Question

Continental Power (CP) builds and operates renewable energy generation facilities across Europe. It is considering expanding its business into a number of developing countries. This expansion would require large capital investments which CP would prefer to finance using debt. CP’s corporate finance advisors believe that the company could not issue additional debt without significantly impacting its credit rating. These projects are generally of a finite life and require little ongoing capital investment once operating. CP is concerned about the impact of political risk in the proposed locations. CP’s advisors have suggested financing, developing and operating these projects using project finance structures rather than corporate finance (as has been the practice to date).

Required:

(i)        Explain how project financing and corporate financing structures differ.

(ii)       Outline how a project financing structure could be developed for the overseas projects. Address the following elements of the structure:

            - Corporate and Legal Structure

            - Capital Structure

            - Distribution of Project Cash-Flows

            - Risk Management               

- Lender Recourse to CP for Project Debt

Answer 1

(i)        Explain how project financing and corporate financing structures differ.

Corporate financing structures are conventional structures where external capital is made available in the main corporate. Thus debt and equity is infused in the main company or at the group level. The capital is then pushed into the subsidiary division, unit that needs the capital. The capital is recorded in the main company's book. The investors get the share of the company. The lenders will have recourse to the entire assets of the company.

Project financing structures are creation of special purpose vehicles (SPVs) that house a one particular / specific project. They are created for a specific purpose of financing the projects. Hence, they are called special purpose vehicles. The investment or borrowing is infused in this specific SPV and is used for this particular project. The investors get the shares of the SPVs and the debt and borrowings sit in the project SPV. The lenders also have recourse to the assets of this particular SPV.

(ii)       Outline how a project financing structure could be developed for the overseas projects. Address the following elements of the structure:

            - Corporate and Legal Structure: Separate special purpose vehicle (SPV) can be created to house different overseas projects. Thus there can be different SPVs for different projects and overseas project. These SPVs may or may not be the subsidiary of the parent company. Such SPVs will have its own registration, corporate identification number and will function like any other organization.

            - Capital Structure: The capital structure here can be that which are typical of the specific project. It can have a cpital structure similar to pure play companies in this particular sector. Alternatively, the capital structure of the SPV can be same or similar to the fir as a whole.

            - Distribution of Project Cash-Flows

Project cash flows distribution will follow a particular waterfall:

• First towards the project level expenses
• Then towards taxes payment
• Then towards interest and principal of the loan, borrowing , if any.
• Then towards the shareholders and investors
• Then to the original sponsors, promoters of the SPV

            - Risk Management           

• Most of the risks remain associated till the SPV level.
• It's the SPV that is subjected to regulatory compliances
• Lenders will have mortgage only on the assets of the SPV
• Lenders will have recourse to the assets of the SPV, mortgaged to them, in case of default.
• More secured and cash flows are then ring fenced