Tianjin Plastics

A case study in international project finance.

Brian Hider Brian Kopan Ernest Lew Juan Villa October 8, 2008 Cal State Fullerton, MBA Program

Background

Case set in 1996 Chinese economy is growing rapidly

Foreign capital needed for infrastructure in China Opportunity to fund power plant project in Tianjin province

TEDA

Established in 1984 Planned area of 33 sq. km. Divided in 3 sub-areas

Land usage restrictions by government of China

Original Land Development Financing: 100% Chinese government

Goal: become a modern industrial area which is the biggest in Asia and the best in China

TEDA

In 1992, TEDA FDI increased-needed for development

New Land Development Financing: combination

of Chinas government & MNCs.

Wholly foreign-owned companies and joint ventures were created to develop of land

MNCs investment in the area has lead to strong economic growth in the TEDA region.

Project Structure: The Players

Maple Energy (49% Equity) US Based company, since 1989 Subsidiary of Northern States Utility Power plant projects in four countries Specialize in turnkey projects Tianjin Plastics (46% Equity) Government run factory Specialty is energy intensive extrusion process MOPI (5% Equity) Chinese Ministry of Power Industry Wintel Had Rmb that could not be repatriated

Project Structure: Fundamentals

Project life-4 year construction, 20 year operation

Operating costs fixed, paid in Rmb

20yr contract for free coal feedstock Selling price of energy guaranteed (Rmb)

Profits virtually guaranteed as long as debt, equity and final

profit are in Rmb Project financed with 85% debt Forecast shows China requiring 21GW of additional power annually for a decade (150 plants of this size)

Project Finance

Definition: the raising of capital to finance an investment project where the capital providers look at the cash flows from the project as the source to: (1) Service their loans (2) Provide the return of equity (3) Provide a return on their investment

Project Finance: Characteristics

Separate legal entity

Separate from investors and MNC

Singular focus of business

Predictable cash flows from operations

Essential to securing project financing from outside partners

Finite project life

Cash flows go toward servings its capital structure (debt & equity)

Exchange Rate Outlook

Chinese Rmb is expected to weaken relative to the US$ International Fisher Effect (IFE)

Higher expected inflation in China In 2000, Bank of China starts to loosen their hold on currency Higher interest rates in China vs. US (13% vs. 8%) on near and long term loans. Forecast 5% depreciation

Interest Rate Parity Theory (IRP)

Basic Issues
Important Urgent

+Exchange Rate risk +Lack of free markets/govt controlled

+Government restrictions on capital outflows

+Two days to make recommendation

Immediate Issues
Important Urgent

+Chinese govt can refuse to fulfill contract

+no hedging available

+Registered capital (equity investment) cant leave country

Cause/Effect
Partially convertible Rmb Lack of hedging options and forecast data

Unpredictability of project profitability

Political instability

Equity repatriation constraints

Lack of EX/IM financing help

Decision Criteria

Quantitative:

Highest likely NPV

Sensitivity to currency exposure Must have positive NPV

Shortest payback period

Qualitative

Overall company growth strategy in TEDA

NPV and Payback Period Model

1996 +Operating Margin -Interest Expense -Taxes =Net Income +75% of Depr -Principal Pmt =Project Cash Flow 17% ROI Project Restriction Maple (49%) CF in Rmb Maple/Wintel Rmb Loan Net CF Bal Available to Repatriate XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX + Repatriated $'s + Maple/Wintel $ Loan Net CF = Maple $ Cash Flow Construction Phase 3% Projected Growth 2020

NPV @ 18% Disc

Option 1
Maple Energy invests directly with US$ Maple leaves US$ in project and cant pull them out = lose equity investment. Debt obligations are in US$ and will be exposed to exchange rate risk. Currency Exposures:

Firm Profitability
Dollar based debt (almost 90% of debt)

Profit Magnitude
Profits converted to dollars

Const. Loan + Syndicate Loans NPV

Renminbi Depreciation Rate Probability 1996 NPV Weighted NPV Payback Period Weighted Payback Period -10% 20% 3.3 0.7 5 1 -5% 70% 7.4 5.2 5 4 0% 5% 13.5 0.7 5 0 5% 5% 23.1 1.2 5 0

7.7 5

Option 2
Back-to-Back loans Maple Energy does US$/Rmb loan with another US firm doing business in China, Wintel Currency Exposures:

Firm Profitability
Dollar based debt (almost 90% of debt)

Profit Magnitude
Profits converted to dollars

Back to Back Loan NPV

Renminbi Depreciation Rate Probability 1996 NPV Weighted NPV Payback Period Weighted Payback Period -10% 20% 4.1 0.8 4 1 -5% 70% 7.5 5.2 4 3 0% 5% 12.8 0.6 4 0 5% 5% 21.2 1.1 4 0

7.8 4

Option 2 (continued)
Back-to-Back loans Mechanics:

Wintel has generated profits in Rmb (cant repatriate earnings) Wintel loans Rmb70.018 to Maple for 6 years Maple loans $8.415 to Wintel for 6 years Maple: instead of converting their US$ and making the equity investment IN China, Maple BORROWS the Rmb from Wintel for the equity investment Maple pays loan with Rmb from cash flows Wintel pays loan with US$

Option 3
Have power price paid by Tianjin Plastics indexed to dollar Tianjin has already contracted to purchase most of the power from the plant. This guarantees earnings would maintain their US$ value. Not allowed by MOPI due to concerns over negative impact it might have on their Rmb invested in project. Currency Exposures:

Profit Magnitude
Profits converted to dollars

Option 4
Finance majority of project in Rmb (borrow locally) Maple would borrow local Rmb. No US$ exposure since Rmb (not US$) are invested in the project. Large exchange rate risk on profit since all profits are in Rmb and must be converted to US$. Currency Exposures: Profit Magnitude
Profits converted to dollars
$101.5 M Deposit NPV
Renminbi Depreciation Rate Probability 1996 NPV Weighted NPV Payback Period Weighted Payback Period -10% 20% (12.8) (2.6) 11 2 -5% 70% (11.5) (8.0) 11 8 0% 5% (9.0) (0.4) 12 1 5% 5% (4.0) (0.2) 12 1

(11.2) 11

Selected Option
Option 2: Back-to-Back loans Loan of Rmb 70.018m Maple Energy Wintel-China

(China)

(China)

Maple Energy (USA)

Loan of US $8.415m

Wintel

(USA)

Selected Option
1996 NPV & Payback Period
Renminbi Depreciation Rate Const. Loan then Syndicate Loans NPV
Payback Period

-10% 3.3
5

-5% 7.4
5

0% 13.5
5

5% 23.1
5

Back to Back Loan NPV

Payback Period

4.1
4

7.5
4

12.8
4

21.2
4

$101.5 M Deposit NPV

Payback Period

(12.8)
11

(11.5)
11

(9.0)
12

(4.0)
12

Probability Const. Loan then Syndicate Loans NPV

Payback Period

20% 0.7
1

70% 5.2
4

5% 0.7
0

5% 1.2
0

Expected NPV 7.7

5

Back to Back Loan NPV

Payback Period

0.8
1

5.2
3

0.6
0

1.1
0

7.8
4

$101.5 M Deposit NPV

Payback Period

(2.6)
2

(8.0)
8

(0.4)
1

(0.2)
1

(11.2)
11

Questions?