The Limited Recourse Diet

Dieting and Project Finance Have More in Common Than You Think

One of my proudest accomplishments in the last year was to lose 25 pounds. My doctors had said my weight was fine, but as it turned out, the lower weight helped me address health issues that had seemed unrelated. So, I guess I needed to do this.

Health benefits aside, dieting isn’t a ton of fun. Surprisingly, eating and drinking whatever one wants whenever one wants is far more enjoyable than writing down every Weight Watcher’s point. Skipping that dessert or glass of wine is even less fun. Clearly, no one who doesn’t have to diet would ever choose to do so.

The experience has made me reflect upon how dieting is like project finance. For nerds like me and some of my lawyer friends, project finance can be fun, just like how the dieticians I know really geek out about dieting. But dieting is no fun for the rest of us and project finance is not fun for those who have to spend the time, energy, and money to structure and submit project finance applications to lenders only to engage with those same lenders in what seems like an endless due diligence and negotiation process. No one would ever diet for the fun of it and no one who could get a loan another way should ever choose project finance.

I’m sure many are skeptical of this analogy already and the rest are sure that the similarities end there. They don’t.

A New Beginning

With dieting, finance, and all things, it’s best to start off on a positive note and there certainly is one. Dieting and project finance can change your life for the better. My WW App is replete with stories of the positive life changes their dieting has brought them.

For those who can pull it off, project finance can be transformative. In the 1980’s, scores of new companies that sold power to large utilities under the Public Utility Regulatory Policy Act (“PURPA”) were able to use project finance to leverage their customers’ larger balance sheets. Many are still around today. I’ve helped scores of borrowers with their first project finance. Those who have put in the time, seen deals through, and stuck to deal covenants have achieved quantum growth. Outside of new economy ventures that can gin up investor frenzy, project finance is just about the only way to achieve this type of growth.

Crash Diets

Sadly, many diets – especially crash diets fail. That’s one reason why the weight loss industry is worth $72 billion, according to Research and Markets. The lure of an easy fix is tempting for those who want to lose weight without doing the hard work, but crash diets seldom work.

The same is true for project finance. Everyone wants the big deal and the promise of growth, but it’s not easy. Many sponsors of early PURPA projects were small, but they somehow managed to execute agreements for sales, fuel and construction that complied with credit requirements of their contractual counter-parties. For projects in risky markets, the demands for contractual terms and credit support are harder. Borrowers who think they can project finance their deals easily invariably cannot.

This all brings us back to this article’s central question that we pose in the section below.

Do I HAVE To?

Half of all Americans are currently on a diet. Except for the supermodels out there who should just eat something, most are dieting because they do have to. About 78 million Americans are obese. Each time I’m in Europe where there’s less junk food, I am reminded of lower obesity rates there, which are about half that of the U.S. Not surprisingly, dieting there is less popular. Only about 1/3 of the French have ever tried to diet. If you can have all that yummy French food and wine without dieting, why wouldn’t you?

The decision whether to do a project finance or some other type of finance is the same.

My first counsel to those contemplating a project financing has always been is to see if other options are available. A corporate financing – based on the financial statements of a going concern – is always easier. Yes, a corporate credit must consider a host of market, industry, and other factors, but it’s much easier than project financing, in which lenders assess intricate interconnections among contracts, evaluate the credit strength of all third parties, and tie up project revenues, costs, and cash flows in what seems like an endless series of accounts.

To use the dieting parallel, why would you pass on a menu of foie gras, sauterne, “magret de canard”, pinot noir, and “moelleux au chocolat” for the fun of counting the points in skinless chicken breast, half cup of rice, salad with a teaspoon of olive oil, and – on special days - a carefully measured five ounces of wine?  The only reason to undertake dieting or project finance is “you have to.”

Some companies do a lot of project finance and for them, it is easier. AES, one of the many companies built on project financed PURPA projects, comes to mind. Until recently, its business model has been to grow notwithstanding a sub-investment grade credit rating by using project finance to keep debt off its balance sheet. After a lot of deals project finance became easier. Hasn’t AES chosen to do project finance? 

Not really.

Even though a company may learn to project finance more efficiently and may have developed something of a “project finance lifestyle” that has worked for a long time, if these companies could finance deals in a way other than project financing, they should do so.

The dieting analogy is helpful to understanding this point.

Like most men who annoy their wives by losing more weight than their far more deserving spouse, I went on my diet later and lost more weight more quickly than my wife. Sorry dear. In fact, I lost 12 pounds more than I had targeted. I was so successful I thought I could stop dieting. But, as I exercised less in the colder late Fall, the ballpark food during the Washington Nationals World Series run and the stuffing and pecan pie over Thanksgiving caught up with me. I quickly regained those 12 pounds. I can lose weight easily, but barring an end to baseball or an increased year around exercise program, I’m not one of those super-annoying people who can eat whatever they want whenever they want.

Few can eat with no consequences and financing large deals on a company’s balance sheet can be challenging when the credit criteria that should apply to new loans is that a company be able to carry new debt even if that project the debt is supporting is a total loss. It’s a tough standard. For now, AES may continue to use project finance, but even AES has been amending its business model as it moves towards an investment grade rating. Perhaps AES could go off its “Limited Recourse Diet” and when it can do so sustainably, it should.

A starker parallel to those annoying people who can eat whatever they want whenever they want are companies like Coca-Cola. Have you heard of Coca-Cola using project finance for its bottling plants? Some satellite companies generate more free cash each year than the cost of a new satellite. When they can bond finance or even pay cash for a satellite, why take six months to a year in a project financing?

Exceptions That Prove the Rule

What about the oil majors?  They’re huge and they use project finance deals?  Didn’t Dow and Saudi Aramco use project financing for the Sadara Petrochemical Project?  All true. In fact, oil majors are responsible for some of the larger and more important project finance deals in most years.

But ask any of these large companies if they would use project financing if they didn’t have to – especially at the end of a long and expensive finance process. They will tell you no. It doesn’t mean they regret the decision and might even consider their experience productive. But these companies would have taken a different path if they could have.

Why do these companies use project financing? 

There is a parallel to be found in dieting. Weight loss isn’t the only reason to diet and not being able to manage a credit on one’s balance sheet isn’t the only reason to take on a project finance. For some, dieting is necessary because of food sensitivity or other reasons. I happily found my lower weight produced a plethora of health benefits.

Many project financings are necessary because of partner concerns or structuring issues. Saudi Aramco could easily take on the $25 billion debt for the Sadara Project, but needed the petrochemical expertise of its partner Dow, for whom a $25 billion, loan obligation was a challenge. The best way to execute this financing equitably between the two partners was project finance. Most resource deals inevitably involve a large energy or mineral company that needs to involve a local, often state-owned company that controls the resource. Putting the debt on the balance sheet of the smaller partner is impossible and having the larger partner pay the debt is impractical and just wrong. Just like dieting can help with blood pressure, project finance is the key to making these deals work.

Understanding the reasons project finance might be necessary is helpful to understanding deal dynamics, deal structure, and strategic concerns. Large partners have to be transparent about sponsor support issues and will need political cover from an export credit agency or multilateral development bank to ensure fair treatment by a weaker partner whose government has jurisdiction over a resource and may be tempted to mistreat its foreign partner once a project is up and running. Typically, an agency lender financing that is simultaneously complex and robust is the only way to pull this off.

What If You Can’t Lose that Weight?

For many – or even most borrowers – project finance is challenging. One can have all the requisite contracts, but the credit strength of the third parties in risky market deals is challenging. Some legal risks are unavoidable. Getting equity is challenging. Should borrowers just give up?

Clearly not. Just as throwing in the towel and saying one will be fat forever is a bad choice, giving up on financing a deal is a bad approach.

Those who have read thus far will not be surprised to see that dieting offers helpful lessons.

There are many for whom weight loss is hard. Aging slows down our metabolisms. Some people have bad genes. It doesn’t mean giving up, but it might mean adjusting expectations or perceptions. Men have long contented themselves with less than perfect “dad bods”. Maybe a loss of a just a few pounds or avoiding an otherwise inevitable gradual drift upward is just fine.

The same applies to project finance. Those who lack enough equity might take on a partner. For others, maybe the answer is a structured financing relying on a combination of escrow accounts, pledged asset security, and corporate recourse. Others might consider an incremental approach and a series of small deals. The number of solutions is almost as numerous as the number of would-be borrowers.

Don’t Cheat on That Diet

Regardless of whether or how one uses project finance, the first and most important step is the same as in dieting. Being honest with oneself. In dieting that means writing down what you eat and keeping track of your exercise.

In finance, it means running the numbers and making a frank assessment of options. If existing free cash is too small to support debt service on a new project loan, better think of project finance or something like it. Those who can’t find fuel purchasers and product buyers with strong credits need to explore credit enhancements. A borrower need not fall on its sword about every potential problem, but one can never assume lenders won’t find problems that are out there.

It would be like over-eating and sitting on the couch and expecting the needle on the scale to drop.