Ayuli Jemide
26 August 2008
opinion
Lagos — Nigeria is today in the phase where it suddenly dawns on government that it may never achieve the (very legitimate) infrastructural aspirations of its citizens without help from the private sector. So the phrases that are rife at this time include: "partnering with the private sector for infrastructure development"; "public private partnerships"; and more.
It is a worthwhile exercise therefore to capture the mindset of the typical investor or lender on such projects. What is uppermost on their minds? Clearly the word "Risk" comes in as number one on the review list.
What do we mean by risk?
In general risk would be defined as any event that would impede, diminish or adversely affect the income streams of any project or business. The worst case scenario being an event that brings the project to a halt or zero income.
Why is risk so important?
The general rule with any business is that there is a risk element and the higher the risk the greater the monetary returns. So what is special about risk in project finance?
Firstly, infrastructure projects deal mostly with assets that are fixed and non-convertible - a power station for example. You cannot sell the power station easily in the market as you would do to your shares if the price dipped. How do you sell a water utility company that belongs to the state government? So recovery of sunk cost is usually only through the success of the project and its expected income - swim or sink. Obviously the externalities concerning such incomes are numerous in a country like Nigeria.
Secondly, project finance mostly deals with non-recourse lending, where the lender expects repayment from the income on a project - meaning what customers would likely pay for electricity if we are dealing with a power project for example. This is different from Corporate Finance where the Lender takes some other offshore or local assets of the project sponsor. It follows therefore that a lender's primary focus will be on the vagaries (the risks) on the projected cash flow. It should be noted with offshore or cross border lending, the lenders are placing money in different jurisdictions - each one with its peculiarities.
What are the types of risk?
Risk can be clothed in any type of garment, but the language of project finance has some broad categories:
Political risk
In Nigeria we would all understand this because we see government contractors lobbying endlessly to avoid project cancellation once a new government comes into power. How many projects have been cancelled in the last one year by the Federal Government? I am sure you can mention a few. What happens in Nigeria once a group of Senators decide to oppose a project and call a public hearing? We should note that the rating agencies take things like this into consideration in placing a country on the risk table. Today Nigeria is a BB- which is what we can refer to as below average. Imagine what it would have been in the Abacha days?
Operational risk
Let us assume that your power station takes off and soon after that the Labour Union decides to go on a protracted strike, or the host community shuts in the plant - as happened in Benue State with a certain cement factory or with Shell in Ogoniland, or militants blow up a portion of the plant as we have come to terms with these days in parts of Nigeria. I leave the rest to your imagination.
Economic risk
Imagine that you just began a project and part of your lending for operations was from domestic banks. Then you open the newspapers on a Monday morning a few weeks later - "the Governor of the Central Bank announces a forced bank consolidation within the next three months". Your domestic bank can no longer lend and your offshore bank has reached its limit. Another example would be where the Federal Government suddenly announces an increase on the import duty on an item that is a key part of your project and this affects the project profitability or ability to repay its loans. Under this umbrella come words like inflation, currency devaluation, and whatever drums the economists would beat in a frenzy.
Financial
The financial advisers had prepared a document before the investment decision was taken that placed the IRR (Internal Rate of Return) at a comfortable profit margin if the tolls charged on the road was at least N100 per car at a minimum of 1,000 cars per day. But traffic became so much in Lagos that people bought bicycles (as in China) and bicycles are toll free. Most of the projected car owners are now bicycle owners, so the road only sees 600 cars a day and bicycle shops are springing up daily. You are stuck with a 20 year concession and the financial risk is your cup of tea. At this point the return on investment (ROI) is in serious jeopardy and the feistiness in the boardroom heightens.
Construction risk
The wrong contractor on a project can be the beginning of the end. A wrong mix in precast concrete or wrong measurements on a design can spell doom for an entire facility. You would notice that procurement process on major infrastructure projects take such a long time (12-18 months) to ensure that the right contractor is selected.
Force majeure
This is what we refer to as "Act of God" - thunderstorm, hurricane, tsunamis, earthquakes, etc. Nigeria is blessed with none of these. Our thunderstorms come daily in other basic issues of life that we have to grapple with.
Are there Risk Mitigating Tools?
The world of project finance has and will continue to develop products that help to compensate (never fully) for any of these eventualities. A few of them are worthy of note:
Insurance comes in very handy here. In Nigeria there are limitations on insuring local assets with offshore Insurers, but some of these can be dealt with by seeking a waiver from NAICOM. Also note that there are Insurance covers available from many multi-lateral agencies for economic, political risks and other risks depending on their individual menu. Many projects would never have taken off without political risk insurance in place.
Many projects also have Sovereign Guarantees from the host governments. This in a nutshell is an underwriting by government to cover certain eventualities. These guarantees are either backed by an International agency or by cash in escrow.
Many Lenders protect themselves from operational risks by insisting on step-in rights - the right to take over a project if the management is inept. The categories of risk mitigation strategies are boundless and still growing.
In all, I doff my hat for those who sink their money into infrastructure projects instead of oil, gold, stocks and commodities. It can be a long hard road and only for the brave.
Ayuli Jemide, Lead Partner, Detail - Commercial Solicitors.
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