The heat is on in Thailand for contractor Hopewell dubbed Hopeless by some Bangkok cynics as it struggles to complete an ambitious 60km road and rail system amid continued concern about the Hong Kong-based company’s financial health. The job has to be finished by 1998 when Thailand hosts the Asian Games. Five years after the concession was granted, however, the $3.2 billion project is just 20% complete. Running the company is Gordon Wu, who is struggling to juggle government and commercial pressures and to raise money to fund the project.
The Hopewell saga is perhaps an extreme example of Asia’s infrastructure problems but it is by no means an isolated case. The region as a whole is fighting to keep its infrastructure up to speed with economic growth. Although some countries notably Hong Kong and the Philippines seem to have got the hang of project financing, there are plenty of latecomers scrambling up a steep learning curve. The question is whether financing problems and political wrangling will drive their utopian visions off the rails.
The World Bank estimates that between $1.2 trillion and $1.5 trillion will need to be invested in infrastructure during the next decade in the developing east Asian countries alone. That implies 7% of the region’s gdp going towards transport, power, telecommunications and water projects. Others believe the actual figure invested could be nearer half that. “Despite the activity and brainpower,” says one adviser, “when you look at what’s been done, it’s a drop in the ocean.”
The sheer scale of the region’s infrastructure needs means there is an almost bottomless pit of deals for the banks. The biggest spoils, however, will go to those with project finance teams skilled enough to distinguish the good from the bad and capable of perfecting the art of structuring a deal. “The turkeys outweigh the good deals by quite a bit,” says Robin Earle, associate director at Deutsche Morgan Grenfell. “A number of project sponsors have not yet realized that for raising limited-recourse debt finance there is a threshold in terms of security which banks will not go below, however much money is thrown at them.”
Overall the banks are upbeat about infrastructure prospects. “It’s not such a negative story,” says JP Morgan Thailand representative John Crane. “Our perception is that project finance works very well for good projects. There is so much that needs to be financed in Asia. Capital is a scarce resource and it is going to be the weak ones that will have a hard time.”
The different pace of regulatory and economic change has meant that some countries offer more attractive projects than others. “It is probably a misnomer to talk about the Asian market, as each country is in itself a different market,” says Conor McCoole of BZW in Singapore. “The Philippines is now like Indonesia was five years ago, which itself is now like Thailand was five years ago. They will progress to greater and greater creditworthiness.”
The growth of demand for infrastructure projects has thrown doubt on funding capacity. “The consensus is that no-one knows where all that finance is going to come from,” says Crane. “The need is greater than the available finance.” But Simon Moules, head of project finance and syndications at HSBC Investment Bank Asia, believes there is a long way to go before funds are exhausted, particularly as US capital markets are playing an increasingly important role. Export credit agencies have also shifted in the last three years from lending with sovereign and quasi-government backing to taking greater project risk. And more banks are entering the field, forcing increasingly aggressive pricing of deals.
Public to private
Some observers, though, reckon there’s an element of hot air in the business. “There is a great deal of talk and a lot of money but not much activity,” says a long-term specialist. “The fundamental issues which host governments need to address are policy issues the trade-offs of getting private-sector participation involved in projects which have a very great social and economic benefit. It has to do with expectations. The governments cannot expect a free lunch, they must compromise.”
The gap between state and private-sector expectations is a central issue exacerbated by political culture in many trade-based economies where long-term issues are neglected. The political environment is different in every country but in Thailand, for example, infrastructure projects that may take years to put together are suffering because of a lack of continuity. “You cannot build a subway in two years, and there haven’t been many governments that have lasted longer than that in Thailand,” says a Bangkok-based banker. Nevertheless the opportunities are there and governments cannot, or will not, use public money to fund projects in future. “Rapid economic growth has seen infrastructure growth lag behind,” says Moules. “There is a clear need for these facilities and a clear recognition that it is not the role of governments to fund these projects any more.”
With private funding now the favoured path, a well-developed legal and regulatory framework would be the ideal. But this is lacking in most countries. Advisers are therefore having to become more inventive in order to tackle the issues and get the deals done. “Because of the lack of a clear regulatory framework or government intervention,” says Moules, “there are some projects which are fundamentally economically sound but never come to fruition.” Toll roads and railways are classic examples of projects financiers want to be sure are going to be free from government interference. “Banks are only going to lend to projects where they are confident about cashflows,” says Crane. “The key to effective project finance is structure, and it is made much easier if the sponsors are strong and we can approach the market with a name that is known, even if there is no recourse.”
Political risk
The reliability of sponsors is a problem for many Bangkok financiers. Here the government and private sector are still battling over the capital’s chronic traffic problems with the saga of Gordon Wu’s road and rail scheme grinding on. The Hopewell project was always doomed to become bogged down, because it was too complicated and a proper feasibility study was never conducted. In addition, though, the problems in Bangkok are an extreme example of one of project finance’s biggest headaches: politics.
Despite initial concern at the outcome of November’s general election in Thailand some bankers are beginning to develop more confidence in Thailand’s new government. Jonathan Price, senior executive director with the merchant banking arm of Siam City Bank, expects to see “enormous progress” in 1997 following a year of “talk and no action”. This period of procrastination was in large part a result of the political machinations of the Banharn Silpa-archa government which was replaced by another coalition headed by Chavalit Yongchaiyudh. With a high-speed rail link and a new airport proposed, the situation now looks more promising. “This government seems much more dynamic than the last,” says Price, “and providing they don’t get into factional in-fighting things should move ahead.” But just a few days after Price’s remark, his optimism was put to the test when the prime minister announced that he might relocate the proposed airport.
The way the Don Muang Tollway project was executed also reinforced the cynical views of Bangkok’s attempts to solve its traffic problems. The company that built it successfully argued for the demolition of flyovers on the route, insisting that it would force traffic to use the tollway, thereby increasing its profitability. But it was proved wrong, mainly because of the relatively efficient and toll-free road running underneath it. “The foreign bankers have been extraordinarily over-tolerant,” says Price.” They have let [the company] get away with murder because they thought there would be a government bail-out.” But state intervention looks an increasingly unlikely prospect. The only alternative is for the banks, led by Commerzbank, to get tough and insist on a proper appraisal and an effective rescheduling.
Price will remember 1996 as the year in which the BTSC light-railway project got under way in Bangkok, despite the “clever trick” that has enabled the company to sign an $80 million loan agreement with an “effective date” clause which means the deal is not yet entirely finalized. The light rail system is being developed by Thai construction company Tanayong but wrangles over acquiring land for a depot have delayed completion. The project’s financing also verged on collapse: financiers were not convinced by the economics of the project in terms of cashflow and capital structure. But now it is scheduled for listing on the Stock Exchange of Thailand in the second quarter.
As the pollution and jams continue, Thailand’s success story for 1996 was its independent power project (IPP) bidding in which the Electricity Generating Authority (Egat) negotiated some “particularly reasonable rates” with the four successful bidders, said company sources. It is now “full steam ahead” for construction. The bids were perhaps too successful and Egat is now curtailing the programme following more than 18 proposals, saying it does not want any more gas-fired projects.
Egat is planning to float three power-plant subsidiaries, but some commentators doubt there is sufficient investor demand to soak up all the new issues due this year when the IPP projects are also expected to be seeking capital. Each of Egat’s three spin-offs is estimated to have a market capitalization of $4 billion, with Egat planning to retain a minority position in each. Thus a minimum of $6 billion will hit the market next year from that source alone. Moreover they are not outstandingly attractive investments because their quasi-utilities status means they have limited growth potential.
Lehman Brothers is Egat’s overall adviser on the sales. A different adviser is appointed to the individual companies each of which will be centred on one of three core power plants Bang Pakong, Mae Moh and Ratchaburi. The advisers are Lehman, Kleinwort Benson and local bank Finance One. “There will be a lot of squabbling over who goes to the market first,” says a Bangbok-based banker. He considers that limited investor demand may mean that being first in the queue to list will be crucial to success.
The banker is also sceptical of the motives of some advisers to projects in general where houses have strong equity underwriting capabilities and are thus blinkered to the alternative of further direct strategic sell-offs.
Excess returns have now been squeezed out and banks are looking to other markets and sectors to improve their margins. That is proving harder to achieve, however, as new players enter the arena and deals get more and more aggressive. Among the more exotic markets although not for the faint-hearted are the countries of Indochina. Attention is also turning towards China, Indonesia and Mongolia which have been the subject of World Bank studies.
Dams have been high-profile projects in these areas although they have been held up by environmental considerations in Laos, Malaysia and China. In China, the State Development Bank of China has unveiled plans to issue $300 million of notes in the US to help fund the Three Gorges Dam. In Laos, a number of hydroelectric projects are in the works, including the controversial Nam Theun II dam, which has been stalled amid World Bank calls for further environmental impact studies, and a 600MW lignite-fired power station joint venture with Thailand. The twist in Laos is that the deals depend almost entirely on cross-border offtake agreements with power-hungry Thailand. Hence the risk is considered to be Thailand’s rather than Laos’s.
Vietnam is focusing on ports and is seen as a market with high potential in project finance though few projects have yet been completed. In Malaysia and Indonesia, transport has been a major focus as road building grows on a large scale. Malaysia is committed to having its entire transport system run by the private sector by 2000 and plans to build almost 16,000km of new roads in the next five years. The country is also leading the way in a new trend towards intra-Asia deal flow, in which Asian contractors are now competing directly in the infrastructure market once dominated by the multinationals.
Indonesia’s political risk element does not seem to have bothered bankers unduly. “People haven’t been as concerned about the slightly unstable political situation as one would expect,” says Lucinda Fletcher-Neal, associate director at BZW. Her Singapore-based colleague McCoole highlights the Seng Kang deal as a significant landmark because it is an integrated project. The project started with the development of a gas field in a remote location that was not big enough to justify a liquified natural gas plant, so the financing of an IPP and the gas field were combined. McCoole thinks there may be more such deals, particularly in Indonesia but also in the Philippines. “Banks continue to believe everything is okay until something goes wrong,” he says. “Unless there is shockingly bad news they won’t react. The currency hasn’t depreciated any more than usual; the economy is very strong in terms of balance of payments, although the foreign debt is alarmingly high, and the outlook is positive for the country rating.”
Hong Kong is at the other end of the spectrum to problematic countries such as Thailand. Its infrastructure formula is tried and tested and it has developed a deep local market for project finance. If a project is economically sound it is likely to be successfully completed. The territory is now at the forefront of the use of equity finance, the latest development. This has begun to catch on as projects are completed and financiers look for an exit. Among recent Hong Kong infrastructure spin-offs that were oversubscribed was New World Infrastructure.
The People’s Republic of China (PRC) has a long way to go compared with the perfected techniques of Hong Kong. All eyes are on it as the barriers start to come down. Fletcher-Neal pointed to the Laibin B project in Guangxi, China’s pilot build operate transfer (BOT) project and the State Planning Commission’s (SPC) model for future power and infrastructure deals.
Opportunities in China
The Laibin B deal has startled banks into action and there are now another two or three power projects in the pipeline as draft BOT rules that have been under discussion for the last couple of years look like being finalized soon. China has been a late entrant and has drawn conclusions from what other countries have done when formulating its regulations. The Laibin project has been put forward as the model before the passing of the BOT laws. A formal international tender for sponsors attracted some 14 consortiums, of which around half finally made bids. Fletcher-Neal says the process, China’s first international tender, was considered fair and transparent. It is due to be closed in May and has the added interest of risk being taken by a province, Guangxi, without a central government guarantee. This means export credit agencies are taking provincial risk for the first time.
So far there has been very little limited-recourse finance in the PRC. The Da Chang water-treatment project was perhaps one of the first, with Shanghai province taking on risk, and international banks providing 70% of the $75 million cost for the BOT project undertaken by UK companies Bovis and Thames Water. “Provided there is a constant political climate, China should really start to open up,” says Fletcher-Neal. “We’ve heard this before and then there was Tiananmen so everyone puts the brakes on. But the consensus now is that this really could be the start of the market and the huge potential could begin to happen.”
The World Bank estimates that around half east Asia’s total infrastructure finance requirements will be in China. HSBC recently completed the $1.22 billion Zhuhai power project, which took three years of advisory work before it saw the light of day. The twin 700MW coal-fired station was funded through a $670 million limited-recourse facility, 60% from the Export-Import Bank of Japan and 40% guaranteed by the Japanese ministry of international trade and industry. A further $126 million came from a syndicated loan. The remainder was financed through $366 million of equity and a $58 million equivalent renminbi loan facility.
HSBC heralded the deal as a breakthrough: the first time the Japanese participants had lent into China on a limited-recourse basis. It was also the largest deal in the PRC without guarantees supporting the obligations of the power purchaser. The project is 55% Chinese-owned and 45% foreign-owned, with a Mitsubishi-led consortium as contractor. The non-convertibility of the renminbi is a serious handicap, along with uncertainty about being able to reset future tariffs. But the problems are not insurmountable, although the solutions are often difficult and time-consuming. “US investors simply haven’t been interested in China until now,” says Fletcher-Neal. According to Earle, it is such a vast country it could turn out a decent BOT every four months. “People shouldn’t underestimate China, but it’s not an easy market.”
While China is just beginning power project finance deals, they are well established in the Philippines. It has one of the clearest sets of regulations for infrastructure deals and is now moving on to privatize water supply. But the Philippines government is now starting to feel that it perhaps offered more sweeteners in BOT deals than other countries have been willing to do. At the time, the Philippines had a critical need for power and now it does not. It is a continuum, not a static situation, and to continue you need a framework that is flexible; “sort of amoeba-like”, another banker says.
Although there are now a large number of banks in the market, McCoole believes rationalization is still a few years away. One example of the new flexibility prompted by increased competition is the First Gas Holdings deal in the Philippines which McCoole believes will attract very aggressive terms and conditions and lead to 15-year financing. In Thailand, local banks have already proved willing to go out to 17 years on IPPs. First Gas is a joint venture between British Gas and First Philippine Holdings which will construct a 400MW combined-cycle power plant.
Domestic obstacles
The massive IPP project in Taiwan is the prime example of how not to finance power projects. Bids were invited on the basis of bettering Taipower’s own cost of generation. It was a very domestic affair without the benefit of international advice. Many of the bidders had never been heard of before and had no experience in the power industry. “There were some very peculiar companies in there,” says one analyst. Many companies approached the tender by continuing to bid lower until they won the deal, only later thinking through construction and funding costs. This aggressive pricing meant the power-purchase agreements were not feasible on a limited-recourse basis and international banks were not prepared to take on the risk. About the only bidder likely to succeed was the massive Formosa Plastics, which had a major advantage over many of the others because of its extremely healthy balance sheet.
South Korea, which is currently drawing up a private finance bill, has similar problems with bringing in foreign money and expertise. People are watching with interest to see whether foreign participation will be welcomed. “There are some extremely powerful and influential companies in South Korea,” says Earle. “Even if the regulatory environment welcomed foreigners with open arms, it would be very difficult to beat them on their own ground. If you can’t beat ’em, join ’em.”
As a factor in its success, the sector involved is as important as the country a project is being carried out in. Transport is the largest sector on Asia’s project finance wish-list. There is almost a “been there, done that” attitude to power projects in some places. Water projects are the up-and-coming sector, being led by the privatization of the Metropolitan Manila Water & Sewerage System (MWSS) in the Philippines. Although power deals have been perfected, transport deals have been less successful. “Transport deals are very difficult, especially when started from a very low base. People are looking for certainty.”
The hardest deals to put together, however, are telecommunications projects. JP Morgan executed what Crane believes was the first non-recourse project finance deal for the sector when PT MitraGlobal won one of five regional concessions in Indonesia. “It’s not a project finance-friendly type of industry but we got it done through creative structuring and the strength of the sponsors,” Crane says.
Asia-wide the broad picture is one of a stampede of bankers, fuelled by renewed Japanese interest, chasing Asia’s prime deals. The less promising projects are sifted out, some filtering down to less well recognized banks and others never seeing the light of day. The good deals are hotly contested and pricing is driven down as a result. Narrowing spreads and lower fees are established.
There is enormous competition for the better deals but for the less commercial ones firms are finding it harder to attract non-recourse finance. “It probably shouldn’t be surprising,” says McCoole, “but there are still a lot of deals getting done and these are becoming more and more aggressive in terms and conditions as there are so many banks willing to do deals.”
Amid all the talk, the structures and the risks, perhaps the most fundamental problem with project finance in Asia is the huge leap of faith required by banks in a market which may operate in very different ways. “Project finance is a western concept,” points out one analyst. “Non-recourse deals are effectively advance dispute resolution.” The basis of the contracts is drawn around western legal and regulatory frameworks and other factors that simply may not be relevant in Asia.
