HOW TO CONVINCE A LENDER

Transcription

1 ILF BUSINESS CONSULT SERVICE LETTER N O. HOW TO CONVINCE A LENDER BANKABLE FEASIBILITY STUDIES ANDREAS LINKE, Ph.D.

2 Introduction When an Investor seeks a non- or semi-recourse financing for his infrastructure project from a Lender, it is necessary to demonstrate experience in commercialising similar projects and provide rigorous documentation which outlines clearly the business opportunities and risks. The latter is subject of this Service Letter. THINKING BACKWARDS Taking the Lender s perspective The Front End Loading (FEL) methodology is an established project planning process in the construction industry. FEL refers to the early planning stages when the ability to influence is at its highest. The amount of detail will as well as the involved capital increase phase by phase. The FEL methodology consists of several stage gates, which a project must pass through in order to continue. Failure to pass could in theory mean the end of the project. Front End Loading (FEL) methodology Ability to influence Capital involved million 0 million 00 million > billion Appraise Select Define Execute Operate In practice, the project development is often not well structured and driven by varying interests of different stakeholders. The question as to whether a project is feasible will often only be discussed from the technical and business point of view, disregarding other drivers such as environment, operations, etc. As a result, the FEL becomes unbalanced, with certain aspects studied in great detail, with others being underestimated or ignored and opportuni- 06 ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT

3 ties for project optimisation uninvestigated. Subsequently, the project may stall, sponsors lose confidence and interest in the project fades with the accompanying loss of necessary resources. Finally, the project ends in a limbo One way in which to avoid such a situation is to focus on the final deliverable and work backwards. Many infrastructure projects need to use project financing for their liquidity, thus a successful project requires a project structure to be bankable to achieve a Financial Close. This final milestone will only be passed if amongst other things the Lender is satisfied that all conditions precedent to the loan drawdown have been achieved. Therefore, the challenge is to structure the project from the early stages of project development to anticipate the Lender s requirements and maximise the opportunity in reaching Financial Close. A key tool to assess the finance ability of a project is a full Bankable Feasibility Study. BUSINESS COMES FIRST Stepwise through a feasibility study It is in the nature of large investment projects to be highly complex, so are associated feasibility studies. All elements of a feasibility study are highly interlinked. However, there is a logical information flow between the tasks as indicated in the example below. The main tasks carried out during a feasibility study are: Business Plan Basic data EXAMPLE Typical components of a feasibility study for an oil pipeline project. Only the commercial and financial evaluation makes a feasibility study bankable. Routing & site location Legal & regulatory screening System design Cost estimation Project execution planning Social & Environmental screening Financial modelling Commercial structuring Economic cost-benefit analysis 06 ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT

4 Business Plan Analysis of supply/demand; infrastructure; existing bottlenecks; market pricing as well as the business model; first ideas on financing; investment and return on investment; first risk assessment. A multi-disciplinary and systematic approach is necessary in order to evaluate the overall feasibility of a project Basis of Design Includes fundamental assumptions needed to carry out a feasibility study such as technical data; financial and business assumptions. Routing / Location study Selection of the routing corridor and location based on constraint mapping as well as geotechnical data; data of land use, infrastructure, population, etc.; input for system design. System design Engineering design in a level of detail which corresponds to the required accuracy of the cost estimate; study of alternative solutions; input for cost estimates. Cost estimates (CAPEX and OPEX) Capital expenditure estimates, e.g. based in accordance with the AACE Recommended Practice No. 8R-97; operational expenditures estimate; input for financial model. Financial model Spreadsheet with CAPEX; OPEX projections and present day values; tariff calculation; depreciation; cash flow and profit/loss projections; balance sheets and financial performance indicators. Economic impact assessment A high-level socioeconomic cost-benefit analysis highlighting employment effects, labor income, related spending, increases in land value and some tax impact during the construction and operation of the pipeline for the subject countries. Legal screening Review of local legislation with respect to regulatory requirements in order to evaluate legal risks. Commercial structuring Commercial and organizational setup including the shareholder structure, guarantors, and Lenders; risk assessment ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT

5 Project execution planning Project execution plan; project schedule; work breakdown, project management organization; project execution strategies including for procurement. Socio-environmental screening Preparatory works for an Environmental and Social Impact Assessment (ESIA); stakeholder management plan; scoping report. A feasibility study is the appropriate tool to analyze and evaluate as to whether an investment can bring the expected return. It comprises all relevant aspects to make a decision to pursue the project or not. It should be kept in mind that to stop a project at the right point in time is a success not a failure. To stop a project at the right point in time is a success In order to make a feasibility study the basis for a decision, the study shall be developed so that one may evaluate the basic criteria including: attractive return on investment in relation to the quantified risk; robust design and application of proven technology; minimum environmental impact; and accepted by the community and local residents. ECONOMICS FINANCE EXAMPLE Project assessment result Market demand Market supply Business plan 4 Commercial structure 5 Investors 4 5 Lenders Guarantors Financial structure Financial conditions 4 4 ENVIRONMENTAL & SOCIAL IMPACT ENGINEERING Engineering design Access of land Authority approval MANAGEMENT 4 Organizational structure Integrated management system Human resources 4 Project execution plan 4 Environmental impact Social impact Stakeholder acceptance LEGAL Legal framework Service contracts Supply contracts Business contracts 4 EXCELLENT HIGHLY SATISFACTORY SATISFACTORY HIGHLY UNSATISFACTORY CRITICAL 06 ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT 5

6 A feasibility study forms the basis for taking the decision to enter into the Define Phase which already needs substantial funding. Taking that into account, the feasibility study should be mature enough to make that decision. However, here starts the problem. How to make a decision to fund a Front-End-Engineering Design and an Environmental Impact Assessment - being usually part of the Define Phase - when it is not clear whether the construction will be financed. The feasibility study shall not only support the decision made by the investor to go ahead but also support the decision of the Lender to finance the project. Thus a feasibility study should be planned and executed with a view to reflecting the needs and interests of potential future Lenders. HOW TO MAKE A PROJECT BANKABLE De-risking and balanced risk allocation are key Taking the Lender s perspective, a project starts from construction and ends with the completion of the debt service many years later. Lenders are risk averse and want to see their concerns properly addressed in a feasibility study. In this respect, a static financial model showing expenditures, cash flow and debt service are not sufficient to address these concerns. Lenders are interested in the allocation of risks to the party best able to absorb them at the lowest cost. These allocations should be supported by signed contracts or guarantee commitments. Assuming a semi-recourse project finance with a typical equity to debt ratio of 0/70 which is quite usual for large infrastructure projects the list of contracts includes support agreements, supply agreements, finan- EXAMPLE Typical contractual framework for an EPC project Guarantor Shipper / Power Producer Borrower Guarantee agreement Support agreement Loan agreement Shareholder agreements EPC contracts O&M contracts Transport agreements Power supply agreements Guarantee agent Security agent Facility agent THE LENDER Lead arranger Lender A Lender B Third parties 6 06 ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT

7 cial guarantees of ultimate shareholder national sovereigns, shareholder agreements as well as necessary host or even intergovernmental agreements in case of cross-border infrastructure. The commercial and contractual structure not the agreements as such are to be defined in a Bankable Feasibility Study followed by a comprehensive risk assessment which includes appropriate risk mitigation measures. Bankable Feasibility Studies should be accompanied by a financial model that has basic Key Performance Indicators (KPIs) as outputs. These KPIs should include: project timing; capacity performance; and debt service coverage ratio. A sensitivity analysis on variations on the key assumptions, should demonstrate the robustness of the project in even the most challenging conditions. This can then be used as a key argument to attract Lenders. Last but not least, one should bear in mind that the final Decision Gate is the Financial Close and the Gate Keeper is the Lender. Keeping in mind: the final Decision gate is the Financial Close About ILF Business Consult ILF Business Consult is a member of the ILF Group which is a leading international and multi-disciplinary engineering company which provides services for major industrial and infrastructure projects in the following sectors: oil & gas, energy & climate protection, water & environment and transport & structures. ILF Business Consult complements the engineering with commercial and financial services supporting project developers, financial institutions, investors and governmental institutions in strategic and business matters. AUTHORS Andreas Linke, Ph.D. Managing Director andreas.linke@ilf.com Hubert Pfeiffer Consultant Project Planning and Execution hubert.pfeiffer@ilf.com 06 ALL RIGHTS RESERVED FOR ILF BUSINESS CONSULT 7

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