Project Infrastructure Finance

A CASE REPORT ON ALUMINIUM BAHRAIN (ALBA): POT LINE 5 EXPANSION PROJECT

Submitted By: GROUP 6

153 Arvind Kumar 168 Anukriti Kothari 312 - Pratik Tibberwal 375 Harshit Yadav 361- Aditya Shekhar 504 Divya Praksash Shrivasta 3 - Aakash Jhaveri

Problem Statement
How will you choose a financing strategy for ALBA Pot line 5 expansion project? Would you include Islamic lease as one of the financing source? What are ALBAs objectives for the financing? Given these objectives, what type of financing sources you recommend, i.e. type, how much from each source?

About the Company

Alba was incorporated in 1968 as JV between the Government of Bahrain, within original ownership interest of 18% and a consortium of aluminum users. It was the first aluminum 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 30years 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 were 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 low-cost producers. The pot line 4 projects saw financing which included combination of commercial bank loans and export credits plus a small amount of Islamic finance. It paid debt service out of revenue generated through quota engagement with its shareholders.

About the Case

Aluminium Bahrain (Alba) was planning to add a fifth pot line to boost itsaluminium 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.

Financing Strategy
We recommend the use of multisourced financing strategy over the single source project finance strategy. In traditional way of financing in Middle East countries, projects tapped into one or two financing sources such as commercial bank loans, ECA loans, project bond and Islamic finance. However, the stand-alone finance would require significant structural changes to the company. Also, there wasnt that much liquidity or depth in any single source of capital i.e., the amount of capital from any single source was limited. As a result, ALBA will have to pay a lot more to get large amounts for capital from any one source including the commercial banks, because their appetite for the region and aluminum industry was limited. Also, another way to finance the project could have been by paying off the project debt by ALBAs total cash flow without recourse to its sponsors. In this way the financing would resemble a project financed deal. However, given that project will be supported by multiple assets, namely the cash flow from Pot Lines 1 to 5, the financing would also resemble a corporate finance deal. This financing strategy is also not viable because it will be significantly more expensive than a structured corporate credit. It would also have required a major restructuring of ALBAs business model and assets as well as a much large equity commitment from the sponsors of $500 million or more. Multisourced financing strategy draws debt from international, regional and local capital pools to raise capital. It is an apt option for financing because tapping several liquidity pools would stimulate interpool competition among the various lenders. This will force the lenders to compete on prices and terms. Also, multiple funding sources are much safer and reliable as the risk is spread amongst various parties. This strategy will give ALBA much more power to negotiate both within and across the tranches. There are eight possible sources of capital for the financing of Pot 5 expansion project: 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 (Quasi equity) 7. Private Placement debt 8. Loans from multilateral agencies (MLAs) such as development banks.

Comparison between Single and Multiple source of Financing

Single source Amount of capital Time Limited Less time consuming Rises with loan amount Loan spreads especially for the projects as there is very high risk of failure present. Complexity (for borrower) 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

Expertise (in case of raising or borrowing company)

Very high end expertise is needed Less expertise needed. eg. sovereign, commercial, and project lending expertise Much higher negotiating power is Lower, as options are less. with the borrower as there is many options available.

Negotiating power (for borrowers)

Negotiating power on price and terms (in case of lenders)

Much higher

Lower

Decisions of quantum

Only one source.

Capacity- pricing tradeoffs for each source is to be determined.

Conflicts of interests & constraints Interest rates Additional costs

Low Usually high Low

High Usually lower High

Advantage of multi-source Financing Strategy

Choice, flexibility and interpool competition: - Multi-source financing strategy is based on the strategy that it will create interpool competition 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 fulfils requirement of borrower 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. No credit rating needed to borrow from commercial banks Advantages Borrowers can draw loan down to match their investment needs No public reporting required, so confidentiality

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)

Islamic Financial Instruments

Islamic financial Institutions operate under Sharias 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 Hallo effect: help sponsors attract financing

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 aluminum)

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 agreement. So customer need to make different covenants for different lenders. In case of Islamic tranche there is a problem between the borrower and lender for the ownership of assets.

Objectives for Financing

There were three main objectives: 1) Alba wanted speedy execution with financial close occurring by the end of 2002. 2) They wanted the lowest possible cost of finance. 3) They wanted to diversify their funding options and to the extent possible, use local funding sources.