The sponsor would, therefore, need to commission a market study of projected demand over the expected life of the project

 

By Michael Tichareva

As the Zimbabwean economy recovers under the 5-year National Development Plan 1 following a largely successful but painful implementation of the Transitional Stabilisation Programme, the country needs to be ready for major infrastructure development in the years to come.

This requires the country to develop the relevant skills among its people for infrastructure development and financing.

Over many years of experience on project financing, we have witnessed poor project preparation as one of the main reasons for slow infrastructure rollout in many countries.

Project sponsors need to assemble a competent and experienced team to prepare a bankable project.

It can easily take several years to prepare a bankable project, and it can cost anywhere between 5% and 10% of total project costs.

 

 

Feasibility studies

A bankable project must have a solid technical and financial feasibility study prepared by a multi-disciplinary team of engineers, finance experts, quantity surveyors, project managers, legal advisors, lawyers and environmental specialists depending on the nature and complexity of the project.

A project feasibility study considers the appropriateness of the project design relative to the needs to be serviced, including social, environmental and legal issues.

Issues such as site selection, capacity to implement, phasing of the project, availability of major inputs, project cost, price of the final products to users and market existence must be analysed to assess commercial viability based on current and projected market conditions.

Additional factors include the potential for unanticipated delays and the project’s operating characteristics such as useful life, reliability, efficiency, required maintenance, and vulnerability of project technology to innovation.

A good feasibility study should focus on both the “hard” construction costs and an initial estimate of the project financing and development costs.

Estimating financing and development costs is a difficult call in the early stages as the interaction between costs and revenues will not have been fully tested yet. However, with experience, a good estimate can be made.

 

 

Market, revenue and costs analysis

Analysis of supply and demand, hence the revenue and costs, under various market conditions is an important step in project preparation.

Assuming that a project is completed on schedule and within budget, its economic and financial viability will depend primarily on the marketability of the project’s output.

Off-take agreements with strong counterparties are important to guarantee revenue. In the absence of an off-take agreement, the products would be sold directly to the market on an on-going basis at unknown future prices.

The sponsor would, therefore, need to commission a market study of projected demand over the expected life of the project.

Such a market study must confirm that, under a reasonable set of economic assumptions, demand will be sufficient to absorb the planned output of the project at a price sufficient to recover the full cost of production, enable the project to service debt, and provide an acceptable return to equity investors.

A market study should generally include a review of competing products and their relative cost of production, an analysis of the expected life cycle for the project output, and an assessment of the potential impact of technological obsolescence.

It is also extremely important to assess the impact of potential regulatory decisions on production levels and prices, and ultimately the profitability of the project.

For very large projects, it may be important to obtain certain guarantees from the government for a minimum period to ensure the impact of any regulatory decisions during the life of a project is not adverse.

Such guarantees assist in managing regulatory and political risks.

Projects that have a single product whose price may vary widely, such as most commodity-based projects, are particularly vulnerable to changes in demand and may need to hedge against product price risk.

Off-take agreements from strong counterparties and certain guarantees become particularly important for hedging.

There are also risks on the raw material supply side. Projects whose success or failure relies heavily on the price of one raw material may also require an input supply agreement on guaranteed prices.

 

Financial modelling

Financial modeling is another particularly important aspect of project preparation, especially when engaging investors. A financial model reflects, in dollars and cents, the provisions made and reached in project agreements.

This must include reasonably accurate assumptions with regard to revenue and costs.

Metrics such as the internal rate of return, the net present value, pay-back period, debt coverage ratios and their acceptability must be analysed.

The financial model often considers, through sensitivity analyses, the impact of construction delays, cost overruns, adverse regulation, the inefficiency of the project relative to existing and projected competition, interest rate fluctuations, unavailability of major project inputs, and major unanticipated inflation and volatility in foreign exchange rates.

 

Michael Tichareva is the Managing Director of National Standard Finance Africa. He can be reached on mtichareva@natstandard.co.za

 

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