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REPORT

Subject: Project Infrastructure Finance (PIF) Course: MBA Tech. (Finance) College: Mukesh Patel School of Technology Management and Engineering, NMIMS Mumbai

Group 1: 111 Rakshit Jhunjunwala 115 Ankitesh Mathur 211 Manu Shrivastava 301 Balagopal Padmakumar 402 Rishi Bajaj

Case Study: Aluminium Bahrain (ALBA): The Pot Line 5 Expansion Project Authors: Benjamin C. Esty, Aldo Sesia Jr. Harvard Business Review Case no. 9-205-027

Contents: Introduction to Case. Comparison of Single source and Multi source financing. Advantages and Disadvantages of Multi source financing. Cost of Financing of both approaches.

Group 1. PIF Report: ALBA

About the case- an Introduction


Aluminium Bahrain (Alba), was planning to add a fifth pot line to boost its aluminium production capacity to over 60% to more than 8, 30,000 tons per year. With regards to this, the company was reviewing various financial options for the proposed $1.7 billion project. The company has hired an external consultant named Taylor-Dejongh (TDJ) to act as the projects financial advisor. The consultant offered various financial options, which included a structured corporate credit using as many as five options inclusive of both project and corporate finance. With the past experience of Pot 4, the company had plans to seek financing from multiple sources. The company was initially worried about the economic situation at that time and they feared if the project would get tainted and hence a diminishing public sentiment. Bahrain, as a country was not quite up to the standards in the oil and gas market as compared to other Middle Eastern countries, but over the years energy sector remained the largest contributor to the countrys GDP followed by financial services and Manufacturing ( Aluminium) at 25%, 19% and 12% respectively. One of the main attractions the Bahrain Government posted was that they did not tax corporate income. Alba was incorporated in 1968 as JV between the Government of Bahrain, with an original ownership interest of 18% and a consortium of aluminium users. It was the first aluminium smelter in the Middle East and it began production with two pot lines and a production capacity to over 500,000 tons and expanded into several downstream and related businesses such as the production of calcinated coke, which was required to make anodes for smelting process. Alba had a history of strong credit history, having operated for more than 30 years without default. The Government ownership rose to 77% and SABIC Industrial Investment Co and Breton Investments owned 20% and 3% respectively. The companys pot 4 projects was huge success which added 235,000 tons of annual capacity at a cost of $1.5 billion. Alba over the years became the largest single-site smelters in the world but also one of the lowcost producers. The pot line 4 projects saw financing which included a combination of commercial bank loans and export credits plus a small amount

Group 1. PIF Report: ALBA

of Islamic finance. It paid debt service out of revenue generated through a quota engagement with its shareholders. Before the pot line 5 projects were to be set up, the company had to analyse the economic feasibility (Phase 1) and assess their financing options (Phase 2). TDJ, the hired external consultant was entrusted with the duty of carrying out the economic feasibility study, which entailed a review of the projects economic feasibility, a recommendation on the optimal organizational structure and an assessment of the markets overall ability to finance the project. TDJ concluded that the project was economically feasible at a cost of $1.7billion but only if the project was combined with Albas existing operations. They commented that the project could not be financed on standalone basis without significant structural changes to the company and therefore the projects debt had to be paid by Albas total cash flow without recourse to the sponsors. Hence it would be classified as a project finance deal. Since the project would be supported by multiple assets, namely the cash flows from the Pot Lines 1 to 5, the financing may resemble a corporate finance. However Alba rejected the proposal citing the reason that the deal would be very expensive than a structured corporate credit. Also, it would have to undergo a major restructuring of Albas business model and assets as well as a much larger equity commitment from the sponsors of $500 million or more would be required. With the Phase 1 completed, the team proceeded toward phase two for identifying the suitable sources of financing. TDJ came up with eight viable sources of financing namely, 1. Commercial bank loans 2. Project Bonds( Local or International) 3. Islamic financial instruments 4. ECA financing: direct loans or guaranteed/ insured loans 5. Metals-linked facility: bank loan with repayment either in metal or linked to metal prices 6. Subordinated debt 7. Private Placement debt

Group 1. PIF Report: ALBA

8. Loans from multilateral agencies such as development banks. However, Alba rejected four options which is being shown in the below table. Option International `Bond Reason for Rejection Price quotes coming in from markets were high. Also Alba would have to have ratings from different agencies which meant more time is required Private Placement Loans from Development Banks Spreads were too expensive Alba would not qualify for a

multilateral loan for pot 5 project considering the past experiences with the pot 4 project Subordinated Debt Sponsors were not interested in

putting more capital into the deal.

Therefore after eliminating the above stated options, TDJ prepared a financing scenario that used up to five sources of debt: Commercial Bank finance, a local bond, an Islamic tranche, a metals linked facility and possibly ECA loans or loan guarantees/ insurance. The company went into paper works with a proposed financing from multisource financing, thus forming a strategy of creating a competitive bidding process that would give Alba the best deal possible.

Group 1. PIF Report: ALBA

Comparison between Single and Multiple source of Financing


Single source Amount of capital Time Limited Less time consuming Rises with loan amount especially for the Loan spreads projects as there is very high risk of failure present. Complexity (for borrower) Expertise (in case of raising or borrowing company) Less expertise needed. Less complex Multiple source Very huge (Much more than single source) Much time consuming Loan spread do not increase with loan amount as the number of sources are more.

More complex Very high end expertise is needed eg. sovereign, commercial, and project lending expertise Much higher negotiating

Negotiating power (for borrowers)

Lower, as options are less.

power is with the borrower as there is many options available.

Much higher, because Negotiating power on price and terms (in case of lenders) as there is less option present with the borrower, lenders can dictate the terms and also the restrictions. Capacity- pricing tradeoffs for each source Decisions of quantum Only one source. is to be determined and then the final decisions
Group 1.to be taken. have PIF Report: ALBA

Lower as borrower have other options too.

Conflicts of interests and constraints

Low

High Usually lower(more

Interest rates

Usually high (less fluctuating)

fluctuating because more kind of funds involved)

Structure, manage and restructure (in case needed). low

High due to presence of different conditions and many parties. High, eg.:

Additional costs

Low

Advisory fees Execution fees Legal fees

Group 1. PIF Report: ALBA

Advantage of multi-source financing strategy


Choice, flexibilty and interpool compitition :- Multi-source financing strategy is based on the strategy that it will create interpool compition among the various lenders.That competition will provide several benefits and power of negotiating to borrower. It also avoids lock-in or depend to a single lender for a large number of services for a long period of time.It allows a customer to evaluate different type of proposals of finance from the different source of finance It provide customer option of the mix and match approach to outsourcing, that is, building on lenders different strengths to obtain better overall service quality. Safety : - Multi-source finance reduce the dependency of customer on any single lenders. so it will reduce the dominance of lenders and if in any

situation single lender gets fail in providing fund or fulfills requirment of borowwer on time then they can take help of other lender for collecting funds.

Multi-sourced benefits related to Alba Commercial Bank Loans Commercial banks syndicate with each other for providing loans for the large projects. Many Banks provide step-up pricing for loans where the spread increases over times for example, A borrower might pay 120 basis points for year 1 to 3,140 bps for years 4 to 6, and 160bps for year 6to10. Banks use step-up pricing to recognize the higher risk associated with longer tenors and to encourage borrower to refinance their loans. The banks to control project cash flows use covenants. . No credit rating needed to borrow from commercial banks Three fundamental advantages Borrowers can draw loan down to match their investment needs No public reporting required, so confidentiality If need be additional funds can be provided

Group 1. PIF Report: ALBA

Local bonds Companies, which need financing, issue bonds in capital market. Advantages of bonds issuance: Allow investors to participate in and benefit from the project Develop the local Capital markets Consistent with the government policy Fixed interest rate Long tenors (10 to 20 years) Few covenants

Islamic Financial Instruments Islamic financial Institutions operate under Shariaa that means no interests are charged for loan. But I.F.I. earns profit on asset ownership. Islamic lenders control asset due to the ownership In case of default Islamic Institutions can reclaim their assets Islamic Institutions are prohibited from earning penalty interest for late payments or default situations Advantage of Islamic financial Instruments: Bahrain is an Islamic country and a regional center for Islamic finance

ECA Financing Provided by export credit agencies cover 90% to 95% of loan losses due to political risk and 85% to 95% of losses associated with commercial risk Advantage: Availability: more easy to be obtained Hallo effect: help sponsors attract financing

Group 1. PIF Report: ALBA

Metals-Linked Facility Typically are handled by different groups within investment or commercial banks It has 2 components A basic commercial loan with a spread over Libor A hedging component similar to a call option on aluminum (The hedging component provides benefits to lower the cost of debt it ties the interest rate and debt service requirements to the underlying price of a commodity such as aluminium)

Advantages of metal-linked facility The hedging component allows decreasing cost of debt. Could be viewed as a competing source of Capital

Disadvantages & Risk of multi-sourced financing Complexity: - The customers operational risk is higher than in a single sourcing because it delegates responsibility to several lenders. This interaction with different parties can make it harder to strike the right deal and ensure that the separate contracts are properly implemented.the more parties involved the more difficult the transaction .The customer often cannot state which lender is ultimately responsible for a default, or cannot prove it to a sufficient standard to enable the customer to enforce its rights and remedies under the contract. In the beginning of project financing its very difficult for customer to structure the initial deal because there are several lenders are involved in financing and each follows different kind of rules and agrrement. So customer need to make different covenants for different lenders. In case of islamic tranche there is a problem betweeen the borrower and lender for the ownership of assets

Group 1. PIF Report: ALBA