Even though we may think that project finance is a new and revolutionary way to ensure the procurement of infrastructure based services, project finance is actually just a more sophisticated way of finance that has been used for more than 500 years. The discovery of America was financed through the means of private equity using some of the techniques that we currently use[1]. Even more what we know now as the French concession model emerged in the mid XVII century. So project finance is not a newly invented financing technique. Modern financial knowledge and the invention of new financial instruments have only refined it and transform it into what we now know.
Project Finance, Infrastructure & PPPs
It is also clear that project finance is closely related to infrastructure development and the provision of a public service. This relationship is due to the characteristics that an asset must posses in order to be financed via Project Finance. Literature points out five essential features that are the basis of structuring and defining a project finance operation.
| The Size of the operation | 2) High leveraged transactions |
| 3)Stable and Predictable Cash Flows | 4)Limited recourse to project sponsors |
| 5)High specificity of the asset | 6)A wide variety of stakeholders |
It can finally be said that Project Finance is a financial technique based in a legal scheme that aims to limit the recourse of lenders towards the project sponsors’. This scheme allows the sponsors to, through the means of a legally and financially independent Special Purpose Company, finance the development of a high-risk economic asset with an elevated percentage of debt. The repayments of this debt will come from the cash flows generated by the asset itself. In order to minimize the underlying risk of the project the technique permits the project’s sponsors to allocate risk to different stakeholders aligning their interests with the success of the Project.[2]
Depending on their Cash Flow profile we distinguish three main types of Projects each one corresponding to a different contractual reality:
>a. Industrial Project: The cash flows generated are unstable and depend a lot of technological improvements.
b. Exploitation of Natural Resources: Cash flows generated by the project are random since revenue is subject to the underlying commodity price in the market.
c. I nfrastructure Projects: As long as the service delivered is regular and the underlying infrastructure is well kept, the revenues are constant and stable. So cash flows are predictable and stable.
This makes of infrastructure projects an ideal type of asset subject to Project Finance.
Very often these infrastructure assets are associated with strategic economical activities[3] and thus are regulated or control by the state/government. In this sense infrastructure assets within the Project Finance category are controlled or regulated by the state/government so in order for the private initiative to invest in such activities/assets it needs an authorization of the government.
In other cases, such as education or health, the service is considered of such a social and economical impact that the government reserves for itself the right and obligation to provide the service. It may also be the case of services considered as public goods[4] such as roads, public lighting, and power distribution.
Private investors will have no interest to invest in the procurement of public goods for it is not easy, see impossible, to identify the final consumer and charge him for the use of the asset or the service consumed.
Public-Private Partnerships (PPPs) are the means through which private investors may engage in the procurement of a public service, or in the financing of a strategic economical activity in collaboration with the government and make a profit from such investments. In other words, PPPs allow the private initiative to invest in profitable activities that were once exclusively developed by the government.
PPPs origin from the idea that: Since government has a monopoly over some cash generating assets, which posses essential characteristics that make them eligible for project finance. And since public authorities are not interested in getting a financial/economical profit from their investments, in contrast with private investors, they do not have the proper incentives to improve the management and operation of this kind of assets, to boost their efficiency and turn them into real “Cash Generating Entities”[5].
A well-structured PPP
The high level of debt that characterizes Project Finance deals is the object of a major dispute between traditional and public-private partnership procurement. Some argue that governments can finance this kind of projects by issuing cheaper debt than privates. Although this is true the fact that Project Finance deals rely in a wide variety of stakeholders implies not only that risks are optimally allocated to the party best able to bear it but also that there is no place for mistakes in time delivery or budget estimations (CAPEX, OPEX, Working Capital).
Thus private provision of public infrastructure based services must be more efficient than government traditional procurement in order to generate significant savings to compensate for the cost of debt. In fact the private partner in a PPP tends to be so efficient that it manage to generate economies that overcompensate for the risk premium between public and private debt and deliver what is known as Value for Money.
In general terms the private party to a PPP solves the following problem:
s.t. SPV’s risk endowment
Since the SPV represents and encompasses all the stakeholders’ interests the problem reduces to maximizing the SPV’s expected return subject to its own risk endowment. The solution to this problem is attained through a process known as: “Risk Take Back.
Credit Spreads PPP versus Corporate
The financing of a Project Finance deal, in this case a PPP, should not depend, in essence, either on the credit capacity of the sponsors or in the value of the assets to be financed/built.
So if a PPP project achieves an optimal risk allocation, receives sufficient government guarantees and has sufficient sponsors equity to cover for financiers maximum potential loss, the credit spread of a loan granted to an SPV should be similar to that of a loan granted to one of the Sponsoring Companies.
The main hypothesis of the present study supports that in order for a PPP project to be financed by a non-recourse credit facility all of the above has to happen. Hence we should not observe a statistical difference between the spread charged to a Project Company and that of its Holding Corporations.
To test this hypothesis credit spreads from 219 transport infrastructure projects from all around the world were compared against the credit spreads of loans hired by their sponsors. Data was extracted from Thomson Reuters Project Finance database focusing only in syndicated loans.
The main difficulty in analyzing the information was that, since syndicated loans are composed of many tranches most of them with different spreads and sometimes with different price reference, it was required to transform the data, by calculating a weighted average cost of the debt, in order to capture the real cost of debt for each project. So for example a syndicated loan of $100 million dollars with 5 different tranches (Tranches A, B, C, D & E) each of them having a different spread and a different amount was considered as follows.
Conclusion
One reason this might be so is that revenues of a Project Finance venture, even if it is a PPP, are uncertain until the completion of the project. Even during the ramp-up period there’s still some uncertainty if the expected level of revenues will be attained. This is not the case for a Corporate Finance project, where the company already exists and generates revenues.
One thing that financiers and investors don’t like it is uncertainty because unlike risk, uncertainty cannot be properly measured. In other words a Project Finance development is based on assumptions and even if we do all that it is possible to give substance to the assumptions they will still be assumptions.
