Bidding for a large infrastructure project - Understanding project evaluation techniques, building a project evaluation model and determining the capital structure
You are the senior portfolio manager of a major infrastructure fund, APM Infrastructure, an Australian based infrastructure fund based in Melbourne, that is invited to participate in a Public Private Partnership transaction that involves building a major toll road in the Indian State of Karnataka. The new toll road will provide an important link in the overall traffic network. Your infrastructure fund has formed a bid consortium that includes a global road building company, a road maintenance and services company, a major Indian Infrastructure Company, a large Indian Bank and an Australian Consulting firm.
The Karnataka State Government will provide a concession agreement that allows the winning bidder (i.e. concessionaire) to collect tolls at a regulated rate over the concession period of 25 years from the date of completion of the project. The State Government has agreed to provide the concessionaire with a "credit wrap" (or financial guarantee) of up a total of 30% of the project value for project finance debt with a maturity up to 5 years The concession agreement requires the bid group to contribute equity of a minimum of 30%.
For the purposes of this analysis we assume that the equity component of all project bids will be fixed at 30% of the total project costs. The remaining will come from debt.
It is estimated that the construction will take around two years and for the purposes of our analysis, we assume that all cash - flows during a period occur at the end of the period.
The Karnataka State Government is rated A Minus by global rating agency Standard & Poors and your banking partner estimates that the residual project debt is rated BBB (flat) based on S&P rating methodology.
For the purposes of this analysis you will assume a "flat term structure" of interest rates or interest rate swap curve of 8%. Your banking partner has estimated the following credit spreads over the inter-bank swap rate:
1. A Minus rated debt = 0.50 %
2. BBB rated debt = 3.50 %
They have offered to provide an interest rate hedge to lock in the interest rates at this level if deemed appropriate by the bid team. They would also be willing to offer credit facilities to help the project lock in any foreign exchange or commodity price risks.
Key parameters of the project as determined by your consultants are outlined below:
INR: Indian Rupee
Project Costs: Year 0 - Bid Costs capitalised - INR 1 billion
Year 1 - INR 14 billion
Year 2 - INR 20 billion
Hence the total project value is estimated at INR 35 billion
Approximately US$50 million of project costs is towards the purchase of bitumen or Asphalt for road building. Bitumen is a sticky, black and highly viscous liquid or semi-solid form of Petroleum. The price of bitumen often correlates with the price of Oil.
The Project costs also include an amount of around U$100 million towards of steel girders that are to be imported from China.
Interest costs on the bank loan during the construction process are capitalised and included in the total amount of INR 35 billion calculated above.
You are also provided with the following cost structures:
1. Annual Expenses other than Bank Interest costs - Estimated at A$ 10 per annum
2. Bank Interest Costs - As calculated by you based on debt structure employed
3. Annual Toll Receipts as outlined below:
• Year 1 of the concession period - INR 5.5 billion
• Year 2 of the concession period - INR 6 billion
• Year 3 of the concession period - INR 6.5 billion
• Year 4 of the concession period - INR 7 billion
• Year 5 onwards to year 25 - INR 8 billion
4. At the end of the concession period, ownership of the toll road will be handed over to the State Government at no cost.
The bid group has agreed on an internal hurdle rate of 18 % for the purposes of evaluation of this project.
In bidding for the project, you are required to provide the State Government with an estimate of either how much you expect the State Government to pay you (upfront) as a subsidy or How much you are willing to pay the State Government in consideration for taking up the concession agreement.
Important note to students:
1. This is a group assignment and the key focus is on ensuring you understand the financial concepts - You are required to discuss key issues among yourselves and develop a detailed excel model for calculating the project NPV.
2. Aspects of the assignment will be discussed during tutorial sessions to assist you in the learning process.
3. You can also avail the time allocated for student consultations to get a better understanding of project related issues.
Assessment tasks:
Questions
1. In the context of this project discuss the difference between:
• The "Funding" mechanism of this project
• The "Financing" mechanism of this project
• Develop a detailed NPV model in excel showing Cash Inflows, Cash Outflows and NPV of the project. What is the amount that you either expect to receive or are willing to pay the State Government to win this concession.
• Provide your arguments.
• Based on the information provided in the case study, you are required to make a recommendation on the following:
a) The key risks in this project from the perspective of APM, in particular:
• Interest Rate Risks
• Foreign Exchange and Commodity Price Risks
• Translation Risks
b) Innovative means of debt financing of the project, a rough debt maturity profile. Discuss the merits and limitations of each form of financing proposed. In particular from:
• Specialist Infrastructure Lending Institutions
• Domestic and International Banks