1. Project Finance Tim Thompson Corporate Restructuring

2. How is most corporate investment organized? • In corporations • Debt is usually recourse to entire organization’s assets • Leverage is usually modest (obvious exceptions)

3. What is project finance? • Refers to a wide range of financing structures. These financing structures usually have one thing in common --- the financing is not primarily dependent on the credit support (credit quality) of the sponsors or the value of the assets involved. Instead, debtholders (banks, public lenders) place a substantial degree of reliance on the performance (I.e., cash flows) of the project itself… • Non-recourse (or at least limited resource) financing • Project finance is both a financial structure and a corporate governance structure aimed at resolving capital market imperfections and efficiently allocating risk.

4. What types of projects? • Somewhat arbitrary, but • Single purpose capital investment • Stand alone entity • Finite and long life • Large in size

5. Project finance versus conventional financing • Modigliani Miller still holds if its assumptions are true • if there were no taxes or transactions costs • no costs of financial distress • no agency conflicts • no information costs • THEN PROJECT FINANCE WOULD ADD NO VALUE RELATIVE TO CONV. FIN.

6. Project finance is very costly • Transactions costs very large • Contracts: very complex organizational structure, not much flexibility • Long negotiations, long time to close • Fees (0.6% of deal size, similar to M&A) • DISADVANTAGE RELATIVE TO CONVENTIONAL FINANCE

7. Costs of distress/bankruptcy • Risk of default and allocation of this risk very different than conventional debt • Less risk contamination with other parts of firm • Less co-insurance benefit • Rearranges “states” in which default occurs • Trade-off, clearly

8. Agency costs • High leverage, dedicated cash flows, very specific contractual terms for repayment and contingencies • May limit opportunities for risk shifting • May limit cross subsidization incentives • May replace managerial incentives of a public-sector project with a for-profit venture, contracts used to enhance incentives

9. May improve economics • MM theorem assumes the investment is fixed • It may be that the investment itself is improved by the structure • Walt Disney got huge tax and governmental relief by setting up EuroDisney as a project structure rather than owning outright • Tax, gov’t. reg.’s may be reduced

10. Outside guarantees • Project finance is usually high leverage and non recourse to project sponsors • even with its possible benefits, this usually leads to high risk debt, which is often illiquid, costly and sometimes simply not available • Often a guarantee or credit support is offered by • Governments/international agency (IFC/World Bank)/Sponsors/etc.

11. Different contractual relationships • Contracts needed: • Management/shareholder agency relationship • Intercorporate agency relationship • Government/corporate agency relationship • Bondholder stockholder relationship • Definition of the organization (corporation) is a nexus of these contracts