Sprint to the finish on financing projects.
When a company faces the right opportunity to grow significantly through a large-scale expansion, management typically focuses on high returns, increased market share and improved margins -- and rightly so. But it inevitably falls to the CFO to inject the sobering dose of realism that they all know they're in for: How do we take advantage of the opportunity given our potentially limited financial resources?
In the telecommunications industry, the developing world is a fertile field just waiting to be planted. The rate of demand for telecommunications services increases 10 percent to 12 percent annually, compared with overall economic growth of about 3 percent to 4 percent, so it's not surprising that telecommunications companies worldwide are looking at major expansion projects.
While we've found that off-shore telecommunications infrastructure opportunities abound, traditional lending structures won't cover most companies' funding needs on this scale. Some $50 billion is lent each year by the multilateral financial institutions (MFIs) like the World Bank, the International Finance Corporation,the European Bank for Reconstruction and Development, the Asian Development Bank and the Inter-American Development Bank. Of this $50 billion, only 5 percent, or $2.5 billion, goes to financing the growth of telecommunications companies. The problem is we need something closer to $15 billion to do the job. Banks, though eager to get in on growth opportunities in the telecommunications field, are capital-constrained and have become more cautious because of the weakening balance sheets and heavier debt burdens of many players in the telecommunications game. So where's a forward-thinking telecommunications company to turn?
Jeannine Strandjord, Sprint's treasurer, asked us this a few years ago when accelerated global expansion became our company's game plan. In the end, we turned to an approach that has worked for industries whose businesses depend on cash flows rather than balance sheets: project finance.
Project financing is based on cash-flow lending in which repayment is linked to individual transactions usually secured by specific assets. The lending has only limited support from, and recourse to, the project's sponsor (Sprint in our case) and any associated parties. Instead, the project needs to live on its own merits, as it is literally "lifted off" the balance sheet. Project lenders will look at the specific assets of the deal, comparing them to the associatedliabilities, including various forms of debt. In the case of Sprint, the lenders may rely on the fiber optic cable, switches and transmission equipment, not on Sprint, as the security for the loans.
Most importantly, project lenders will look at cash flow from these assets, which will determine the project's ability to service debt. In doing so, the lenders may decide to set stringent requirements that the project achieve specific targets before they release additional funds. These requirements could include specific completion dates, pricing and cost guarantees, customer sign-up schedules, and quality- and service-level commitments.
Another way for project sponsors to comfort lenders is to literally assign specific receipts to them. This is why the approach is so popular for infrastructure projects, which are beginning to include telecommunications opportunities. For instance, oil refinery deals and toll-road projects have been highly successful as project-finance structures. In the case of refining, an "off-take" agreement often assigns cash flows from the refined oil directly to lenders for specific assets. For toll roads, the cash flow can be the tolls themselves.
Like refining and classic infrastructure projects, telecommunications companies like Sprint can finance their large-scale projects by assigning cash flows unique to their industry. One such cash-flow possibility results from the imbalance between international telephone calls coming into developing countries versus those going out. This ratio is often four or five to one, with the net settlement payments currently going to foreign post, telephone and telegraph administrations (PTTs) for handling inbound calls to their countries. Thesesettlements are in hard currency, usually U.S. dollars or a basket currency such as special drawing rights (SDRs), which makes assigning such payments to lenders a straightforward process. This may be a significant political issue, however,since developing countries often view such receipts as sacred, given the virtual guarantee of hard currency the countries need to pay for other desperately needed imports. They wouldn't easily give up these settlements. To a lesser extent, assigning local currency receipts may also be possible. But these assignments may not be quite as attractive because cash flows may not be in a freely convertible currency and could be subject to significant exchange risk.
A LITTLE OF THIS AND A LITTLE OF THAT
For successful project-finance structures, many companies must rely on a melange approach -- that is, a blend of sponsor equity, local borrowing, MFI participation, Export Credit Agency (ECA) involvement, vendor financing, international debt/equity financing, derivative products to hedge exposures and so on.
There's no single recipe for success in project financing. In fact, what makes it work is the uniqueness of the most advantageous combination of financing sources available given the time, the place, the nature of the project and the players involved. However, at Sprint we believe that a project sponsor that's guided by the following rules has a greater chance for a successful venture:
* Get the group that's responsible for project financing involved in the project as early as possible. The earlier these people become part of the business development process, the more effectively they can evaluate and mitigate the risk -- and the better chance they'll have of financing the project at the lowest overall cost. It's important to identify potential partners, vendors and financial institutions early on so you have time to research themthoroughly before you approach them. And the project-finance group needs time to adapt to changing local market conditions that could allow the project to make some significant savings associated with the optimal timing of borrowings, guarantees and so forth.
* Share the risk. In major undertakings like large-scale telecommunications infrastructure expansions, projects do best when they "offload" as much risk as possible onto potential equipment suppliers and construction parties. In the best case, a company would achieve a "pure" project-finance structure, in which all of the risks are based on project cash flows without the associated securitization of assets or sponsor company (or companies) support. While this may not be possible in practice, due to the nature of cash flows, a hybrid approach that also includes traditional export finance relying on ECA credits can offer limited recourse structures that make these projects feasible.
As an example, let's look at a project that utilizes a build/operate/transfer (BOT) structure. While they take various forms, BOTs typically allow for the sponsor company to "run the business" for an extended period of time (often 10 to 15 years) and ultimately pass ownership back to the government entity. Host governments often maintain the illusion of full control, either through participating in management or using the entity's name in its billing material, advertising, and so forth. This obviously leads to a more palatable structure in the eyes of local politicians focused on maintaining sovereignty in the eyes of their constituencies.
For example, as one of the first companies into Kuwait after the Gulf War, Sprint looked for creative financing solutions to rebuild the communications infrastructure there. In order to install a $3 million satellite earth station, we used traffic settlements due to Kuwait as the funding vehicle. As calls were initiated, Sprint netted the settlement obligation due the Kuwaiti PTT versus the payment due for the satellite dish. In a BOT structure, this scenario could be carried further to include complete retention of title to the goods until final payment is received.
One caveat here: In such a structure, the project's sponsor should maintain either control over the selection of manufacturing sites, if these are owned directly or through alliances, or flexibility in selecting equipment vendors. This approach minimizes the risk from any one supplier and allows the project sponsor the option of shopping for optimal terms. It also opens the door to potential "soft" loans, which are particularly common in Europe. (A soft loan is a loan that has better-than-market terms or pricing. For instance, the final maturities may be longer, grace periods may be granted on interest and/orprincipal, or interest rates may be lower than market. Vendors and other parties sometimes grant these better terms or pricing simply to secure business.) In the bidding process for BOT projects, vendors typically approach their respective ECAs for supported financing. In the United States, they might approach the Export-Import Bank (EXIM); in France, Coface; in Germany, Hermes/KFW. Under the Organization for Economic Co-operation and Development (OECD) guidelines, the terms available through any of these agencies should be comparable, offering supported financing for 85 percent of a project's needs, usually with a five- to seven-year payback. And the clever suppliers that can produce their equipment in various locations can approach multiple ECAs for financing.
By effectively managing competition among suppliers -- and suppliers, in turn, doing the same with ECAs -- companies have been highly successful in pushing out the terms of the financing for some projects to as long as 20 years with several years of grace.
Another benefit of managing the supplier competition is the potential for you to develop natural foreign-exchange hedges by raising part of the financing in the currency of production or one that's closely aligned to it. Such currency offsets help you eliminate risks associated with the project. For example, if a French equipment manufacturer bids its equipment to the project in French francs, borrowings by the project denominated in francs effectively eliminate the concern of currency fluctuations for that component of the build-out. In those cases where production must occur in the country where the project is taking place, you'd be wise to secure agreements for currency convertibility or exchange. Where countries specifically forbid conversion of local currency receipts, you may find you're unable to use such a "blocked" currency for servicing debt or paying suppliers.
How else to reduce the risk? Get suppliers to be responsible for completion contracts, which are generally required by lenders.
The result of carefully managing all of your suppliers is low-cost financing, passing some risks on to your suppliers and, when you diversify your suppliers, reducing your overall completion and quality risks. And by sharing your equipment-procurement risks, your chance to have a successful project-finance structure increases substantially.
* Leverage the right multilateral financial institution. What about working capital and long-term equity financing? The answer is to bring in a respected MFI as an equity participant. A well-chosen equity partner lends instant credibility to a project, which can be vitally important when you're trying to get corporate approval and round up potential investment partners.
The MFI also can be very valuable in infrastructure projects by acting as a strong partner in negotiating complex and often sensitive issues with foreign government ministries. For example, developing countries may lack effective (or any!) government policies on interconnection among telecommunications carriers, which would outline rules for sharing long-distance and international revenues among operators. Having a respected MFI at your side while you're discussing a political issue with a foreign government could be just the impetus you need to negotiate an acceptable agreement.
You also may be able to raise debt financing through the MFI or a respected international investment bank. As mentioned earlier, project finance offers other areas of comfort to debt holders, too: assignment of settlement proceeds (PTT hard-currency receipts for terminating international traffic), completion agreements (where some risk can be offloaded onto vendors) and loan guarantees. The Overseas Private Investment Corporation (OPIC) can offer such guarantees to U.S. lenders. Also, lenders that participate in an MFI's loans can obtain preferred-creditor status. (By extending preferred-creditor status to other lenders, the MFI provides the same repayment assurance to lender X that the MFI enjoys.) Borrowers default on these loans only at the risk of being denied further support by MFIs.
Local working capital financing depends on the degree to which the capital markets are developed in the region. Again, for markets that can raise local currency funds, you'll have a partial natural hedge against local revenues, which is particularly important in volatile exchange-rate environments where hedging instruments may not exist.
Finally, look for insurance arrangements for equity investments provided by agencies like the Multilateral Investment Guarantee Agency (MIGA-World Bank) or sponsor government agencies (the OPIC in the United States). Such arrangements can reduce, if not eliminate, such risks as expropriation, inconvertibility and political violence. The cost of insuring your equity investments will be relatively small, typically up to 1.5 percent of the book value of the insured investment.
* Be flexible. Above all, remain flexible when pursuing your financing options and remember the project-finance recipe is different for every project. International expansion projects pose a unique set of circumstances in every country you approach. You'll encounter different laws, ideas, business practices and levels of development. So you'll maximize your chances of success if you involve your key financing parties early, spread as much risk as possible among your suppliers and hook up with an MFI that's strong and highly thought of. Today, financing large-scale expansion projects can often be more complex than executing them, and with telecommunications infrastructure expansion, that's saying a lot. But then complexity and diversity are the strengths behind the project-finance approach.
NICE TO HAVE FOR FRIENDS
Here are some of the leading players among multilateral financial institutions:
The Asian Development Bank (ADB)
Focused on developing economies in the Pacific Rim. Similar activities to IBRD.
The European Bank for Reconstruction and Development (EBRD)
Focused on developing economies in former Soviet-bloc countries. Higher lending limits for projects than IFC. Also takes equity positions in projects.
The European Investment Bank (EIB)
A European Community (EC) institution, providing sovereign lending to promote EC exports. Loans denominated in European currency units (ECUs). The Inter-American Development Bank
A majority investor (51 percent) must be from Latin American member country. Lends to projects on own book, provides guarantees on debt and may take equity position in project.
The International Bank for Reconstruction and Development (IBRD)
A World Bank entity that provides co-financing, partial guarantees to cover political risk. Lending is to sovereign agencies.
The International Finance Corporation (IFC)
A World Bank entity that provides co-financing directly through "A" loans, indirectly through syndicating "B" loans. "B" loans carry preferred-creditor status, thus increasing repayment comfort to lenders. Also takes equity positions in projects. Total support is typically less than 35 percent of capital investment needs over project life cycle.
The Multilateral Investment Guarantee Agency (MIGA)
A World Bank entity providing insurance on both debt and equity.
The Overseas Private Investment Corporation (OPIC)
Provides co-financing and guarantees and can insure both debt and equity. U.S. company must have at least 25 percent ownership share. Increasingly active in making equity investments.
Mr. Chehayl is vice president of capital markets at Sprint in Kansas City, Mo., and Mr. Berger is director of international treasury operations at Sprint International in Reston, Va.
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|Author:||Berger, Edward E.|
|Date:||Jan 1, 1994|
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