)
Sales
revenue
Anatomy of FCF Year
for project finance
Input cost
Operating cost
Construciton
costs Taxes
Net investment
(in maintenance)
Net Present Value (NPV)
Financial Agreement (Closing)
Free t=5 t = 10 t = 20 t = 30 t = 40
cash flow
Year
Salvage
Sunk value
costs
Sunk cost does not affect
Cash cash flow analysis because
out flow it is an existing fact regardless
of the investment decision
(it is not incremental costs).
t=0 Example
t=1 - CF2
t=2 Present value of PV =
cash out flow at t=2 (1 + r ) 2
CF10
Present value of PV =
Present Value cash in flow at t=10 (1 + r ) 10
NPV versus IRR
NPV
1000
800 Project N Project M
600
400
200
0
0% 5% 10% 15% 20% 25% 30%
-200
-400
Financial Evaluation- IRR/NPV
Focus is on adequacy of cash flow for servicing debt.
“Interest and principal cannot be serviced out of earnings, which is an
accounting concept- payment has to be made in cash. Many transactions and
accounting entries can affect earnings, but not cash and vice versa” Standard
and Poor’s
Present value numbers are not the best indicators of project viability,
given that they reduces the importance of sizeable amounts of “residual”
cash flow that may be available towards the latter periods of the project’s
life.
IRR is not an useful measure of project viability as it assumes
reinvestment of cash flows at the IRR- often an incorrect assumption.
Calculating NPV necessitates making assumptions on the cost of capital-
often difficult to estimate.
27Project IRR and Equity IRR ( Sponsors Perspective)
Lenders Perspective – Coverage Ratios
and DSCR
Thus, from a lender’s perspective the key ratio is the DSCR.
The most widely accepted method for computing DSCR is as
follows;
Available Cash Flow (ACF)/ Principal + Interest, where ACF is
defined as
Operating Cash Flow (Revenues minus operating expenses)
less Taxes
less Working Capital Increase
less Maintenance Capital Expenditure
less Monies for replenishment of reserves such as maintenance
and debt service reserves
plus Callable Capital
less Clean up/ abandonment costs
plus Residual/ Salvage value
At the end of the project
Net Net Cash Flow = ACF- Principal - Interest
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Lenders Perspective – Other measures
ACF/ Interest
Interest Cover Ratio
ACF-Interest/ Principal
Principal Cover Ratio Measure of surplus that would be available for
prepayment/ servicing subordinate debt
holders/ dividend.
Loan Life Ratios
PV of ACF over relevant period/ Max debt outstanding
Measures cash flow cover available for servicing debt
This ratio is a function of discount rate used.
Does not measure year to year variations in cash flows.
No “correct” level for a project.
Debt Equity Ratios Would depend upon what cash flows the
project can support
Leveraged/Equity
Measure of returns available to equity
29IRR
investors.
Challenges in PPP in India
Regulatory Environment
No Independent PPP Regulator
Lack of Information
Database regarding projects to be awarded
Project Development
Detailed feasibility study, land acquisition, environmental/forest
clearances etc are not given adequate importance by
Concessioning Authorities
Lack of Institutional Capacity
Financing Availability
Dependent on Commercial Banks to raise debt for PPP Projects
Sectoral Exposure Limits
