Tianjin Plastics A case study in international project finance. Brian Hider Brian Kopan Ernest Lew Juan Villa October 8, 2008 Cal State Fullerton, MBA Program

Background Case set in 1996 Chinese economy is growing rapidly Foreign capital needed for infrastructure in China Opportunity to fund power plant project in Tianjin province

TEDA Established in 1984 Planned area of 33 sq. km. Divided in 3 sub-areas Land usage restrictions by government of China Original Land Development Financing: 100% Chinese government Goal: become a modern industrial area which is the biggest in Asia and the best in China

TEDA In 1992, TEDA FDI increased-needed for development New Land Development Financing: combination of China’s government & MNCs. Wholly foreign-owned companies and joint ventures were created to develop of land MNC’s investment in the area has lead to strong economic growth in the TEDA region.

Project Structure: The Players Maple Energy (49% Equity) US Based company, since 1989 Subsidiary of Northern States Utility Power plant projects in four countries Specialize in turnkey projects Tianjin Plastics (46% Equity) Government run factory Specialty is energy intensive extrusion process MOPI (5% Equity) Chinese Ministry of Power Industry Wintel Had Rmb that could not be repatriated

Project Structure: Fundamentals Project life-4 year construction, 20 year operation Operating costs fixed, paid in Rmb 20yr contract for free coal feedstock Selling price of energy guaranteed (Rmb) Profits virtually guaranteed as long as debt, equity and final profit are in Rmb Project financed with 85% debt Forecast shows China requiring 21GW of additional power annually for a decade (150 plants of this size)

Project Finance Definition: the raising of capital to finance an investment project where the capital providers look at the cash flows from the project as the source to: (1) Service their loans (2) Provide the return of equity (3) Provide a return on their investment

Project Finance: Characteristics Separate legal entity Separate from investors and MNC Singular focus of business Predictable cash flows from operations Essential to securing project financing from outside partners Finite project life Cash flows go toward servings its capital structure (debt & equity)

Exchange Rate Outlook Chinese Rmb is expected to weaken relative to the US$ International Fisher Effect (IFE) Higher expected inflation in China In 2000, Bank of China starts to loosen their hold on currency Interest Rate Parity Theory (IRP) Higher interest rates in China vs. US (13% vs. 8%) on near and long term loans. Forecast 5% depreciation

Basic Issues +Exchange Rate risk +Lack of free markets/gov’t controlled +Government restrictions on capital outflows +Two days to make recommendation Important Urgent

Immediate Issues +Chinese gov’t can refuse to fulfill contract +no hedging available +Registered capital (equity investment) can’t leave country Important Urgent

Cause/Effect Unpredictability of project profitability Partially convertible Rmb Lack of hedging options and forecast data Unpredictability of project profitability Political instability Equity repatriation constraints Lack of EX/IM financing help

Decision Criteria Quantitative: Qualitative Highest likely NPV Sensitivity to currency exposure Must have positive NPV Shortest payback period Qualitative Overall company growth strategy in TEDA

NPV and Payback Period Model

Option 1 Maple Energy invests directly with US$ Maple leaves US$ in project and can’t pull them out = lose equity investment. Debt obligations are in US$ and will be exposed to exchange rate risk. Currency Exposures: Firm Profitability Dollar based debt (almost 90% of debt) Profit Magnitude Profits converted to dollars

Option 2 Back-to-Back loans Maple Energy does US$/Rmb loan with another US firm doing business in China, Wintel Currency Exposures: Firm Profitability Dollar based debt (almost 90% of debt) Profit Magnitude Profits converted to dollars

Option 2 (continued) Back-to-Back loans Mechanics: Wintel has generated profits in Rmb (can’t repatriate earnings) Wintel loans Rmb70.018 to Maple for 6 years Maple loans $8.415 to Wintel for 6 years Maple: instead of converting their US$ and making the equity investment IN China, Maple BORROWS the Rmb from Wintel for the equity investment Maple pays loan with Rmb from cash flows Wintel pays loan with US$

Option 3 Have power price paid by Tianjin Plastics indexed to dollar Tianjin has already contracted to purchase most of the power from the plant. This guarantees earnings would maintain their US$ value. Not allowed by MOPI due to concerns over negative impact it might have on their Rmb invested in project. Currency Exposures: Profit Magnitude Profits converted to dollars

Option 4 Finance majority of project in Rmb (borrow locally) Maple would borrow local Rmb. No US$ exposure since Rmb (not US$) are invested in the project. Large exchange rate risk on profit since all profits are in Rmb and must be converted to US$. Currency Exposures: Profit Magnitude Profits converted to dollars

Selected Option Option 2: Back-to-Back loans Loan of Rmb 70.018m Maple Energy (China) Wintel-China (China) Loan of US $8.415m Wintel (USA) Maple Energy (USA)

Selected Option

Questions?