Tolstoy famously said “all happy families are alike; each unhappy family is unhappy in its own way.” The same can be said of projects. I’m speaking here of the various hurdles that consortia must overcome before projects can get underway, even before their bid is confirmed.
From beginning to end there are roadblocks and considerations that must be carefully navigated to achieve a successful project financing. These can be anything from unworkable penalties to having to adapt to country-specific rules for project structuring.
Below I go through some of the most important areas where lack of planning or understanding can cause significant setbacks.
Picking teams
The first and arguably most important hurdle to clear is to make sure that you have assembled a consortium capable of winning the project and securing funding. Debt funders and public sector bodies want to see experienced contractors with strong, relevant track records. Contractors also need to have the balance sheet strength to be able to stand behind various contractual commitments.
Establishing early on which entities will perform the various roles and provide the relevant guarantees avoids difficult conversations later on in the process, when there might be less room to manoeuvre.
Unforeseen penalties
Public-Private Partnership (PPP) projects, even more so than other forms of project finance, are exercises in risk allocation. When bidding for these projects, the deal is presented to the bidder typically in an “Invitation to Tender” document which includes an initial draft of the concession agreement which will govern the project. Careful investigation of the draft agreement is key to revealing what roadblocks you may face.
Operis advised on one project where the contingencies in these documents regarding ‘delays’ to the construction timetable actually showed on review that the project wasn’t financeable. There were severe penalties on the project company for being late in delivery, disproportionate to the size of the project and not in line with the market.
This kind of situation presents several roadblocks: the bidder might not be willing to accept any higher liability caps than normal and debt funders might not be comfortable with heightened exposure to missed deadlines or under-performance by contractors, when delivering a few weeks late could cost millions of pounds. That pressure puts the project in a much worse position and creates a situation where project companies can’t service their senior debt.
To get around this the financial model can be used, with input from an experienced technical advisor, to work out an appropriate level of liability for delays and to determine what could feasibly be supported while maintaining a sufficiently creditworthy financing structure. Negotiation would then need to be undertaken to ensure approval by the procuring authority. Throughout this process, it must be kept in mind that there is a chance that competing bidders might be able to accept the risk, but the bidder must always aim to deliver a proposal that all consortium members can support and debt funders can lend against.
Understand the bidding process
For PPP projects, the bidding process varies across jurisdictions. For example, in Ireland we’ve supported several projects on the advisory side where an “authority term sheet” is provided for the financing. This neutralises the effect of the financing at the bid stage so that bidders are evaluated on a financial model that uses the same funding terms and the same interest rate and fees. Bidders can vary the required equity return but otherwise all candidates are bidding on a level financial playing field, evaluated on what they can offer to build and maintain and for how much.
On the financial side, evaluation processes can range from affordability targets (“what’s the best thing we can build and maintain for €X million?”) to relative scoring , where bidders are each given a score based on the overall cost of their proposed solution, which is then combined with a technical score to decide who wins.
Regional differences in procurement don’t necessarily create roadblocks – but understanding them from day one and focussing your strategy so that it delivers an optimal bid for that bid process is key.
Volume risk
In the cases of the recent Irish PPP projects I mentioned, revenue tends to be availability-based: if the build is completed on time (and the facilities are kept available and open for use), how much revenue it will generate is fairly certain. But in other sectors – student accommodation, toll roads, energy projects – debt and equity providers may be required to take volume risk. In the case of student accommodation this comes in the form of demand risk, i.e. the risk that there will be students willing to rent the rooms over the life of the project. These deals are particularly interesting for their super long term nature: generally 50+ year terms, as opposed to the 25 to 30 timescales which are more standard for government-backed projects.
Carrying out due diligence around the demand risk is essential. Student accommodation provides a good example of this. To take everything into account experts in the local property market will need to comment on key issues, including: student-to-bed ratios at the university; the blend of undergraduates and postgraduates (which affects the demand for different types of accommodation); mix of domestic and overseas students; competing accommodation nearby. Analogously, a bidder on a toll road project would need to employ a traffic forecaster and a wind farm developer would work with a technical advisor to get comfort on typical wind speeds and forecast power prices.
Deals involving volume risk are inherently a bit more “interesting” from a revenue perspective because external factors play a larger part in the outcome of the project. The financial model therefore needs to be carefully optimised to deal with a broad range of outcomes – considering a 50-year student housing project, a seemingly small difference in occupancy rates can over time make a large difference to the financial performance of the project company.
I have used PPP projects as examples here but, realistically, the complicating factors above could be encountered in any number of different project finance sectors. It is important to remember that just about any roadblock can be successfully navigated with due diligence and proper use of the financial model. To avoid troublesome delays, it’s worth working closely with your model advisors early in the process to ensure you’ve got a plan to address or evade every bump in the road ahead.
