BINH AN WATER CORPORATION (BAWC)

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FULBRIGHT ECONOMICS TEACHING PROGRAM Jan 15, 2007 NGUYEN XUAN THANH BINH AN WATER CORPORATION (BAWC) South East Asia was in a full-blown financial crisis by the end of 1997.

1 FULBRIGHT ECONOMICS TEACHING PROGRAM Jan 15, 2007 NGUYEN XUAN THANH BINH AN WATER CORPORATION (BAWC) South East Asia was in a full-blown financial crisis by the end of A month before, the Binh An Water Corporation (BAWC) had been told by a group of Malaysian banks that due to they were not able to provide the US$25-million loan for the implementation of the company s BOT water project in Ho Chi Minh City (HCMC). It was two years since the BAWC, a company with 100% foreign owned capital from Malaysia, got the go-ahead for the construction of a water treatment plant after the Build-Operate-Transfer (BOT) strategy. Since this was the first BOT project of its kind in water supply, the Malaysian investors had spent a great deal of time on negotiations with the Vietnamese Central Government as well as the HCMC Authorities. Finally though, the Malaysian investors managed to obtain a promising agreement which permitted BAWC to build the plant and operate it for a 20-year term. It was evident that a refusal to the loan could have ruined the whole project which was supposed to generate considerable financial benefits. At that time BAWC was in a hurry to prepare financial reports to acquire loans from other financial organizations. The International Finance Corporation (IFC), an organization affiliated to the World Bank (WB), whose job is to give support to the development of the private sector in the developing economies, showed the willingness to fund the Binh An project. Ho Chi Minh City and its Water Supply System HCMC is the largest city of Vietnam with a population of approximately 5 million in The annual average growth of the population during the period of was 2.8%. Along with the increase in population, the work force in the national economies in the city also rose from 1.41 million in 1990 to 1.90 million in 1997 the average rate was 4.35% a year. HCMC was the first place in the country to experiment with the development of market relations while expanding the involvement of different economic sectors. The economy of HCMC is believed to start to accelerate in 1991, a few years after the introduction of the overall economic reform. The average growth rate of GDP between 1986 and 1995 was 8.3% a year, while the average growth rate of GDP during the previous decade was at a mere 5.1% a year. Between 1991 and 1995 in particular, the rate reached 12.6% a year and in the years it was 12.4% a year. At this rapid growth, HCMC had become for the past several years the economic region in the country which generated one-fifth of the GDP and accounted for 30% of the industrial products and 30% of the national total revenue. 1 (See Exhibit 1). 1 Statistis from the Statistics Annual provided by the HCMC Statistics Office. This case study was prepared by Nguyen Xuan Thanh, lecturer at Fulbright Economics Teaching Program. Fulbright Economics Teaching Program s cases are intended to serve as the basis for class discussion, and not to make policy recommendations. Copyright 2007 Fulbright Economics Teaching Program

2 The growth in population and in economy, however, had exerted great pressure on the infrastructure of the city, such as the transport as well as the power and water supply systems. In 1997, the total capacity of the water supply of the city was 750,000 cubic meters a day, while the daily consumption required 1.25 million cubic meters. Clean water for HCMC came chiefly from the Thu Duc Water Plant, which had recently been renovated to raise the capacity from 480,000 cubic meters to 650,000 cubic meters a day. The Thu Duc Water Plant supplied clean water to both HCMC and Bien Hoa Industrial Park. The other water supplies to the city were from the Hoc Mon Underground Water Plant (whose capacity was 50,000 cubic meters a day) and from various water wells found everywhere inside and outside the city. All the clean water was distributed through the network of HCMC Water Supply Co. (WSC). 2 Due to poor management and maintenance, the running-off amount on distribution was as high as 34.5%. 3 The average water provision per capita in HCMC in 1998 was 97 liters a day. According to WSC itself, only 70% of the urban population and 30% of the people in the rural areas had access to the clean water supply. Foreign Investments in the Water Supply System Faced with the inadequacy of the investment in the water supply system from the national budget, the HCMC People s Committee since the beginning of the 1990s had sought foreign investments for two water supply projects the Thu Duc and the Binh An Water Plants. The signal sent from the City Authorities attracted the interest of Sadec Malaysian Consortium Sdn Bhd (Sadec). Sadec was founded in Malaysia as an investment funding firm with the sole purpose of making investments into Vietnam. In April 1992, only a few months after it was founded, Sadec signed a memorandum with WSC for the implementation of a water treatment project in HCMC. Tonkin & Taylor, a consulting firm, was hired to do the pre-feasibility studies and the preliminary design work of the project. After obtaining a report of pre-feasibility studies in January 1993, a group of consulting firms and construction companies in the field from Malaysia began to take an interest in the project. The first company to arrive at the scene was Kumpulan Emas Bhd (KEB) and its affiliate Salcon Engineering Sdn Bhd (SESB). KEB was originally a consulting firm involved in the development of the plantations in the 1970s. It had, however, become a corporation doing a wide variety of business in palm and cocoa growing, industrial production, water supply and treatment, and real estate. SESB, which was fully owned by KEB, was specialized in the construction of mechanic and power facilities for water treatment plants. SESB had so far carried out over 150 water treatment projects on various scales. The second firm to join was IJM Corporation Bhd (IJM). IJM dealt with construction work, real estate, production of building materials, rock exploitation, palm growing, university training, and consultancy. The IJM Group, through its oversea agencies, had done business in real estate, electricity production, infrastructure development, and construction management in the United States, Great Britain, Australia, Hong Kong, China, and Vietnam. The third company which was interested in the project was Malaysian South-South Corporation Sdn Bhd (MASS), an organization founded with the purpose of promoting the bilateral trade and investment between Malaysia and other developing countries. Masscorp was especially interested in the pushing up of the joint venture of Malaysian entrepreneurs and the investors in the southern countries (South-South) of the third world. 2 Now the SAWACO. 3 According to the Overall Planning of Economic and Social Development till 2010 promulgated by the HCMC Economic Intitute, the actual average amount of water supplied is 458,500 cubic meter a day while the total filtered amount which is produced is 700,000 cubic meter a day after a deduction of leakage. Page 2 of 9

3 These three companies decided to found Emas Utilities Corporation Sdn Bhd (EUC) with the sole purpose of investing in the water supply project in HCMC. Of the capital structure of 3 million ringgit (approximately USD 1.15 million) for EUC, KEB held 40% of the shares, IJM 40%, and MASS 20%. The Binh An BOT Project On August 12, 1994 the BOT Agreement was signed by HCMC People s Committee and the Malaysian investors Sadec and EUC. The 100% foreign owned capital BOT company called The Binh An Water Corporation Ltd, (BAWC for short) was founded, in which Sadec held 10% and EUC owned 90% of the total shares. (see the Structure of the Project in Exhibit 2). WSC was in charge of the direct supervision of the implementation of the project. According to the BOT agreement, BAWC would build the water treatment plant in the village of Binh An in Binh Duong, a province adjacent to HCMC, would operate it for 20 years, and then would transfer it to HCMC People s Committee. BAWC officially obtained the permission for the investment from the State Committee for Co-operation and Investment (SCCI) on March 15, The Binh An BOT Water Plant would be capable of supplying 100,000 cubic meters of clean water a day and the whole project would be completed within 30 months. The works included the construction of pumping stations where raw water would be taken from the Dong Nai River and of a conducting pipe line 3.2 km long from there to the treatment plant in Binh An, Binh Duong, which is adjacent to HCMC. the construction of the water treatment plant with a daily capacity of 100,000 cubic meters completed with filter tanks, reservoirs, and pumping stations. the installation of a pipe line 1.0 meter in diameter and 6.0 km long to conduct the water after treatment. the installation of a generator run by diesel to supply power to the pumping stations and to the treatment plant. the installation of a pipe line 0.45 meter in diameter across the Dong Nai River. According to the estimates of the consulting specialists in designing and the evaluation of the investors themselves, the total cost of the project was USD 37.5 million, of which USD 13.8 would go to the construction, USD 13.7 million to the mechanic and power facilities, and USD 10.0 million to other expenses. (See Exhibit 3 for the detailed initial investment costs as well as additional and substitutional investments during the operation of the plant.) BAWC signed a contract for the construction and the supply of equipment with EUC. As the chief contractor, EUC was responsible for the construction cost of USD million. All the land sites for the project were provided free of charge. BAWC was not liable for the compensation or the clearance, nor did they have to pay the rent for the land. The only expense as regard of land was the cost of levelling and filling. According to the agreement with HCMC People s Committee, BAWC would pay only as much as USD 500,000, and if the cost of levelling and filling turned out to be higher, HCMC People s Committee would cover the difference. By that time, the right to land use at the raw water collecting stations, at the treatment plant, and along the pipe line had been granted. The Malaysian investors contributed USD 11.1 million of capital stock to BAWC. The net income from 4 The State Committee for Co-operation and Investment and The State Planning Committee was merged into the Ministry of Planning and Investment in November Page 3 of 9

4 the project during the first years of operation would raise USD 1.4 million, and the rest, USD 25 million, would be acquired through loans. (See the capital structure in Exhibit 4). The water purchase agreement was signed on May 25, Among the project documents, the water purchase agreement is is the most important because it could be said that the only turnover from the project would depend solely on the sale of clean water to WSC. One of the articles in this contract was that WSC would buy the total amount of clean water supplied right at the plant according to the takeor-pay principle that is to say, WSC would buy from BAWC 95,000 cubic meters of water a day at the least during the first year of operation and 100,000 cubic meters in the following years, no matter whether WSC would need all this amount or not. Thus, WSC would be in charge of the distribution and the sale to, and the bill collection from the consumer, and it would also have to cover the losses due to leakage in the system. WSC agreed to pay BAWC 20 cents for each cubic meter of clean water. This price was adjusted to meet inflation by the formula Pn(cents) = 20*Cn-1/4.41, in which Pn was the price of the year in consideration, 20 was the agreed price by cent per cubic meter; 4.41 referred to the direct production cost by cent per cubic meter at the time of investment, and Cn-1 to the direct production cost of the previous year also by cent per cubic meter. BAWC was responsible for the turnover tax 5 of 1% out of the sales of the clean water sold to WSC. According to the water sale contract, BAWC would not sell clean water to WSC on credit. Any delay in payment would result in an interest rate of 10% per year. Payment would be made in the Vietnamese dong relative to the US dollar on the basis of the current exchange rate on the market. HCMC People's Committee would act as guarantee for the total payment for the clean water supplied. However, the State Bank would not assume responsibility for the conversion between the VND and the USD. The inflation rate of the USD was expected to be at 3% a year. According to the calculations made by BAWC, relatively compared with the amount of water sold to WSC (100,000 cubic meters a year), the raw water collected would be 115% and the clean water after treatment would be 110%. During operation, BAWC signed a Contract for Technic Management Service with Integrated Water Services Sdn. Bhd. (IWS) 6. IWS would transfer the technology and the management of the water treatment plant as well as other facilities while the BOT Contract was in effect. Management and maintenance costs would be paid to IWS at 5% of the net turnover earned from the sale of clean water 7. The production cost was calculated by BAWC on the basis of the operation cost at the Thu Duc Water Plant and the costs in Vietnam as a whole. The average direct production of 1 cubic meter of clean water cost 4.41 cents. (The composition of the production cost is showed in Exhibit 5). No royalties would be paid for the raw water taken from the Dong Nai River. In its calculation, BAWC applied the maximum depreciation rate approved by the law. To be specific, all the buildings, machinery, and mechanic and electric equipment would have a time depreciation of 20 years; the costs resulting from the project, the construction, and the land use would also have a depreciation of 20 years; means of transport, 5 years; and the machinery and equipment replaced during operation, 12 years. According to the investment licence issued by SCCI, BAWC was entitled to a number of privileges or incentives in profits taxes (taxes on the income of a business in accordance with the Laws on Enterprise s Income Tax). The applied tax rate was 10%. However, the company was exempt from 5 The Turnover Tax was changed into the Value Added Tax in May Salacon and IJM, two principal stock holders of EUC, also hold stocks of Integrated Water Services. 7 Net turnover is equal to gross receipts minus turnover tax. Page 4 of 9

5 income tax during the first four years, and duty would only start with the year in which the profits were greater than the accumulated debts of the previous years. BAWC would be entitled to a tax reduction of 50% for the next four years. A deduction of 5% of the after-tax profits would go to the provident fund until the total value of the fund reached 25% of the equity of USD 11.1 million. The remittance tax rate was 5%. All the agreements had been reached by the investors and HCMC People's Committee by the end of Of the equity of USD 11.1 million, USD million was provided by the Malaysian investors by the end of July 1997 and the rest would be settled in 1998 prior to the withdrawal of the loan. The development of the project depended wholly on the acquisition of the loan of USD 25 million. Commercial Loans Due to the financial crisis in Asia, the Malaysian banks refused to grant loans to the Binh An BOT project. During the first days of 1998 the Malaysian investors began their efforts to obtain loans from the International Finance Corporation (IFC). IFC is the commercial arm of the World Bank. It aims at promoting investment in the private sectors in developing countries. As a subsidiary of the the World Bank, IFC can mobilize capital from the international financial market at a lower interest rate than governments of developing countries can. IFC uses this capital to give loans to developing countries, offering a commercial loan rate at which no international commercial banks are willing to lend money to developing countries. In several cases, IFC can also arrange loans and take part in loan syndication with other commercial banks and financial organizations. BAWC requested a USD 25-million loan for a 7-year term, including one year for the withdrawal of capital and a grace period of half a year. After the grace period, the debt was to be paid biannually over 5 and a half years until maturity. The annual fixed interest rate was expected to be 8.5% and to be paid biannually dependent on the outstanding debt. (A detailed plan for the withdrawal of the equity and of the loan is showed in Exhibit 6). The loan was guaranteed first by the cash flow from the BOT project and the assets of BAWC. Furthermore, the three investors KEB, IJM, and MASS promised to make up for any shortage of capital during the investment, operation, and debt repayment. To the belief of the Malaysian investors and the Vietnamese Government, that IFC would grant the loan was a great possibility. The Binh An BOT Project was the first project in water supply and environment in Vietnam to be implemented by way of seeking capital from international private commercial organizations. IFC wanted to be the agent to speed up this trail-blazing project. To materialize this loan, however, BAWC had to prove the financial soundness of the Binh An BOT Project. In particular, the free cash flow of the project would have to be more than sufficiency in order to be able to pay the debts and the interests. The managing directors of BAWC would need, relying on the basic information on the project and updating the changes in the economic situation over the past time, to reconstruct a model of financial analysis of the whole project to report to IFC. Page 5 of 9

6 Exhibit 1: Ho Chi Minh City s Economic Statistics Official population Price GDP 1994 FDI (USD million) Year Absolute Growth Billion Growth Inflation Registered Implemented number rate (%) dong rate (%) rate (%) ,112,669-17, ,259, , ,426, , ,582, , , ,693, , , ,764, , , ,880, , , ,989, , , ,096, , Source: HCMC Statistics Office Exhibit 2: The Structure of the Binh An BOT Project KEB Equity $11.1 mil IJM IFC or commercial banks MASS 40% 40% 20% EUC Sadec Debt $25 million 90% 10% 31% 69% HCMC Water Supply Company Water purchase agreement Binh An Water Corporation (BAWC) EPC EUC Management Integrated Water Services Land Local government Page 6 of 9

7 Exhibit 3: The Investment Costs of the Binh An BOT Project (US$ 1,000) Total Total 41,985 1,560 7,946 23,610 4, , Construction Raw water collecting stations 2, ,540 Treatment plant 7,400 2,220 5,180 Pipeline 4,200 1,260 2,940 Sub-total 13,800 4,140 9,660 Machinery and power equipment Pumps 6, , Generators 6, , ,020 Treatment equipment 4, , Sub-total 18,138 1,371 9,660 2, , Other assets Vehicles and office equipment Land Project-related costs Feasibility studies Financial costs Legal costs Pre-operation costs Other expenses 1, Sub-total 3, Construction-related costs Design-consultancy costs 1, Page 7 of 9

8 Insurance Management costs 2, , Other expenses Providents 1, , Sub-total 6, ,395 3,300 1,162 Page 8 of 9

9 Exhibit 4: Capital Structure USD 1,000 % Equity 11, Debts 25, Balance (net cash flow during the first year of operation) 1, Total 37, Source: Department of Transport and Civil Engineering and HCMC Water Supply Co. Exhibit 5: Average direct production costs Articles Costs (USD per cubic meter) Chemical 0,0043 Energy 0,0374 Staff 0,0013 Maintenance & others 0,0011 Total 0,0441 Source: Department of Transport and Civil Engineering and HCMC Water Supply Co. Exhibit 6: Drawdown Schedule Equity(USD 1,000) Equity 5,000 5, Loans (USD 1,000) Mar 1, 1998 Jun 1, 1998 Sep 1, 1998 Dec 1, 1998 Mar 1, 1999 Loan 7,500 7,500 7,500 2,500 Source: Department of Transport and Civil Engineering and HCMC Water Supply Co. Exhibit 7: Cost of Capital The credit rating for Moody s for Vietnam in 1998 was B1, which is equivalent to a country risk premium of 4.5%. The average beta (with loans) of 17 water treatment plants in the US in 1998 was The average debt-equity ratio was 70.55% and corporate income tax was 36.56%. According to historical data up to 1998, the market risk premium in the US (the difference between the average rate of return on the market portfolio and risk-free interest rate) was 5.16%. The yield on the US 20-y Treasury bond in 1998 was 5.877%. Page 9 of 9

THANH CONG SECURITIES COMPANY Floor 3&5, Centec Tower, Nguyen Thi Minh Khai, Dis.3, HCMC Phone : + 84 (08) Website:

THANH CONG SECURITIES COMPANY Floor 3&5, Centec Tower, 72-74 Nguyen Thi Minh Khai, Dis.3, HCMC Phone : + 84 (08) 3 827 0527 Website: www.tcsc.vn MONTHLY REPORT MAY 2012 Research Department research@tcsc.vn