FINANCIAL PERFORMANCE AND PROJECTIONS OF LAO HOLDING STATE ENTERPRISE

Transcription

1 Greater Mekong Subregion Nam Ngum 3 Hydropower Project (RRP LAO 41385) Supplementary Appendix 3 FINANCIAL PERFORMANCE AND PROJECTIONS OF LAO HOLDING STATE ENTERPRISE A. Introduction 1. An assessment of the Lao Holding State Enterprise s (LHSE) financial performance over the past six years, as well as that projected for the next 10 years has been undertaken in accordance with the Asian Development Bank s (ADB) Financial Management and Analysis of Projects (2005). This appendix presents the findings of this analysis in two parts as follows: (i) review of LHSE s financial performance over the period, and; (ii) financial projections for LHSE to assess its financial viability and sustainability over the period. 2. LHSE is a state enterprise, wholly owned by the Government of Lao PDR (GOL), that was established in February 2005 by the Minister of Finance under Decision No. 0453/MOF. LHSE functions under the provisions of the Law on Enterprises, which was enacted in amended form in December The initial purpose of LHSE was to hold the GOL equity in the Nam Theun 2 Power Company (NTPC), the company established to construct, own, and operate the Nam Theun 2 Hydropower Project (NT2). LHSE s scope was then soon expanded to include other GOL investments in energy generation, including a 23% shareholding in the Nam Ngum 3 Power Company (NN3PC), the special purpose company established to construct, own, and operate the Nam Ngum 3 Hydropower Project (NN3). B. Actual Financial Performance: Scope of Operations. As the holding company for GOL investments in the energy sector, LHSE s business activities are limited to the purchase of equity in selected projects, financing of this equity, receipt of dividends from these investments, and payment of dividends to GOL. Over the period from its establishment in 2005 through to the end of 2009, LHSE s equity investments were limited to its purchase of 25% ownership in NTPC. By year-end 2010, LHSE s holding in NTPC totaled $93.38 million. With NT2 beginning its initial operations in 2010, LHSE will receive its first dividends from its investment in this project in Beyond NT2, LHSE has also been active in planning for potential investments in other projects, which led to initial investments in two new projects during This included an initial $15.2 million investment in the Hongsa Power Company Limited, the company established to construct, own, and operate the Hongsa Mine Mouth Power Project (HPP). LHSE also made a very small initial purchase of equity in NN3PC as part of the legal establishment of the company in October As of April 2011, LHSE employed a total of 58 staff, all on a full-time basis, in three divisions: (i) Administration and Accounting; (ii) Business Planning; and, (iii) Projects. Of these 58 staff, 11 have been seconded to NTPC with their salaries being paid by NTPC. Therefore, LHSE funds the cost of only 47 of its 58 staff. Within the LHSE Projects Division, a three person NN3 section has been established. 5. Revenue & Profitability. The limited scope of LHSE s business activities are reflected in the summary financial data given in Tables S3.1 and S3.2. Over the period, LHSE had no operating revenue. Instead, the only revenue was that from interest on LHSE s 1 LHSE s financial year is the 12 month period ending December 31.

2 2 bank deposits and short-term investments. Revenue from this source was $91,000 in 2009 and $130,000 in Operating expenses, which consist primarily of labor and the cost of operating LHSE s office, have progressively increased, from $87,000 in 2005 to $529,000 in With revenue being less than expenses, LHSE has incurred annual net losses, which have been covered by GOL s initial equity contribution and a working capital advance, also provided by GOL. The losses have increased from $87,000 in 2005 to $434,000 in In 2010, the loss was reduced to $409,000. While these losses are large relative to income, they are not large in absolute terms. Furthermore, LHSE is expected to be profitable in 2011 with payment of the initial dividends from NT2. The initial dividend to LHSE from its investment in NT2 is estimated at $10.3 million and is scheduled to be paid in mid Table S3.1: LHSE Income Statements ($ thousand - current prices) Sales Cost of Sales Gross Profit Other Operating Income Distribution Cost Administrative Expenses Other Operating Expenses (87) (177) (218) (309) (438) (529) Operating Profit (87) (177) (218) (309) (438) (529) Financial Income Financial Expenses (86) (61) Loss on Foreign Exchange (1) 51 Net Financial Costs Profit before Tax (87) (175) (197) (209) (434) (409) Tax Profit after Tax (87) (175) (197) (209) (434) (409) Source: Derived from unaudited financial statements provided by LHSE. 6. Investments & Debt. As a holding company for GOL investments, LHSE s major financial transactions are reflected in its balance sheet (Table S3.2). LHSE s holding of financial assets, which consists of its equity investments and the capitalized interest on the loans used to fund these investments, increased from $76.3 million at the end of 2006 to $131.2 million by the end of Since this equity was funded entirely by debt, total borrowing from the Ministry of Finance (MOF) increased in line with the value of these financial assets. The borrowing from MOF consists of the onlent proceeds of grants and loans to GOL from ADB, the World Bank s International Development Association (IDA), European Investment Bank (EIB), and Agence Francaise de Developpement (AFD). 7. Up to the end of 2009, LHSE s investments were limited to its 25% holding of NTPC. By the end of 2010, LHSE s total equity investment in NT2 was approximately $93.4 million. However, in 2010, LHSE also made its initial investment in its second project; the Hongsa Mine Mouth Power Project (HPP). The amount invested in 2010 was $15.2 million, which was LHSE s

3 3 share of the registered capital of the project company, the Hongsa Power Company, Ltd. LHSE s total investment in this project is estimated at $185 million with the remaining amount of this equity scheduled to be purchased in 2014 and In addition, LHSE also made a very small purchase of equity in the newly established NN3PC during The investment amount was only $13,800, which was LHSE s share of the initial registered capital of NN3PC. Assets Table S3.2: LHSE Balance Sheets ($ thousand current prices) Current Assets Cash & Cash Equivalents 1,298 1, ,715 Receivables & Prepayments Total 1,299 1, ,739 Non-Current Assets Property, Plant & Equipment Intangible Assets Assets in Process Total ,065 1,118 Financial Assets Investment in Associates 0 76,256 79,958 88,658 88, ,589 Interest during Grace Period 0 0 6,906 11,454 18,091 22,655 Total 0 76,256 86, , , ,244 Total Assets 1,478 77,818 88, , , ,101 Liabilities & Equity Current Liabilities Trade & Other Payables Current Tax Liabilities Total Non-Current Liabilities Repayable State Capital 1,374 1,156 1,156 1,002 1,002 2,759 Borrowing (Domestic Bank) Borrowing (MOF) 0 79,214 86, , , ,153 Total 1,374 80,370 88, , , ,912 Equity Registered Capital Retained Earnings (87) (262) (459) (645) (1,079) (1,488) Total (412) (821) Total Liabilities & Equity 1,478 80,775 88, , , ,101 Source: Lao Holding State Enterprise, from unaudited annual financial statements. 8. In addition to the debt used to funds its equity in NTPC, LHSE also borrowed a much smaller amount from a domestic commercial bank to temporarily cover a portion of its operating

4 4 expenses until the release of an additional working capital advance from GOL could be made. The first drawdown of this loan was made in December 2008 with two further drawdowns during By the end of 2009, drawdowns and accumulated interest on this loan totaled $869,000. In September 2010, an additional working capital advance of just under $1.8 million was provided by GOL to LHSE. A portion of the proceeds of this advance was used to repay the loan. 9. GOL Working Capital Advance. Prior to 2010, an initial working capital advance, equivalent to just under $1.4 million, was made by GOL to LHSE. Over the period, this advance was recorded as repayable capital contributed by the State and, therefore, classified as a non-current liability, meaning it is a form of debt. However, in 2010, this initial advance, together with the additional $1.8 million advance made in 2010, was reclassified by LHSE as equity in its unaudited financial statements. LHSE states that there is no formal agreement with GOL specifying the repayment obligations, if any, relating to these advances. Furthermore, GOL has not made any request, or issued any notification to LHSE, regarding repayment of these funds. Therefore, given that no agreement could be confirmed to exist for the conversion of this advance into equity, the LHSE balance sheet given in Table S3.2 more conservatively continues to classify these funds as a non-current liability. 10. Capital Structure. LHSE has had to rely entirely on debt to fund its investments in NT2 because it has not yet begun to earn dividend income from this project. This reliance on debt has led to a highly leveraged capital structure. In fact, by the end of 2009, the equity balance was negative, meaning that the capital structure was entirely comprised of debt. As NT2 begins operating and generating dividend income for LHSE, equity levels are expected to gradually increase relative to debt, eventually leading to a more balanced capital structure. 11. Property, Plant & Equipment. As a holding company for GOL equity investments, LHSE s purchases of property, plant and equipment are limited. As of the end of 2010, the net value of property, plant and equipment was only $823,000. Almost 80% of this total is attributable to the LHSE head office building, with most of the remaining amount representing the cost of vehicles, office furniture, and office equipment. C. Projected Financial Performance: Financial projections have been prepared for LHSE in order to assess its financial viability and sustainability over the period. The projections consist of annual financial statements (income statement, cash flow statement, balance sheet), key performance indicators, and supporting financial data for LHSE. The projections were prepared using a financial model 2 developed for LHSE in Revisions to the model inputs were made to reflect LHSE s current investment plan and incorporate updates to other key assumptions underlying the projections Investment Plan. Including NT2 and NN3, the LHSE investment plan consists of nine existing, planned, and proposed projects (Table S3.3). While NT2 has now entered operations and initial investments by LHSE have been made in HPC and NN3PC, the remaining six projects are in more preliminary stages of preparation. As such, the viability, timing and financing arrangements for these projects have yet to be confirmed. In some cases, project viability is uncertain and as a result, some of these projects may not proceed, or at least not 2 LHSE Corporate Model (LHSE Corporate Model - Master - New Version 4 - Cycle 5 For Mr. Keo.xlsm), prepared for LHSE by Ridgway Capital Projects, September Revised LHSE Corporate Model renamed as LHSE 20.xlsm, July 2011.

5 5 proceed in their present form. Furthermore, GOL and LHSE have not yet concluded agreements with the project sponsors to invest in these projects. Of the six projects, only the Xepian Xenamnoy Hydropower Project (XXP) appears to be sufficiently certain to proceed in its present form and with LHSE participation that it could be included in the financial projections. Therefore, the LHSE financial projections incorporate only four projects (NT2, NN3, HPP, XXP) of the presently included in the investment plan. Project Installed Capacity (MW) Table SG.3: LHSE Investment Plan Project Cost ($ million) LHSE Equity ($ million) Current Project Status 1. Nam Theun 2 1,080 1, Completed, COD 2010 Yes 2. Hongsa Mine Mouth 1,878 3, LHSE purchased initial equity LHSE financing finalized COD Nam Ngum 3 a LHSE purchased initial equity LHSE financing in advanced stage but not yet finalized MOU signed with EGAT COD Xepian Xenamnoy Advanced stage of preparation and approval LHSE financing not yet finalized MOU signed with EGAT COD Nam Theun , Uncertain in present form No investment yet by LHSE 6. Nam Ngiep May possibly proceed, but cost might be an issue No MOU signed yet with EGAT No investment to date by LHSE 7. Xekong Uncertain in present form No investment to date by LHSE 8. Xekong Uncertain in present form No investment to date by LHSE Included in LHSE Projections? 9. Nam Kong Uncertain in present form No investment to date by LHSE No COD = Commercial Operations Date MOU = Memorandum of Understanding a $925 million project cost is exclusive of $200 million delay contingency. $61.2 million equity is base equity, exclusive of $23 million contingent equity. Source: Lao Holding State Enterprise (LHSE). 14. Financing of Investment Plan. The LHSE financial projections incorporate the actual, planned or proposed financing plan for each of the four projects included in these projections. These are summarized as follows: a) Nam Theun 2 (NT2). LHSE entered into a loan agreement with MOF in May 2005 for the funding of its equity purchase in NTPC. This loan was funded from the onlent proceeds of grants and loans provided to GOL from ADB, IDA, EIB and AFD. As of the end of 2010, the total amount borrowed was equivalent to $109.9 million. The loan will be repaid over a 24 year period beginning in Yes Yes Yes No No No No

6 6 b) Hongsa (HPP). In September 2010, GOL entered into loan agreements with two Thai banks, Krung Thai Bank Public Company Limited and Government Savings Bank, to fund the entire cost of LHSE s equity purchase in the Hongsa Power Company, Ltd. (HPC) plus interest during construction and other financial charges. The proceeds of the loans have been onlent by GOL to LHSE on the same terms and conditions as applied to GOL. The tenor of both loans is 17.5 years, inclusive of the six year grace period. Therefore, principal repayments are made over 11.5 years, which is significantly less than the 25 year operating period of the concession. Based on projected dividend receipts, this mismatch between the period of loan repayment and the concession will result in a funding shortfall over the first 11 years of project operations. To cover this shortfall, GOL has agreed to provide additional financing to LHSE. This financing would cover the funding gap and, therefore, effectively extend the repayment period. These terms have not yet been finalized, but have been tentatively agreed as follows: (i) drawdown of $85 million between 2016 and 2026 as required to cover the funding gap; (ii) 10 year repayment period ( ), and, (iii) annual interest rate of 1.5%. c) Nam Ngum 3 (NN3). It is presently proposed that the proceeds of loans from ADB s Ordinary Capital Resources (OCR) and Asian Development Fund (ADF Hard Terms) to GOL be onlent to LHSE to fund the entire cost of LHSE s equity purchase in NN3PC. The proposed term of the OCR loan, well as the onlending of the proceeds, is 25 years, inclusive of a seven year grace period. For the purposes of the financial projections, the annual interest rate is assumed to be 4.16%, which is equivalent to the current rate for OCR loans, LIBOR %, converted to a fixed interest rate at the 20 year swap rate. The term of the ADF loan to GOL is 32 years, inclusive of an eight year grace period, with an interest rate of 2.02% per annum. The proceeds of the loan are assumed to be onlent to LHSE on these same terms and conditions. d) Xepian Xenamnoy (XXP). Financing for LHSE s proposed investment in this project has yet to be arranged. For the purposes of the financial projections, it is assumed that the funding is secured on terms similar to the propose OCR funding for NN Other Key Assumptions. In addition to the investment and financing plans, the other key assumptions employed in the preparation of the LHSE financial projections include: a) Revenue. Virtually all of LHSE s revenue is derived from dividend income from its project investments. Projected dividend income is that estimated on the basis of projections prepared for each project by the respective project sponsors and provided to LHSE. Additionally, additional revenue is derived from interest on LHSE s cash holdings and short-term investments. This includes interest on a loan made by LHSE to NN3PC from the proceeds of the $23 million contingent equity amount. The interest rate on this loan is 5.00% and will be paid over the , given that the funds are not converted into equity to cover any cost overrun. b) Dividends Paid to GOL. LHSE is required to pay dividends to GOL that it receives from each project after deductions for dividend tax, debt service, operating expenses, dividend tax, and mandatory contributions to its reserve fund, and a minimum cash balance requirement. For the purposes of the financial projections, the minimum cash balance is set at $700,000 and then is increased by 5% per year thereafter.

7 7 c) Operating Expenses. Operating expenses consist of three main components: (i) wages and personnel costs; (ii) purchases of materials, supplies and external services; and, (iii) other operating costs. These are projected over the forecast period on the basis of the existing expense level plus a 5% annual increase to cover inflation as well as real cost increases. d) Depreciation Expense. Depreciation on LHSE s fixed assets is projected on the basis of the weighted average useful life of these assets. In 2010, the weighted average useful life of LHSE s fixed assets, exclusive of land, was 11.4 years, which is equivalent to an annual depreciation rate of 8.8%. This rate of depreciation has been assumed to remain constant over the forecast period. e) Taxes. Dividends paid to LHSE are subject to a 10% tax. Profit earned from other income is subject to 35% corporate income tax. Tax obligations are assumed to be paid entirely in the year in which they are incurred. 16. Projected Financial Performance. All four investment projects included in the financial projections appear to be financially viable and will generate attractive returns to LHSE. As a result, the projections indicate that LHSE will be financially viable and sustainable over the forecast period. LHSE is anticipated to be profitable in all years with profit levels being particularly high over the second half of the forecast period when all four projects are operational and, therefore, paying dividends. Returns on equity are expected to be very high over all of the forecast period, although this is in part due to LHSE s relatively small equity base. 17. Dividends earned from LHSE s investments in NTPC and NN3PC should be sufficient to service the debt used to fund the equity purchases in these companies and generate a surplus that can be paid out as dividends to GOL. However, as noted in paragraph 14 (b), the tenor of the commercial bank financing arranged for LHSE s investment in HPC is shorter than the period over which the dividends will be paid, which creates a temporary funding gap. As noted earlier, this gap is to be covered by additional financing extended to LHSE by GOL, which is presently being finalized. For XXP, the projections assume that longer-term financing is secured similar to that proposed for NN3, which should mean that dividends are sufficient to service this debt in all years. However, if commercial bank financing is instead used to fund LHSE s investment in XXP, the loan tenor will be shorter than assumed, which might then lead to a funding gap similar to that which now exists for HPP. As in the case of HPP, LHSE would then require additional debt in order to cover the gap. 18. Revenue. With dividends being paid to LHSE on its investment in NTPC beginning in 2011, revenue will be significantly higher over the forecast period than over the period (Tables S3.4). Revenue is conservatively estimated at $13.3 million in 2011, compared to only $130,000 in Over the period, almost 95% of total revenue is attributable to NT2 dividends. In 2016, dividends payments from LHSE s investment in HPC are set to begin. In 2017, NN3 and XXP are both scheduled to commence initial operations. As a result, dividend income to LHSE will increase rapidly over this period. Total revenue is projected to increase from $16.2 million in 2015 to $42.5 million by By 2020, revenue is projected at $66.9 million, over five times that of 2011.

8 8 Table S3.4: LHSE Projected Income Statements ($ million current prices) P r o j e c t e d Revenue Dividend Income Interest Income Total Expense Operating Expense Depreciation Financial Expense Total Profit before Tax Tax (1.32) (1.38) (1.37) (1.39) (1.62) (1.96) (4.25) (5.34) (5.33) (6.69) Profit after Tax LHSE = Lao Holding State Enterprise. Source: Asian Development Bank estimates derived from LHSE financial model (LHSE-20.xlsm).

9 9 Table S3.5: LHSE Projected Cash Flow Statements ($ million current prices) P r o j e c t e d Operating Activities Dividends Received Other Operating Receipts Operating Expenditures (0.50) (0.52) (0.53) (0.55) (0.57) (0.58) (0.60) (0.62) (0.64) (0.66) Taxes Paid (1.32) (1.38) (1.37) (1.39) (1.62) (1.96) (4.25) (5.34) (5.33) (6.69) Net Cash Flows from Operating Activities Investing Activities Project Equity Investments (93.31) (4.31) (5.83) (57.82) (98.26) (51.70) (6.44) Financing Activities GOL Equity Injections Dividends Paid to GOL (9.99) (5.12) (5.24) (5.34) (7.31) (5.89) (8.51) (16.55) (8.51) (19.48) Loan Drawdowns (10.16) Loan Principal & Interest Paid (12.47) (16.07) (17.31) (18.45) (20.70) (33.27) (43.54) (44.32) (47.92) (47.73) Net Cash Flows from Financing Activities (8.44) (7.08) (32.29) (71.02) (47.41) (59.61) Net Cash Flow (2.38) Cash Balance at Year End LHSE = Lao Holding State Enterprise. Source: Asian Development Bank estimates derived from LHSE financial model (LHSE-20.xlsm).

10 10 Table S3.6: LHSE Projected Balance Sheets ($ million current prices) P r o j e c t e d Assets Current Assets Cash Non-Current Assets Investments Property, Plant & Equipment Total Assets Liabilities & Equity Current Portion of Debt Non-Current Portion of Debt Equity (1.23) Total Liabilities & Equity LHSE = Lao Holding State Enterprise. Source: Asian Development Bank estimates derived from LHSE financial model (LHSE-20.xlsm).

11 11 Table S3.7: LHSE Key Performance Indicators P r o j e c t e d Profitability Return on Equity (ROE) n.a. n.a. 659% 260% 202% 117% 162% 108% 60% 60% Free Cash Flow ($ million) Debt Total Debt ($ million) Net Debt Service ($ million) Debt Service Coverage Ratio (DSCR) Capital Structure & Liquidity Debt Equity Ratio (DER) 101:-1 100:0 99:1 99:1 99:1 99:1 96:4 92:8 88:12 84:16 Current Ratio LHSE = Lao Holding State Enterprise. n.a. = Not applicable, average equity balance is negative in 2011 and Source: Asian Development Bank estimates derived from LHSE financial model (LHSE-20.xlsm).

12 Profitability. With growth in revenue expected to be much greater than increases in operating expenses, LHSE is projected to become much more profitable over the forecast period (Table S3.4). However, this improved profitability is expected to occur entirely over the second half of the forecast period, between 2017 and Between 2011 and 2016, annual profit after tax is projected to remain in a fairly narrow range between $6.6 million and $9.3 million. However, with much higher dividend income as of 2017, net profit will increase significantly, to about $23.6 million, or over four times that projected for Net profit should then continue to increase over the remainder of the forecast period. In 2020, the final forecast year, net profit after tax is projected at $42.6 million. 20. The return on equity (ROE) earned by LHSE is projected to be very high over the entire forecast period (Table S3.7). However, this is in part due to the lack of equity in the LHSE capital structure. With all of LHSE s project investments being financed by debt, the equity base on which ROE is calculated is small. As a result, net profit is large relative to equity, which then leads to very high ROE levels, particularly over the initial part of the forecast period. For example, in 2013, the projected ROE is 659%. As the equity base increases, ROE declines, but remains high. Over the last two years of the forecast period, 2019 and 2020, ROE is projected at a very healthy 60% per year. 21. Investments. Based on the LHSE investment plan given in Table S3.3, total equity investment over the forecast period is estimated at $294.7 million (Table S3.5). Annual investment levels are determined by the specific funding requirements of each project, and these are uneven from year to year. Investment levels are highest in 2011 and 2015 with equity purchases of $99.3 million and $98.3 million respectively. The amount invested in 2011 is entirely attributable to NN3, while the investment in 2015 is primarily attributable to HPP with a smaller amount for XXP. With all of the investment for NN3 made in 2011 and additional equity purchases in HPC not due until 2014, investment levels in 2012 and 2013 are projected to average only about $5 million per year. In 2018, LHSE s investing activities are projected to actually yield a net cash inflow of $23 million because of the refund of contingent equity made by LHSE for NN3 in However, this refund is dependent on the project being completed on schedule and within budget. 22. Beyond 2018, annual equity investments are zero. However, this is based on the assumption that only four of the nine projects included in the LHSE investment plan actually proceed over the forecast period. Should GOL and LHSE proceed with investments in one or more of the five projects left out of financial projections, investment levels over and the second half of the forecast period will be greater than presently forecast. 23. Debt. Given that all investments made by LHSE over the forecast period are debt financed, debt levels increase rapidly, from $136.9 million at the end of 2010 to $505.0 million by the end of 2016 (Tables S3.6 and S3.7). Assuming that LHSE s equity purchases are limited to the four projects given in the investment plan in Table S3.3, debt levels will then begin to decline after 2016 as repayments exceed new borrowing. However, because of all of LHSE s debt is long-term, and due to the planned refinancing of a portion of the HPP loans, the decline in debt will be gradual. By the end of 2020, total debt is projected to be $425.2 million, about 16% lower than the peak in Debt Service. LHSE will repay its loans from the proceeds of the dividends it receives from its equity holdings. Annual debt service, which includes principal repayments, interest and other financing charges is projected to increase from $12.5 million in 2011 to $47.9 million in 2019 (Table S3.5). However, that portion of debt service relating to interest during construction

13 13 and other financing charges is being financed by lenders. As a result, the net amount actually paid by LHSE to service its debt, particularly over the first half of the forecast period, is lower. For example, the net amount paid by LHSE is only $3.9 million in 2011 and $7.8 million in 2015 (Table S3.7). While total debt service averages $17.0 million per year over the period, the average net amount paid over this same period is only $6.9 million. 25. The ability of LHSE to finance interest during construction and other financing charges significantly improves its capacity to service this debt. The debt service coverage ratio (DSCR), which is the ratio of free cash flow 4 to annual net debt service, is satisfactory in all years over the first half of the forecast period. As shown in Table S3.7, the DSCR ranges from a low of 1.7 over the to a high of 3.0 in A DSCR of at least is typically considered satisfactory. However, over the second half of the forecast period, debt service capacity is weaker. In 2016, the DSCR is only 0.8, meaning that free cash flows generated during the year would cover only 80% of net debt service during the year. Over the remainder of the forecast period, the DSCR is projected to be at least 1.0, meaning that free cash flow should be sufficient to cover debt service. However, there is little or no margin to cover unanticipated reductions in free cash flow. 26. The main reason for the weaker debt service capacity of LHSE over the period is the existing financing arrangements for HPP. As noted in paragraph 14 (b), based on these existing financing arrangements, debt service will exceed dividend income over the first 11 years ( ) of project operations. This shortfall in dividend income reduces LHSE s overall DSCR over this period. In order to cover this shortfall, an additional loan from GOL to LHSE will be provided, which will extend the overall repayment period of the project debt. Therefore, given that this additional financing is finalized, which appears to be very likely, LHSE will be able to adequately service its debt. 27. Capital Structure. As discussed in paragraph 10, because LHSE has relied entirely on debt to fund its investments, its capital structure is highly leveraged. In fact, by the end of 2010, the capital structure was comprised entirely of debt. However, over the forecast period, increasing dividend income should eventually lead to the establishment of a more balanced capital structure The debt to equity ratio (DER) is projected to be 99:1 over the period, indicating that debt continues to comprise almost all of the capital structure (Table S3.7). However, beginning in 2017 with significantly greater dividend income, the proportion of equity in the capital structure should begin increasing. Between the 2017 and 2020, the DER is projected to decline from 96:4 to a more satisfactory 84:16. However, should LHSE invest in additional projects over this period, in addition to the four included in these financial projections, the improvement in the capital structure will be more limited. 4 Free cash flow is cash revenue, almost all of which is dividend income, less cash operating expenses and taxes paid.