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Abstract: This paper looks at competitive interactions between Airbus and Boeing in very large aircraft. It concludes that Boeing attempted to preempt Airbus in introducing a new product in this space but failed to do so because of the incredibility, given the assumption of value maximization, of self-cannibalization. A theoretical model is used to illustrate this credibility constraint, and an assortment of evidence-involving pro forma financial valuations, product market data (on prices and quantities), capital market reactions to key events, and qualitative information on Boeing's organizational structure and recent changes to it-is assembled to support the hypothesis that the constraint on self-cannibalization ultimately proved decisive.
Preemption, Airlines, Valuation, Entry, Game Theory
Abstract: This paper examines the relation between legal risk - defined as the strength and enforcement of creditors' rights - and debt ownership concentration to understand the various governance roles played by banks as large creditors. Using a sample of 495 project finance loan tranches (worth $151 billion) to borrowers in 61 different countries, we document high absolute levels of debt ownership concentration: the largest single bank holds 20.3% while the top five banks collectively hold 61.2% of a typical loan tranche. We also show that syndicates in countries with weak creditor rights and poor legal enforcement are larger and more diffuse. Based on this finding, we conclude that lenders structure loan syndicates to facilitate monitoring and low-cost re-contracting in countries where creditors have strong and enforceable legal rights. In contrast, lenders attempt to deter strategic defaults by creating larger and more diffuse syndicates when they cannot resort to legal enforcement mechanisms to protect their claims.
creditor rights, international corporate governance, bank lending, project finance, syndication
Abstract: This paper examines how legal risk, defined as the strength of creditor rights and legal enforcement, affects debt ownership concentration in the project finance loan market. Using a sample of 495 project finance loan tranches from 61 countries, worth $151 billion, we document high levels of debt ownership concentration: the largest single bank holds 20.3% while the top five banks collectively hold 61.2% of a typical project finance loan tranche. We also show that weak creditor rights and poor legal enforcement are associated with more diffuse ownership structures, which leads us to conclude that international project finance lenders structure syndicates to deter strategic default rather than to enhance monitoring incentives or facilitate low-cost re-contracting in the event of default. On a more theoretical level, the results illustrate the continuous nature of debt ownership and refute the overly simplistic distinction between single bank creditors and atomistic public bondholders commonly described in the literature. Key words: bank lending, project finance, syndication, international corporate governance, creditor rights, legal rules and enforcement
Abstract: This paper analyzes how different legal and financial systems affect the composition of loan syndicates, and how the composition, in turn, affects loan pricing. In contrast with previous work on the availability and allocation of external finance, I study the supply of long-term funds to large, illiquid project companies located in 61 countries. Using a sample of 495 loan tranches worth $151 billion, I find that foreign banks provide a greater share of total funds in countries with stronger creditor rights, stronger legal enforcement, less-developed financial systems, and less government ownership of banking assets. I also find that loan spreads and fees are positively related to the fraction of total funds provided by foreign banks. These findings show that both legal and financial systems affect the availability of funds, the pricing of funds, and, presumably, capital investment decisions and economic growth.
Creditor rights, legal origin, project finance, bank loan, economic development
Abstract: CalFed Bancorp is one of 126 S&Ls suing the U.S. government for breach of contract related to supervisory goodwill, a form of goodwill created by the acquisition of insolvent thrifts during the early 1980s. Before a determination of damages in its lawsuit, CalFed announced and issued a litigation participation security giving shareholders a proportional claim on recovered damages, if any. This announcement generated a positive excess return in part because it made CalFed a more likely acquisition target. This security also reveals important, yet previously unavailable, information about CalFed's lawsuit: its price reveals a market-based estimate of damages while its beta provides information about expected returns and the time until payoff. In a broader context, this security highlights acquisition facilitation as a benefit of issuing targeted stock as well as a series of lawsuits that will set important precedents regarding the determination of liability and the estimation of damages in breach of contract cases.
Savings and loans, targeted stock, valuation, litigation, goodwill
Abstract: Despite the fact that more than $200 billion of capital investment was financed through project companies in 2001, an amount that grew at a compound annual rate of almost 20% during the 1990s, there has been very little academic research on project finance. The purpose of this article is to explain why project finance in general and why large projects in particular merit separate academic research and instruction. In short, there are significant opportunities to study the relationship among structural attributes (i.e., high leverage, contractual details, and concentrated equity ownership), managerial incentives, and asset values, as well as improve current practice in this rapidly growing field of finance.
Abstract: SUBJECT AREAS: project finance, infrastructure finance, financing, capital investment This note provides an introduction to the fields of project finance and infrastructure finance, as well as a statistical overview of project-financed investments over the last five years - it is the fourth note in a biannual series dating back to 2000 but the first one to cover infrastructure finance. Examples of project-financed investments include the $4 billion Chad-Cameroon pipeline, $6 billion Iridium global satellite telecommunications system, 900 million A2 Toll Road in Poland, $1.4 billion Mozal aluminum smelter in Mozambique, and $20 billion Sakhalin II gas field in Russia. Globally, firms financed $328 billion of capital expenditures using project finance in 2006, up from $217 billion in 2001. Despite a few setbacks (e.g., in 1998 due to the Asian crisis and in 2002 due to crises in the U.S. power and telecommunications industries), the use of project finance has grown at a compound rate of 13% over the past 10 years. The note begins by defining project finance and contrasting it with other well-known financing mechanisms such as asset-back securities and secured debt. The next section describes the evolution of project finance from its origins in the natural resources industry in the 1970s to the U.S. power industry in the 1980s, to a much wider range of industrial applications and geographic settings in the 1990s, and most recently to infrastructure finance (e.g., Public-Private Partnerships, 3P) in the 2000s. The third section provides a statistical overview of the project-financed investment over the last five years (2002-2006). It covers a variety of institutional details at the industry, project, and participant level. For example, it presents data on the average size of projects ($435 million) and their capitalization (71% debt-to-total capital) as well as league tables for project loans, project bonds, and advisory work. The final section discusses current and likely future trends including the rise of infrastructure finance, the increase in project re-negotiation and expropriation, and the evolution of financing sources and structures. This note can be used by itself to explain project finance or in conjunction with specific cases on project finance.
Abstract: SUBJECT AREAS: project finance, business ethics, sustainable development, environmental and social risk, bank lending, regulation On June 4, 2003, ten leading banks announced a new voluntary framework to guide project finance lending decisions called the Equator Principles. In the years leading up to the announcement, non-governmental organizations (NGOs) and other civil society organizations (CSOs) had begun targeting sponsoring firms and, more recently, private commercial banks in high-profile campaigns. NGOs wanted the financiers of large projects to take legal and moral responsibility for the social and environmental damage caused by projects they financed. While the banks presented the Equator Principles as a major step toward sustainable development, they were quickly attacked by many NGOs which argued the Principles were incomplete, if not flawed. Given the criticism, the Equator banks had to decide what to do: should they encourage other banks and export credit agencies (ECAs) to adopt the Principles, focus on implementation, or respond to the criticism directly? Although this case was written for a course on project finance, it is appropriate for a variety of courses including business ethics, general management, risk management, financial institutions, and environmental economics. Depending on the nature of the course, instructors can tailor this teaching plan to meet the following pedagogical objectives. First, the case illustrates a private-sector attempt to promote sustainable development. Students must assess whether the Equator Principles will help mitigate environmental and, to a lesser extent, social risks in project-financed deals. Relatedly, the case highlights the challenges of being a pioneer in setting standards. Second, the case examines a set of voluntary standards for environmental and social accountability. Students must decide how effective the Principles are likely to be, and what can be done to make them more effective (i.e., how much and what kind of disclosure is needed for the standards to work? what kinds of enforcement mechanisms, if any, are needed? etc.) Third, the case highlights the importance of uniformity and consistency when establishing industry-based regulations. Failure to ensure widespread adoption could result in a race to the bottom among financial institutions in their willingness to finance environmentally harmful deals. Finally, students assume the role of bankers and analyze the likely effectiveness of a financing strategy designed to minimize reputation and termination risks. Will the Principles reduce the probability that a blocking coalition of stakeholders (e.g., NGOs, political opponents, CSOs, etc.) will delay or stop a project? Beyond these immediate issues looms the much larger issue of how history will judge the actions taken by the Equator Banks. Will the Principles be seen as a bold step towards achieving sustainable development, a negligible step with little long-term impact, or simply a public relations stunt? In addition to the case, there is a technical note entitled, An Overview of Project Finance - 2004 Update, that provides background information on project finance and describes some of the institutional details of this rapidly growing field of finance.
Abstract: SUBJECT AREAS: project finance, capital investment This note provides an introduction to the field of project finance and a statistical overview of project-financed investments over the last five years. Examples of project-financed investments include the $4 billion Chad-Cameroon pipeline, $6 billion Iridium global satellite telecommunications system, Euro 900 million A2 Toll Road in Poland, and the $1.4 billion Mozal aluminum smelter in Mozambique. Globally, firms financed $234 billion of capital expenditures using project finance in 2004, up from $172 billion in 2003. Despite a few setbacks (e.g., in 1998 due to the Asian crisis and in 2002 due to crises in the U.S. power and telecommunications industries), the use of project finance has grown at a compound rate of almost 20% over the past 10 years. The note begins by defining project finance and contrasting it with other well-known financing mechanisms such as asset-back securities and secured debt. The next section describes the evolution of project finance from its origins in the natural resources industry in the 1970s to the U.S. power industry in the 1980s and to a much wider range of industrial applications and geographic settings in the 1990s and 2000s. The third section provides a statistical overview of the project-financed investment over the last five years (2000-2004). It covers a variety of institutional details at the industry, project, and participant level. For example, it presents data on the average size of projects ($400 million) and their capitalization (69% debt-to-total capital) as well as league tables for project loans, project bonds, and advisory work. The final section discusses current and likely future trends. This note can be used by itself to explain project finance or in conjunction with specific cases on project finance.
Abstract: SUBJECT AREAS: project finance, corporate (and project) governance, organizational structure, capital investment, telecommunications industry In late September 1999, representatives from Telstra, Japan Telecom, and Teleglobe met to discuss the structure of the Australia-Japan Cable (AJC) project, a $520 million submarine cable system that would run from Australia to Japan. The sponsors, excited by the possibility of large returns, needed to move quickly to capitalize on the projected shortfall in Australia's broadband capacity. As telecommunications carriers, the sponsors needed additional capacity to serve their retail and wholesale customers. As cable system owners, they wanted to earn an appropriate return on their invested capital while mitigating ownership risks. The need to move quickly in the face of significant demand, competitive, and technological uncertainty made it particularly risky to invest at this time. The case asks students to create an optimal governance structure for the AJC project. As part of this task, they must identify the factors that could prevent capital providers from earning an appropriate risk-adjusted return on their investment. They must then design an optimal governance structure to mitigate these risks to the extent possible. For example, they must decide whether to include additional equity investors (sponsors) and if so, which firms. Students must then determine the size and composition of the project's board of directors. Finally, they must design a compensation package that encourages senior managers to maximize shareholder value. In addition to these equity concerns, they must assess the project's target debt-to-total capitalization ratio of 85% and the decision to pre-sell a large amount of system capacity. This case was written for a course on project finance, but is appropriate for courses on competitive strategy, corporate governance, international finance, and general management. It illustrates one of the primary reasons to use project finance: it allows firms to create a governance structure that mitigates costly agency conflicts inherent in particular greenfield assets with dedicated uses. One of the major conflicts is over the use of "free cash flow" (Jensen, 1986) - the project structure is explicitly designed to prevent inefficient re-investment and expropriation of quasi-rents. The case offers an effective way to teach corporate governance by contrasting the unique structural features of project companies with the features found in most corporations. Second, it prevents a framework to help identify which assets are the most appropriate for project finance. And third, it documents a set of stylized facts - institutional details such as leverage ratios, equity and debt ownership structures, board structures, and management compensation - about project companies. For this reason, the case serves as a very good introduction to the field of project finance. Finally, there is a technical note entitled, "An Overview of Project Finance - 2002 Update," that accompanies this case which provides additional institutional details.
Abstract: SUBJECT AREAS: business ethics, project finance, international investment, emerging markets, capital investment Despite persistent opposition from various nonÂgovernmental organizations (NGOs), the World Bank Group's (WBG) board of directors was planning to vote on whether its affiliate organization, the Multilateral Investment Guarantee Agency (MIGA), would approve a $250 million loan guarantee for the Bujagali Dam project. Without the loan guarantee, the project company, AES Nile Power (AESNP), would not be able to raise the capital needed to finance the $582 million hydropower project located on Uganda's Nile River. International Rivers Network (IRN), a U.S.-Âbased environmental NGO had been campaigning for over three years to stop the project because it felt the project economics unreasonably favored the sponsors, the project entailed significant environmental and social risks, and the investment process set a bad precedent for private investment in Africa. IRN, in conjunction with local NGOs, had delayed but not stopped the project. As of early June 2002, IRN campaigners wondered what else they could do to improve the terms of the deal for local citizens, enhance the debate about the investment process and the environmental impact, or stop the project. This case is appropriate for courses on international finance, business ethics, economic development, general management, and negotiations. It is written from the perspective of an NGO and can be used to: 1) Illustrate the potential impact large infrastructure projects can have on host nations across a wide range of dimensions (e.g., financial, social, environmental, etc.). 2) Analyze the roles and responsibilities of various parties in developing socially, environmentally, and economically responsible projects. Which party has (or parties have) the responsibility for protecting the interests and economic well being of local citizens? 3) Understand the roles played by NGOs. To what extent do NGOs, especially foreign-based NGOs, have legitimacy (do they have the right to critique a domestic project that may provide badly needed services such as power)? 4) Show how infrastructure investments can be viewed as development options - the opportunity cost of overinvestment can be very substantial. 5) Question whether large infrastructure projects with private participation should proceed under different rules and procedures from public-sector projects (i.e., should there be equal or greater transparency, additional reviews and assessments, incremental disclosures, etc.).
Abstract: SUBJECT AREAS: project finance, course overview, corporate finance, teaching Large-Scale Investment (LSI) is a case-based course about project finance that is designed for second-year MBA students. Project finance involves the creation of a legally independent project company financed with nonrecourse debt for the purpose of investing in a single purpose industrial asset. In 2001, firms financed almost $220 billion worth of capital expenditures through project companies, an amount that has grown and will continue to grow rapidly in the years ahead. As the name implies, the course focuses primarily on large projects those costing $500 million or more because they provide a clear window on how managers make important structural decisions and how those decisions, in turn, affect firm value and performance. At the same time, large projects often encounter financial distress witness EuroTunnel, EuroDisney, Dabhol, and Iridium, yet are critical to economic growth and prosperity in both developed and developing markets. The central theme of the course is that structure matters, which stands in sharp contrast to the neoclassical view of the firm as a black box production function and the assumption underlying Modigliani and Miller's first irrelevance proposition that financing and investment are separable and independent activities. Through this course, students learn how structure affects managerial incentives to create value and manage risk. Ultimately, students learn how to increase value through both investment and financing choices. Project companies provide a particularly powerful laboratory in which to study the determinants and implications of various structural attributes because they are, as newly created companies, less influenced by the vagaries of history. Moreover, the size of the investments (75% of projects cost more than $100 million) and the time it takes to structure them (one to five years) ensures that managers have the opportunity and the economic incentive to make careful, value enhancing structural decisions. Finally, as standalone entities, it is easier to observe the structural choices and outcomes. The intellectual challenge for students is to understand how financial structure affects managerial incentives and project value. A thorough understanding of these relationships, however, requires advanced finance theories. For this reason, the course introduces more advanced theories of capital structure, corporate governance, and risk management as well as more advanced valuation and credit assessment tools. This note describes the course's key themes, structure, and content. It is designed for educators interested in teaching a course on project finance. Although several business schools now have project finance courses (Columbia, HBS, Kellogg, LBS, NYU, etc.), the field is still relatively new and much of the pedagogical material has only recently become available. Instead of creating a new project finance course, the material described in this note can also be used to create a module in an existing course on corporate finance, international finance, or financial institutions. Alternatively, it can be used to create courses on emerging market corporate finance, risk management, and energy finance. In summary, the material is quite flexible and has broad applications across many academic disciplines. Given the pedagogical nature of this note, it is only available to academic instructors.
Abstract: SUBJECT AREAS: project finance, capital standards, bank regulation, risk management CASE SETTING: August 2002, banking industry, Basel Capital Accord In June 1999, the Basel Committee on Banking Supervision (part of the Bank for International Settlements) announced plans to revise the capital adequacy standards for international banks. As part of the new proposal, known as Basel II (the 1988 Accord is known as Basel I), the Basel Committee asserted that project finance loans were significantly riskier than unsecured corporate loans and, therefore, warranted higher capital charges. The Committee admitted, however, that their assertion was based on qualitative factors and that the industry lacked sufficient historical data to conclude otherwise. Bankers, fearing that higher capital charges would seriously damage project lending by lowering profits, curtailing lending to developing countries, and driving business to non-bank competitors not subject to the same capital standards, formed a consortium to study the actual default and loss characteristics of their combined portfolios of project loans. The study showed that project loans had lower probabilities of default and higher recovery rates than corporate loans; in other words, project loans are not riskier than corporate loans. Armed with the results, the consortium sent a letter to the Basel Committee in August 2002 trying to convince them to lower the proposed capital charges on project finance loans. This case challenges students to examine the new capital Accord, understand the differences between project and corporate loans, and critique the statistical analysis and the arguments advanced by the consortium to support its position. Students, acting as bankers, must present the data and try to convince other students, acting as Basel Committee members, to change the proposed capital standards on project finance loans. The case not only presents entirely new data on the performance of project loans, it also describes the regulation of bank capital and the process of setting new capital standards. Even though the case focuses on project finance loans in particular, the issues are broadly applicable across the banking industry making this case appropriate for courses on project finance, financial institutions, and risk management.
Abstract: SUBJECT AREAS: project finance, emerging markets, risk management, CASE SETTING: March 1999, petroleum industry, $4 billion investment Following the BP Amoco (hereafter "BPA") merger in December 1998, the new CFO, David Watson, asked Bill Young to create a policy statement recommending when the firm should use project finance instead of corporate finance for new capital investments. Young and his team created a new policy statement recommending that BPA always use corporate finance with three exceptions: mega projects, projects in politically volatile areas, and joint ventures (JV's) with heterogeneous partners. Essentially project finance would be a tool for managing project risk. In the A case, students must assess the economic rationale for the policy and the exceptions. The B case presents an interesting natural experiment involving two firms from the same industry financing the same asset in two different ways. Prior to their merger, BP and Amoco joined the Azerbaijan International Oil Consortium (AIOC), an 11-firm consortium that was developing oil fields in the Caspian Sea at a cost of $10 billion. As of March 1999, AIOC had completed the $1.9 billion Early Oil Project. BP used internal corporate funds to finance its share of the project while Amoco was one of five AIOC partners that raised $400 million of project finance. The managers in BPA's newly merged Finance Group must reassess the Early Oil financing strategy in light of the new policy statement and determine the best way to finance its share of the remaining $8 billion Full Field Development Project. Should it use corporate finance, project finance, or a combination of the two? While these cases were written for a course on project finance, they make an effective introduction to the field of project finance for advanced corporate finance, international finance, or emerging markets courses. The cases have four pedagogical objectives. First, the cases describe what project finance is and why it creates value-project finance reduces the net cost of financing certain assets. For BP Amoco, separate incorporation for investment purposes (project finance) reduces expected distress costs. For other firms in the consortium, project finance allows them to raise capital when they otherwise could not (it solves a debt overhang problem). Second, in conjunction with the teaching note, the cases present a framework based on portfolio theory that explains why large, risky, tangible assets are the best candidates for project finance. Third, the B case not only gives students an opportunity to apply the new policy statement in a real investment decision, it also illustrates the benefits of staged investment and multi-lateral support. Finally, the cases build appreciation for the complexity of merger integration, particularly horizontal mergers between former competitors.
Abstract: SUBJECT AREAS: project finance, emerging markets, business-government relations, business ethics, risk/return evaluation CASE SETTING: June 2000, petroleum industry, $4 billion investment On June 6th 2000, the World Bank's and International Finance Corporation's (IFC) Boards of Directors were scheduled vote on whether to approve funding for the $4 billion Chad-Cameroon Petroleum Development and Pipeline project. Although the project presented a unique opportunity to alleviate poverty in Chad, one of the poorest countries in the world, Chad had a President who had been described as a "warlord," and a history of civil war and oppression. One of the most contentious issues, however, was how this President would handle his newfound wealth - the project would increase Chad's annual government revenues by more than 50% (up to $125 million per year). To address this issue, the Bank Group had proposed a novel Revenue Management Plan (RMP) that would isolate Chad's project revenues and target them for poverty reduction programs. Whether this plan would work and what would happen if it did not were two questions that had to be resolved before the Directors could approve the deal. The A case describes the project, the setting, and the Revenue Management Plan. It includes a discussion of the World Bank Group's reasons for participating in the deal - mainly an opportunity to alleviate poverty, enforce environmental standards, and minimize the impact on indigenous people. The case also describes the very public, and very ardent opposition to the project's environmental, social, and revenue management policies. Faced with a high-risk, but potentially high-return opportunity to improve conditions in Chad, students, as Directors, must decide whether to approve funding for the deal. The B case, set in January 2001 after Chadian President Deby spent part of a signing bonus on weapons to quell rebellions, forces students to reconsider their decisions as directors and project sponsors. While this case was written for a course on project finance, it is appropriate for a wide variety of courses ranging from international finance to business-government relations to business ethics. The case illustrates not only the complexity of negotiating very large deals between public and private entities, but also the opportunity inherent in large-scale investment. Students must assess whether the benefits received by the host countries are commensurate with the risks they bear. This discussion raises critical ethical and moral issues related to investment in development countries: How do you decide what is an appropriate trade-off between project risk (environmental, social, and, in this case, political) and expected social returns (economic development)? With regard to project finance, the case illustrates the difference between project and corporate finance, and shows that risk sharing and risk mitigation are two motivations for using project finance.
Abstract: SUBJECT AREAS: project finance, electric power, deregulation, financial and corporate strategy, organizational structure CASE SETTING: May 1999, California, US Electric Utilities, $6B investment In early 1999, Calpine Corporation's CEO Pete Cartwright adopted an aggressive growth strategy with the goal of increasing the company's aggregate generating capacity from approximately 3,000 to 15,000 megawatts (MW) by 2004. He changed the strategy because he believed there was a fleeting opportunity to re-power America given the inefficiency and age of current generating capacity as well as the recently-granted ability to compete in wholesale power markets. To achieve the new goal, Calpine will have to build or acquire as many as 25 power plants at a total cost of $6 billion (approximately $500,000 per 1000MW). For a company with assets of $1.7 billion, a sub-investment grade debt rating, a debt-to-capitalization ratio of 79%, and an after-tax cash flow of $143 million in 1998, raising this much money would be a formidable challenge. The case opens with Calpine's finance team trying to decide how to finance four power plants currently under development. Should they use project finance, corporate finance, or a new hybrid structure with elements of both? Knowing the importance of speed, feasibility, and efficiency, SVP Bob Kelly and VP Rohn Crabtree must select a financial strategy that not only supports the company's high-growth competitive strategy, but also maximizes firm value. This case describes what project finance is, how it differs from corporate finance, and why firms use it to finance capital investments. While the case illustrates two benefits of using project finance - it encourages investment by solving the debt overhang problem and increases value from interest tax shields, it also illustrates the disadvantages of using project finance: it is time consuming and costly to arrange, and very rigid once in place. The case also illustrates the profit opportunities in the US power industry created by changes in technology and regulation, and the importance of adapting a company's financial strategy to support a new, high-growth competitive strategy designed to capture these fleeting profit opportunities.
Abstract: SUBJECT AREAS: project finance, syndicated lending, financial strategy, Asia, emerging markets, investment banking, commercial banking CASE SETTING: August/October 2000, investment banking, entertainment industry, $3.6 billion investment In December 1999, the Walt Disney Company and the Hong Kong Government agreed to develop Hong Kong Disneyland, a HK$28 (US$3.6) billion theme park and resort complex with a scheduled opening date of 2005. As part of the total financing package, the sponsors decided to raise HK$3.3 billion of non-recourse bank loans for construction and working capital, and selected Chase Manhattan Bank to underwrite these facilities. The A Case concerns the process by which Chase successfully competed to lead this transaction. The key questions facing Chase were whether to bid at all, how to bid, and how to structure the syndication to meet the borrower's needs, its own profit objectives, and the market's expectation for an attractively priced credit. The case includes a generic section about the process, participants, and economics of syndicated lending for students who are unfamiliar with the practice. The B Case presents the results of the general syndication in October 2000, and illustrates the issues for Chase in allocating final commitments. The B Case also raises the fundamental question of whether the syndication was a success. The case illustrates: 1) the process, participants, and economics of syndicated lending (a market that now exceeds $2 trillion annually); 2) the key issues in designing a syndication strategy (e.g. how many banks to invite, which banks to invite, what fees to offer, and what share of the loan to hold in the end); 3) the importance of relationships in syndicated lending. Although this case was written for a course on project finance, it can easily be modified for courses on corporate finance, capital markets, investment banking, or financial institutions.
Abstract: SUBJECT AREAS: project finance, product development, valuation, demand analysis, capital budgeting, competitive strategy CASE SETTING: July 2000, commercial aviation, $13 billion investment In July 2000, Airbus Industrie's Supervisory Board was on the verge of approving a $13 billion investment to develop the A3XX, a new super jumbo jet that would seat from 550 to 1000 passengers and have a list price of $216 million. Having secured firm orders for 22 jets, the Board must decide if there is sufficient long-term demand to justify the investment. At the time, Airbus was predicting that the market for very large aircraft (VLA) would exceed 1500 aircraft over the next 20 years and would generate sales in excess of $350 billion. According to Airbus, it needed to sell 250 aircraft to break even on an un-discounted cash flow basis, and could sell as many as 750 aircraft over the next 20 years. Boeing, however, was predicting that the VLA market would be less than 400 aircraft over the next 20 years. The difference stems from fundamentally different perspectives on the industry's likely evolution: Airbus is predicting an increase in "hub to hub" travel and the need for larger planes to service key hubs. In contrast, Boeing is predicting an increase in "fragmentation" and the expansion of point-to-point service. The case explores the two sets of forecasts, and asks students whether they would proceed with the launch given the size of the investment and the uncertainty in long-term demand. It also analyzes the competitive interaction between Airbus and Boeing in the battle over the VLA market. This case presents one of the most interesting "high stakes" gambles of the current era. From a finance perspective, it illustrates the basic economics of large projects. They involve small, relatively uncertain future cash flows to pay back large, up-front costs. More importantly, unlike venture capital, most of the development cost must be spent prior to selling a single product. In other words, it cannot be staged nor can it be salvaged with much value. In terms of analysis, students must estimate the breakeven number of planes and decide how likely it is that Airbus will sell that many planes. This analysis shows how difficult it is to estimate even top-line demand for a product with a useful life of up to 50 years. The answer, of course, depends on market growth rates and assumptions about Boeing's likely response. Here, the case merges strategy and finance by exploring the competitive dynamics between a monopolist and a potential entrant in a market with entry costs in excess of $10 billion. An important yet unknown determinant of the outcome will be the role of government intervention-governments play a role on both sides as customers, investors, and interested parties. For this reason, the case is appropriate for finance, strategy, and general management courses.
Abstract: SUBJECT AREAS: project finance, financial strategy and execution, valuation analysis, corporate governance, global investment CASE SETTING: August 1999, telecommunications, $5.5 billion investment, $6 billion projected revenue This case analyzes the demise of Iridium LLC, one of the largest private-sector projects in corporate history. The satellite communications company declared bankruptcy on August 13, 1999, and is now in the process of being liquidated under the auspices of the US Bankruptcy Court. Despite almost $6 billion of investment, the assets appear to be worth less than $50 million. The first half of the case describes Iridium's creation, development, and commercial launch, and gives students an opportunity to critique the vision behind this project and estimate its value using discounted cash flow analysis. The second half of the case focuses on Iridium's financial strategy and execution. In particular, the case describes Iridium's target debt-to-total book capitalization ratio of 60%, the various kinds of capital Iridium used (secured bank debt, guaranteed bank debt, zero coupon bonds, cash pay notes, etc.), and the sequence in which it issue them. Although this post mortem analysis is intended to help students understand the relevant issues in financing large, greenfield projects, the lessons on financial strategy and execution readily extend beyond the realm of large projects. The case has four pedagogical objectives. First, it illustrates the financial strategy and execution of a very large, greenfield project. The case helps students understand why project sponsors select highly-leveraged capital structures, why they use specific types of capital (bank debt vs. public notes), and why they raise capital in the sequence they do. This analysis forces students to confront the "capital structure puzzle" yet the setting differs from other attempts to differentiate among various capital structure theories because Iridium is a start-up venture that is less affected by prior financing decisions or past performance. Second, the case illustrates not only the benefits of using project finance for high-risk projects, but also the dangers of using project finance for high-technology projects. With more than $43 billion of announced capital expenditure for satellite communications systems, it is critical to learn from Iridium's mistakes. One key lesson is that while financial structure can improve firm performance and increase the probability of success, it cannot save a project with fundamentally flawed economics. Third, it illustrates how difficult it can be to value a large project with unproven technology. The case presents wide ranging revenue projections from some of the most informed investors (equity research analysts). The combination of large, relatively certain, upfront costs with large, relatively uncertain, distant revenues makes large-scale investment very risky. And fourth, it provides an opportunity to discuss the governance of large projects. One of the key questions in this case is, "How could this have happened?" Part of the answer lies in Iridium's board structure (size, independence, and ownership).
Abstract: SUBJECT AREAS: project finance, emerging markets, sovereign risk, valuation analysis, Africa, International Finance Corporation, multi-lateral agency CASE SETTING: June 1997, Mozambique, aluminum smelter, $1.4 billion investment, $700 million revenue, 750 employees In June 1997, a project team from the International Finance Corporation (IFC) was recommending that the board approve a $120 million investment in the Mozal project, a $1.4 billion aluminum smelter in Mozambique. Four factors made this recommendation controversial. First, it would be the IFC's largest investment in the world and by far its largest investment in Sub-Saharan Africa. Second, the project was enormous by Mozambican standards--it was not much smaller than the country's 1996 gross domestic project (GDP). Third, Mozambique was a very poor country at the time (per capita GDP of $90) and had only recently emerged from 20 years of civil war. Fourth, many aspects of the deal remain undetermined such as who was going to provide half the equity needed to finance the project. Despite these concerns, the sponsors, Alusaf (the aluminum subsidiary of the South African minerals company, Gencor) and Industrial Development Corporation of South Africa (IDC is a development bank), want to structure a limited-recourse deal to finance the smelter; it will be non-recourse to the sponsors after completion. Commercial bankers have refused to participate unless the International Finance Corporation gets involved in the deal and so the sponsors have approached the IFC about participation. After reviewing the project's commercial viability and development impact, the IFC team is recommending the investment. The board must decide whether it is the right time and the right project to make such a large investment. The case has four pedagogical objectives. 1) It presents an extreme example of political risk in a developing country setting and shows how organizations like Institutional Investor, the Economist Intelligence Unit, and The PRS Group attempt to analyze it for prospective investors. 2) It illustrates the modern form of political risk management through project selection, structuring, and insurance, and contrasts this approach with the older, financial style of political risk management whereby sponsors simply increased hurdle rates to ensure sufficient project returns. 3) It highlights the various roles multilateral development institutions, in general, and the IFC, in particular, can play in financing major projects. 4) It analyzes IFC's involvement in appraising, structuring, monitoring, and financing projects, and shows how these activities create value by resolving costly market imperfections including information, distress, agency, and transactions costs. It also explores the IFC's performance in these various activities. Given these objectives, the case is appropriate for business/government, strategy, international business, and finance courses.
Abstract: SUBJECT AREAS: project finance, emerging markets, valuation analysis, petrochemicals, Middle East, Islamic Finance, religion and business CASE SETTING: December 1995, Kuwait, petrochemicals, $2.0 billion investment, $700 million revenue, 900 employees Equate Petrochemical Company (Equate) is a joint venture between Union Carbide Corporation and Petrochemical Industries Company (PIC) for the construction of a $2 billion petrochemical plant in Kuwait. The sponsors began construction in August 1994 using a bridge loan and are in search of permanent, non-recourse finance. As part of the permanent financing, the sponsors want to use a tranche of Islamic finance-funds that are invested in accordance with Islamic religious principles known as Sharia. According to Sharia, financing cannot be interest-based (i.e. debt), it must be profit-based where the lender accepts the risks and rewards of asset ownership. The sponsors hired Kuwait Finance House (KFH is a Kuwaiti Islamic bank) which, in turn, approached The International Investor (TII is a Kuwaiti investment bank) to assist in structuring and underwriting the Islamic tranche. The case is set in early December 1995, as members of The Institutional Investor's Structured Finance Group are deciding which Islamic structure to use, how to resolve various conflicts between the Islamic and conventional tranches, and how large a commitment to make on behalf of their investors. This case provides an introduction to Islamic finance in general and Islamic project finance in particular. It describes the primary instruments used by Islamic investors and challenges students to develop a financing plan that is consistent with Sharia's prohibition against the payment of interest (riba) while at the same time appropriate for a large, long-term greenfield project. The case also explores the complications of integrating Islamic and conventional Western financial instruments in a single transaction as well as some of the possible solutions. With more than a billion Muslims living primarily in regions with enormous infrastructure needs (the Middle East, Asia, and Africa), there is a growing need to understand Islamic culture, traditions, and financial systems. There is also a note on Islamic Finance (An Introduction to Islamic Finance) that provides some background information on Islamic religious principles as they relate to banking and finance; a section on Islamic financial instruments and institutions; and an overview of recent developments in the Islamic capital markets.
Abstract: Subject Areas: project finance, emerging markets, capital expenditure, valuation analysis, sovereign risk and bond ratings, oil and gas, risk management Case Setting: January 1997, Venezuela, oil-field development, $2.4 billion investment, $800 million revenue Situation: Petrolera Zuata, Petrozuata C.A. (Petrozuata) is a proposed $2.4 billion oil-field development project in Venezuela consisting of three components: a series of inland oil wells, two pipelines to the coast, and a refinery. It is the first in a series of development projects aimed at re-opening the Venezuelan oil sector to foreign investment and is part of PDVSA's (Venezuela's national oil company) $65 billion capital expenditure program. The case is set in January 1997 as the project sponsors, Conoco (a DuPont subsidiary) and Maraven (a PDVSA subsidiary), are planning to meet with various development agencies in Washington and rating agencies in New York City regarding the proposed financial structure. According to the current financing plan, the sponsors hope to raise at least a portion of the $1.5 billion debt financing in the capital markets using project bonds (60% debt-to-value ratio). To facilitate a bond offering in the Rule 144A market, the deal must secure an investment-grade rating, yet neither PDVSA nor Venezuela is investment-grade-both are B rated. The key questions facing the sponsors is whether the project will achieve an investment grade rating and, if not, how to finance the deal so that it remains economically and operationally attractive to the sponsors. The case has four objectives. First, it illustrates an extremely well-crafted deal which allows students to examine why firms use project finance to fund large-scale capital expenditures. Virtually every major journal covering project finance selected this transaction as "1997 Deal of the Year," and one of them selected it as "Deal of the Decade." Second, the case shows how project financing creates value by minimizing capital market imperfections and by efficiently allocating risk. Third, it explores the potential for the capital markets to fund infrastructure projects and describes the corporate bond rating process in terms of project, corporate, and sovereign risks. Largely due to skilled execution, this project was able to "pierce the sovereign ceiling" (achieve a higher project rating than the home country's sovereign rating), a relatively rare occurrence in the rating world. Finally, it illustrates some of the financial analysis, tools, and terminology used in structuring project finance deals. There is an Excel spreadsheet which allows students to conduct sensitivity analysis on the project's value and coverage ratios.
Abstract: SUBJECT AREAS: Chapter 11 bankruptcy, restructuring, valuation, incentive conflicts, insider trading, media and entertainment, vulture investing, corporate control. CASE SETTING: January 1997, USA, comic book publisher and trading card manufacturer, $800 million revenue, 1,600 employees. REQUEST FOR COPIES: To receive a copy of this case please contact Ben Esty via e-mail at MAILTO:besty@hbs.edu Situation: Marvel Entertainment Group is the leading comic book publisher in the country with superheros like Spider-Man, The Incredible Hulk, The X-Men, and Captain America. It is also one of the leading manufacturers of sports and entertainment trading cards under the Fleer and SkyBox brand names. In recent years, it has experienced sharp declines in both businesses causing it to file for bankruptcy in December 1996. The case is set in late January, 1997, shortly after Marvel filed its reorganization plan with the bankruptcy court and approximately one month before creditors will have to vote on the plan at the confirmation hearing. The case pits two of the most prominent raiders of the 1980s against each other for control of the company. On one side is Ronald Perelman who controls Marvel through his MacAndrews & Forbes holding company. On the other side is Carl Icahn who controls 25% of Marvel's public debt. Icahn and the other bondholders must decide whether to accept Perelman's plan, to reject it in favor of their own plan, or to sell their bonds before the confirmation hearing. Perelman must decide whether to change the plan in response to the debtholders threats to or to wait and see what happens at the hearing. I use the case in an advanced corporate finance class for MBA students in a module on managing decline and restructuring. It would, however, also be appropriate for doctoral students as a concrete example of a distress situation following a lecture on bankruptcy procedure and evidence - the teaching note references many academic articles on bankruptcy and restructuring. The case has four objectives: it provides an opportunity to value a Chapter 11 restructuring plan; it illustrates debtholder/equityholder incentive conflicts in a distress setting; it raises the issue of whether insider-trading" in debt instruments, specifically junior debt in a distress situation, should be illegal; and it illustrates the role played by vulture investors in Chapter 11 restructurings. In addition, the case can be used to discuss the importance of reputation in capital markets by asking whether Perelman will be able to raise new debt following this ordeal.
Abstract: South Shore Bank, the country's first community development bank, began in 1973 with the dual objectives of making a profit and improving conditions in the community of South Shore, Chicago. Although the bank has been hailed as a success, there has been little work on defining or measuring its performance against either objective. This paper compares the bank's financial performance against comparable banks (holding companies) and the demographic changes in the South Shore community against changes in the contiguous communities. The results suggest that both the bank and the community exhibit worse relative performance. Additional research is needed to verify these results and to determine how to improve the effectiveness and efficiency of community development banks.
Abstract: SUBJECT AREAS: mergers and acquisitions, hostile takeovers, bidding wars, two-tiered offers, valuation by multiples, competitive strategy, takeover defenses, deregulation, valuing merger synergies, industry consolidation CASE SETTING: Fall 1996 to Spring 1997, USA, railroads, 23,500 employees, $3.7B sales. REQUESTS FOR COPIES: To receive a copy of this case, please contact Harvard Business School Publishing, 60 Harvard Way, Boston, MA 02163. Phone: (800) 545-7685. E-Mail: MAILTO:custserv@hbsp.harvard.edu Or you may contact Ben Esty via e-mail MAILTO:besty@hbs.edu Situation: On October 15, 1996, Virginia-based CSX Corporation and Pennsylvania-based Consolidated Rail Corporation (Conrail), the first and third largest railroads in the Eastern United States, announced their intent to merge in a friendly deal worth $8.3 billion. This deal was part of an industry-wide trend towards consolidation and promised to change the competitive dynamics of the Eastern rail market. In the A case, students, as shareholders, must decide whether to tender shares into the front-end of a two-tiered acquisition offer. To make this decision, they must value Conrail as an acquisition target and understand the structure of CSX's offer. Eight days after CSX Corporation announced it was going to buy Conrail for $88.65 per share, Norfolk Southern Corporation made a hostile $100 per share bid for Conrail. Over the next several months, the potential acquirers upped their bids while exchanging criticism in the popular press, prompting analysts to call this one of the nastiest takeover battles of the 1990s. The B case is set in January 1997, just before Conrail shareholders are scheduled to vote on the proposed deal with CSX. The case analyzes the bidding war for Conrail and the various provisions in Pennsylvania's strict anti-takeover law which restricts the market for corporate control. Although the cases were designed to be taught over two consecutive days, they can be taught in a single session. Both cases provide an opportunity to value a large-scale acquisition using comparable transactions and discounted merger synergies. The A case, in particular, analyzes and uncontested takeover, illustrates the mechanics of a two-tiered offer, and provides a vehicle to discuss various anti-takeover provisions including poison pills, lock-up options, break-up fees, and no-talk clauses. The B case analyzes a contested takeover offer, explores the strategic and financial implications of a bidding war, and challenges the assumption that failure to acquire is a zero net present value endeavor. It also examines the nature of and economic basis for regulating of the market for corporate control. While these cases were written for a module on corporate control in an advanced corporate finance course, they have also been used with executives in a special program on valuation and in an introductory corporate finance program.
Abstract: SUBJECT AREAS: Valuation by discounted cash flow and multiples, leveraged recapitalization, cyclicality and valuation errors, impacts of extreme leverage, market for corporate control CASE SETTING: May 1988, USA, building materials, $2.9 billion revenue, 22,200 employees In 1988, USG was the world's largest manufacturer of gypsum products including "sheetrock," USG's trademark product name. Despite being the market leader, and being ranked seventh on the Fortune 500 in terms of return on equity (ROE) and fourteenth in terms of 10-year earnings per share (EPS) growth, USG became the target of two hostile takeover attempts between 1986 and 1988. USG paid greenmail in November 1986 to escape the first attempt. The case is set after USG's board has proposed, but shareholders have not yet approved, a leveraged recapitalization to thwart the second offer. Students, as shareholders, must decide whether to tender their shares or wait and vote in favor of the recapitalization plan. The USG Corporation case analyzes a defensive leveraged recapitalization and illustrates the capital cash flow methodology for valuing highly leveraged transactions. It highlights the complexity of valuing cyclical companies and the potential errors made by ignoring cyclicality in cash flow projections. The facts in this case are consistent with Kaplan and Stein's (1993) theory of overheating in buyout pricing during the late 1980s and Palepu and Wruck's (1992) documentation of poor ex post performance in defensive recapitalizations. When paired with a discussion of voluntary recapitalizations, it also allows the instructor to compare voluntary versus defensive recapitalizations in terms of ex ante incentives and ex post performance. Although this case was originally written as a final exam for an advanced corporate finance class, it has been used regularly for class discussion with MBA students and executives in course on valuation. This case was featured in the 1998 Graduate Business School Finance Case Competition sponsored by Carnegie Mellon.
Abstract: SUBJECT AREAS: Managing growth and value creation, acquisition strategy, venture capital, capital structure, financial and competitive strategy. CASE SETTING: July 1995, USA, funeral homes (death care industry), $1.7 billion sales, growth company. This case is part of a module on managing growth and value creation in an advanced corporate finance course. An overview note (Note on Value Drivers) provides a theoretical framework for the module while individual cases highlight specific value drivers. For example, this case focuses on acquisitions as a form of investment and challenges students to understand the relation between growth and value creation. The case opens as Service Corporation International (SCI), the world's largest funeral services company, has just announced its acquisition of two French death care companies for $423 million. This acquisition is the culmination of a 30-year acquisition program which has transformed SCI from being a single, Houston-based funeral home to an international company owning 2,680 funeral homes and 320 cemeteries around the world. Through acquisitions, SCI has grown, and expects to grow, in earnings per share, sales, and operations at 20% per year even though underlying demand--the death rate--is growing at approximately 1% per year. SCI's Chief Financial Officer, George Champagne, is worried that investors do not understand SCI's growth strategy and its ability to create value. In addition, he is concerned about how to finance future growth and what constitutes an appropriate capital structure for a high- growth company. SCI creates value by acquiring funeral homes, incorporating them into clusters, and eliminating redundant costs--a strategy known by venture capitalists as a "roll-up". Through consolidation, SCI is able to quintuple the value of a stand-alone funeral home. The biggest threat to value creation, however, is overpaying for deals and SCI has recently paid record prices for international targets. The key questions in the case are whether SCI has lost is pricing discipline and whether its future acquisition strategy is value enhancing or not. Different answers to these questions yield different implications regarding the advisability of future growth and the appropriateness of debt financing. Finally, the case illustrates how difficult it can be to communicate a strategic vision.
Abstract: From 1863-1933, commercial shareholders were subject to a broad range of liability rules for the obligation of their bank ranging from limited liability to unlimited liability. By increasing shareholder liability, the regulators hope to minimize incentives for risk shifting in these highly leveraged institutions. I find that risk taking is negatively related to the severity of the liability rule primarily because banks choose to hold less risky assets and greater net worth. These findings indicate that the shape of the equityholders' payoff function has a significant effect on their incentives particularly in regard to risk taking.
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