Tianjin Plastics/ Maple Energy – China Project Joint Venture

Tianjin Plastics/ Maple Energy – China Project Joint Venture

Generally speaking, Maple has been ready to take the China MOPI project. Although different from the U.S., Tianjin is directly administered by Chinese central government, the political factor would not affect the revenue-generating ability of the project. As a newly-emerging industrial and port city of China, Tianjin carries out a series of a more open and more foreign capital favored policies, attracting numerous outstanding foreign investment during a decade. Tianjin Plastics was a government-owned enterprise relying on intensive energy input to produce a wide range of raw industrial plastic products, which supports the company provide an attractive policy of its contract with Maple -- Tianjin Plastics would provide free coal feedstock for the life of the power plant, that is more than 20 years. Among various investing methods, Maple intended to adapt project finance venture to settle financing needs of the deal. The method came with some nature concern, for instance, is there any Chinese government approval required? Or, is there any regulations restricting the investment? One issue, besides currency exchange issue, had already exposed is that the Ex-Im Bank refused to lend money to Chinese Three Gorges Dam Project, given the consideration of environmental factors, and it could be the same reason for the bankers to reject Maples request. Even though Maple successfully borrow money, there would be a relatively higher interest rate to satisfy lender’s risk expectation of Chinese market.

Some of the benefits are pretty clear for current stage: the contract date would start after the power plant construction and testing. In other words, Maple could expect a flow-in gross revenue by the summer of 2000 and consider the project’s life ended in the year 2020, regardless the economic life of the project and the coal storage problem during the 20 years. However, once the project starts to generate gross profit, it would face a tax rate of 40% after corporate income, and Chinese government particularly required that 25% of annual depreciation charges be “reinvested” in operations. That means there would be no recapture of depreciation at the end of the investment and a higher tax amount in total.

Another favored item for Maple is that the joint venture structure would split as 49% by Maple, 46% by Tianjin Plastics, and 5% by MOPI. Consequently, Maple could control the operation of the project with an absolutely majority percentage of investment; on the other hand, it didn’t have to worry too much about financing pressure, because Tianjin Plastics, its local partner, would share the burden as much as Maple would take. What’s more, the second biggest shareholder position would positively motivate Tianjin Plastic to make full use of local resources: lower the price of raw material, keep a steady sales and gain a strong voice to negotiate with local banks. But all of the investor's’ equity world equity would make up only 15% of the total $110 million in capital needed in this case. In order to lower the financing risk, it became a crucial chain for the project to succeed that diversify the fund resources, not only in equity part, also in debt part.

Despite all the difficulties Maple was facing, it still eagerly wanted to reach the deal, it believed there would be a huge increase in Chinese electricity market and the project is a perfect timing and opportunity to step into the Chinese market.

Some investors may think it is always riskier to invest in a foreign country. To some extent, it is. There would be more unfamiliar administrations and regulations, cultural gap between government and between local investors, different working habits and even time differences. All of these will bring uncertainty to the project, but one of the most dangerous factor should be currency risk. The renminbi was not freely convertible at that time, leading to an issue that any cash flows back to the U.S. would have to require a government approval process. The long procedure of approving expanded the investment payback periods, and the unsure ending date of each procedure also brought more troubles for Maple to manage currency risk, regarding the surprising performance of Renminbi in recent years.

Although the macroeconomic environment in China was substantial and sustainable, there are still something not fit in Maple’s situation. Chinese government increased the limitation of return on investment (ROI), still lower than Maple’s expectation. Another major concern was that he Chinese government often refused to guarantee fulfillment of the similar contracts. Finally, according to the central authority, Maple would only return the profit of project back to the parent company, instead of all the investment.

Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporation, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. In conventional corporate finance, the sponsoring company typically raise capital by borrowing money from lenders that is has sufficient assets on its balance sheet, to use as collateral in the case of default. The lender will be able to foreclose on the sponsor’s company’s asset, sell them, and use the proceeds to recover its investment. But in project finance, the project must be backed by a strong credit, the repayment of debt is not based on the asset reflected on the sponsoring company’s balance sheet, but on the revenue that the project will generate once it is completed. For lenders, it is riskier. So, the sponsor should be financially healthy to assure lenders that the sponsor will be around to build it and operate over its lifespan. And sponsor company should demonstrate that revenue streams from the completed project will be sufficient to repay the loan.

In this case, equity would make up 15% of the total $110 million in capital needed. The majority of the capitalization would come from bank financing- local banks, foreign banks and international lending institution. And the joint venture would be split 49% Maple, 46% Tianjin Plastics, 5% MOPL. Maple’s equity financing is close to Tianjin Plastics’, but Maple could hold the controlling interest and maintain actual control of operation. This is advantageous for Maple.

First, Maple contributes $8.085 million to get the controlling interest. Holding the controlling interest means holding the decision-making power. If there is conflict of company’s operation, Maple has the power to make a decision. Second, this structure helps the joint venture raise money more quickly. But at the same time, this structure also has some difficulties to overcome. First, bearing more benefit means bearing more risk. If this project fail, Maple will loss more. Second, debt capitalization makes up 85% of the total $110 million in capital needed, so the cost of debt is very high, which means you should pay for money to the lenders not the equity stakeholders although joint venture earns the profit. Third, debt financing makes up a large percentage in the whole capitalization. However, several major U.S.-based firms had openly campaigned for the U.S. Export-Import Bank support, so it’s hard to raise the enough loan from the U.S. Export-Import Bank.

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