Tianjin Plastics (China)-Case Study Analysis

Read the case Tianjin Plastics (China) then answer 5 questions.

1. 1. Situation Analysis – evaluate Maple’s state of readiness to undertake the China project in terms of its grasp of the political, regulatory, legal, economic and financial considerations with which it had to deal.
   2. Joint Venture Analysis – consider the appropriateness of the joint venture partnership from the perspectives of Maple and Tianjin. What did each bring to the venture in terms of business capability, market potential, relationships, management capability, financial resources and commitment and other key factors. What were the strengths and weaknesses of the venture and how did these characteristics impact the financial issues which were addresses?
   3. Country Analysis – review the principal governmental requirements, limitations and advantages for an investor entering China. Evaluate the depth of difficulties and the motivations an investor such as Maple needed to encourage its exacting efforts.
   4. Project Finance Structure – review Exhibit 1 “Characteristics of a Viable Project Financing” in terms of the interests of each of the joint venture partners and in terms of the expectations and risks of financial sources. Compare project finance in terms of its risk considerations to conventional corporate finance conditions.
   5. Joint Venture Structure and Capitalization – review the ownership structure and the contributions of equity made by the partners. What were Maple’s advantages with this structure? What were its risks or potential difficulties?

Solution

1-SITUATION ANALYSIS

Maple Energy is a US-based wholly owned subsidiary of the Northern States Utilities. The company is adept at completing of power plants in regions like UK, Costa Rica, and the Dominican Republic. The company is truly considered development of the power plant projects. The company has worked on other similar joint venture projects. It is capable of arranging the financing, acquiring, and making contracts for the power sales. The company has experience in project finance. However, it is facing some new challenges as well because of the challenging business environment provided by China to foreign investors regarding legal regulations, currency exchange rate risks, lack of availability of hedging alternatives and barrier for financial repatriation of the equity investments. However, the company is well prepared to tackle these barriers through strategies like the back-to-back loan with another US based company operating in China, and financing of the major portion of the project in Renminbi. Through these strategies, the company can cater to the financial, economic, and regulatory hurdles. However, political and currency risks persist. The motivation for the project is an entrance into an untapped power sector, which is expected to grow exponentially shortly.

2-JOINT VENTURE ANALYSIS

The joint venture builds upon to finance $117.4 million projects for Tianjin Plastics and Ministry of Power Industry. Debt financing does the major portion of the sourcing through the Bank of China and Syndication Loan of total $100.9 million. The other $16.5 million is financed by equity.

From the Maple Perspective, it is one of the partners in the equity funding. Maple has 49% of the shares which are suitable for its operations. The appropriateness of the Joint Venture for Maple is based on its leading equity share providing it the hold it requires in operational decisions. Moreover, it also provides the benefit of its partners who are contributing about equal funding to the project, however, with Maple having the top hand. The business capability of handling such power projects by Maple has been shown in its past projects. The company has the management capability to handle such projects. However, working in China is new to it, and it is essential to make this project success to get a competitive edge in the untapped market of China. It has to build the power plant and then give the keys to the Tianjin Plastics. The financial sourcing is much dependent on debt financing and is handled by Maple. The Maple company is committed not to withdraw any of the invested capital and has only authority on the profits earned from the project. It is the weakness for Maple as it cannot withdraw its invested capital. However, by using a back-to-back loan from a US-based company working in China, Maple will be able to withdraw its funds indirectly.

Tianjin Plastics holds the other 46% of the shares with sourcing of $7.59 million. Tianjin Plastics bring its energy-extensive extrusion process skills. The power plant is needed to source its manufacturing plant needs. The company is in a joint venture with Maple who will bear the operational, currency, and credit risk. The venture is most beneficial to it by providing it with its needed power in four years with the bearing of minimum risk. Tianjin is only liable to the 46% of the equity funding which it holds.

Ministry of Power Industry holds 5% of share with $0.8 million funds. The remaining of the power from the Tianjin Plastics is negotiated to be offered to MOPI. The Ministry is offering Maple Company free feedstock of coal for the life of the project. Even though the Ministry is a partner in the project, there is no guarantee of the project. It is a risk which is posed by the US firm and is a weakness of the project.

The capabilities of all partners are well tested, and all have prior experience with these types of projects. Still, certain political, currency, credit and operational risks imply on the parties.

3-COUNTRY ANALYSIS

The project of the Power Plant in Tianjin offers a vast number of opportunities for future projects. However, the Chinese business environment is not the one who makes things easier for the foreign investors. The Chinese government has limited to return on investment in such vast projects to 15%, which is not enough for the power plant project. This project at least needs to have 18% returns on Investment for adequate compensation. Furthermore, the Chinese governments have a reputation for refusing the guaranteed fulfillment of such contracts. It poses increased project risk and cost of borrowing. Other than this, the Chinese government also does not allow the equity investors to repatriate their registered capital. The foreign investors can repatriate only the earnings. Another problem faced by the foreign investors in the Chinese market is the lack of any hedging derivatives. The lack of hedging derivatives and markets make it difficult for the foreign investors to hedge currency exchange risks on their investments and earnings.

Foreign investors, thus face challenges in the form of no hedging, lack of support from the government, inexperienced local partners, and restrictions on repatriation of the capital to its host country, bearing of currency risk, and operating in a devalued RMB.

The motivation of this project is, however, quite attractive. The potential of the market is vast with expected similar power plants in China in coming years. It has been estimated that the there is going to be the demand of about 21 gig watts of new power plants each year in the coming years. It is like providing electricity to the whole southern California each year from scratch. This promising opportunity is enough to make investors face challenges in the Chinese market.

4-PROJECT FINANCE STRUCTURE

Project finance and traditional corporate finance differ from each other regarding the collateral or proof of security of funding provided by the lenders. The corporate financing is usually done when the corporations show their balance sheets to lenders making them feel secure about their investments. These balance sheet assets are used as collateral. However, for Project finance, the future cash flows expected from the project (for which funding is needed) is provided as evidence for paying back of the lend finance. Thus, project finance minimizes the risk for the sponsoring company, i.e., Maple and Tianjin. The lenders can only rely on the project earnings and cannot pursue to look at the assets of the companies. The characteristics of viable project finance make sure that the interest of each of the stakeholders is covered. The strong credibility of the sponsor gives relief to the lenders in expectation of payback from the sponsors in case of loss. The lack of risk related to equity also safeguards the interests of lenders. The financial viability and access to technical expertise safeguard the interests of all stakeholders. Thus, each characteristic is important for making the project finance a successful project.

Risks:

There are many risks associated with the project, which are faced by the partners of the Joint Venture. These are;

Construction Risk:

The construction of the project is expected to take four years. There is a risk of delay in the construction of the project. This risk can be more for the Maple who as an experienced company has to work with less experienced partners in China. These activities, like construction are going to be subcontracted to third parties who cannot be judged from their track record. The risk of losses from the delay in the construction will pose a risk for the parties as per their stake of equity in the project.

Operational Risk:

The operations are also going to be subcontracted to the third parties. These also pose the same level of uncertainty and risks as the companies who are going to perform the operations like the construction are not known to the US Maple company. They are also less experienced as compared to the US firm. The operational risk declines with the free feedstock offered by the Ministry of power. All other factors like the potential of a breakdown in the internal procedures can be predicted. Thus the operating risk is relevant for the Maple, MOPI, and Tianjin.

Credit and Currency Risk:

With the operational and construction risk, there is an increased level of credit risk. The changes in exchange rate pose a risk to the loan of USD and increase the credit risk as well. The investors also increase their returns because of the inclusion of the Chinese government, which is known for its bad reputation.

These risks are posed by the three partners, but more by the US firm. The profits, and benefits attached with the project in the form of the power of the manufacturing plant of Tianjin, power resources for MOPI and entry into the Chinese market for Maple are the source of attraction of the project.

5-JOINT VENTURE STRUCTURE AND CAPITALIZATION

The joint venture equity portion is split in this proportion; 46% of Tianjin Plastics, 49% of Maple and 5% of MOPI. Maple has the controlling interests. It is suitable for Maple as it prefers this structure. It enables Maple to maintain control of operations with its local partners, financing approximately equally to the project. The financing from equity is only 15%, whereas the other part is borrowed from the banks and leading international lending institutions. There are some risks associated with the project as well. The company has a reputation for an average payback period of 6 years, and there is a need for higher hurdle rate for the project as the Chinese market poses many risks. However, the government is not letting it be raised from 15%. Moreover, the lack of hedging derivatives and repatriation of the registered capital makes it challenging for Maple. The risks posed by the Maple are;

Currency Risk:

The changes in the exchange rate will have an impact on the debt structure of the financing. The borrowing of a loan of the 90.7 million RMB @ 13% by Maple, and 33 million USD @ 6.9% and 57 million USD @ 7.7% will be affected by the rate risk. The income of the project is also denominated in RMB, but the loan in USD does the project exposed to the fluctuations in exchange rate. The RMB also is not easily convertible and needs approval from the government for debt service or the repatriation of the profits. Thus the currency risk is posed by the foreign party, i.e. Maple bears the currency risk the no hedging techniques making the risk worse.

Credit Risk:

With the potential for operational risk and systematic breakdown of the operations the debt, paying ability can be affected. The currency risk is also part of the credit risk. When the earnings of the project are denominated in RMB, but the loans are in USD, and the RMB is devalued, the loan would become more expensive making the credit risk higher. The fluctuation in LIBOR rates will also affect the loans that are based on the LIBOR rate.

Political Risk:

The NPV of the project is endangered because of the strategies of the Chinese government to keep it lower than 15% which is not enough for this project. Secondly, the Chinese partners cannot be trusted with their guarantees. They have a reputation of withdrawing from their guarantees. It makes the risk higher for the investors making the cost of debt higher. The restriction on the withdrawal of the invested capital also restricts Maple not to send any profits or dividends to the US Company (parent).

The analysis shows that the project offers more to the Chinese partners than to the US Company. The US Company also bears the highest and most risks of the project.