Project Finance Modeling in Excel

This post contrasts the modeling requirements of a project financing deal and a private equity deal

I began my career as a lending officer at Chase Manhattan Bank in New York. In my second job there I was involved in several project financings in Latin America. Project financings typically involve a take-or-pay contract for some natural resource such as minerals or petroleum and require the construction of a huge infrastructure in some very remote part of the third world. For the Cerro Matoso nickel project in Colombia, which I worked on, to successfully commercialize the nickel deposit required the building of a power plant, a three hundred mile railroad spur and a port. Debt financing is typically the largest part of the capital structure and the debt covenants to control cash flow are the most complex that I have seen. In summary, I know enough about project finance to be dangerous.

The remainder of this post is a guest post by Rickard Warnelid, Director of Navigator Project Finance. Navigator, based in Sydney, Australia, specializes in preparing the sophisticated excel models required for project financings. Rickard's post contrasts the modeling requirements of a project financing and a private equity deal and makes very clear the all important point--the model must meet the requirements of the financing source (and not what you think is important). 

"Financial models are developed at different stages of a project/company for a number of different reasons which results in very different structures depending on the purpose. Some people assume that ‘a financial model’ is a universal description of a tool that can be used to solve any problem in relation to the financing situation, but nothing could be less true.

The scoping phase of the development of a financial model is often the hardest part. This is when the modeler’s expertise is tested to make sure that not just a general financial model is constructed, but one that is tailored and optimized for the users’ current needs. To illustrate this I will give you some examples of the difference in a private equity transaction model and a project finance debt model. This will highlight the major differences in focus between these two otherwise closely related areas of finance and clearly show why it is important to make sure what the purpose of the model is before one starts the modeling of the transaction

Timing

Private equity

A private equity model generally has a lower timing resolution than a project finance model, but the biggest difference is generally the modeled operational life. Private equity transactions are often based on a valuation of a company as a going concern and very little focus is spent on anything beyond an assumed ‘exit’ for the PE investor.

Project Finance

Project finance models are often (in transactions including a construction phase) modeled monthly during construction and quarterly during operations. As the construction can extend to 5+ years on larger infrastructure deals the banks will analyze the debt draw down on a monthly basis during this time. The modeled operational life is commonly extended 20-30 years, depending on the type of asset that is being modeled. Resources project generally have a shorter life, as banks are reluctant to bank on reserves extending past 10 years. Flexible timing in a financial model is shown here.

Valuations

Private Equity

The valuation section is the core component of a private equity model as the main reason for analysis is to make sure that the right exit multiples are achieved and that the investment is worthwhile. Often a number of different valuation techniques are used to cross-check findings before making an investment decision. Using scenario analysis investors try to work out structures that will protect their investment in downside cases and at the same time does not restrict the upside potential in the investment.

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The valuation component (if any) of a project finance model is generally limited to project and equity NPV and IRR. More detailed models would have a comparison of pre-/post-tax effects but in general this section does not get much attention as the model was built primarily to facilitate the bank’s analysis of debt recovery in downside scenarios.

Debt Modeling

Private Equity

Private equity models are commonly extremely simplistic in regards to the debt analysis compared to a project finance model. Drawdown dates, refinance terms, margins, covenants and other assumptions are not focused on in much detail.

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This is the heart of a project finance transaction and often where the majority of the complexity sits. Features like revolving facilities, borrowing base calculations, cash sweeps, refinances, debt sculpting, lock-ups, debt service reserve accounts (DSRA), look-forward/look-back-DSCRs can make the modeling daunting for inexperienced modelers as it can sometimes be modeled in +1,000 lines of Excel code."