PROJECT FINANCE

Financing the Mozal Project

SUBMITTED TO: DR. ANUPAM RASTOGI

Submitted By:TEAM 3 - GROUP II

1. Should Alusaf/Gencor invest in the Mozal project?

The IRR (Internal Rate of Return) for the Mozal project has been calculated using the
projected cash flows (pre interest) in base case and expected case.

The base case has been considered at sales price of $1750 and expected case is at sales
price of $1800.

The IRR calculated using the projected cash flows returns a yield of 14% in base case and
15% in expected case.

The GDP and FDI were increasing & the inflation decreased. The Mozambican Govt.
made constant efforts to improve the macroeconomic situation & encourages the private
sector investment.

The ICGR risk rating for the group changed from 7.6 to 14.0

Attractive power tariffs and attractive labor cost were available in Mozambique

The alumina supply was contracted for 25 years from Billitons, Australia

The supply of electricity was also contracted for 25 years from Eskom & Mozambican
Govt.

The average capital cost for any smelter was $4850 per ton but the Mozal Project had an
overall capital cost of $4750 per ton

Average production cost $1510 per ton (Excluding depreciation & financing charges) but
Mozal projected breakeven price $1493 per ton (Including depreciation & financing
charges) in the 4th year and further declining to $1070 in the 11th year

Cost of equity Calculations

The risk free rate has been taken as 6.56% as this was the yield on 10-year US Treasury
bonds

The market return for a period of 1987-1997 was 13% (CAGR)

The equity beta has been calculated as 1.596

The country risk premium is 6.79%

The total cost to equity has been calculated as 21.36%

Based on just the IRR the company would generally not invest in such a proposal. But given the
other economic benefits and the fact that they have entered into long term contracts, makes the
project seem doable. Hence the company can look to invest in such a project if it considers other
benefits. But based on only the IRR calculated, the project doesnt seem much attractive.

2. What are the greatest risks? Have they been adequately discussed?
The Mozal project involves the establishment of a venture between three entities Eskom, Alusaf
and Mozambican government. It will be exposed to a number of risks such as :
Technology risk
The project involves use of technology and so its success would largely depend on the
technology being used. Thus a major risk would be the use of inappropriate technology.
However, Alusaf has been involved in the aluminium business for some time now and so the
judgement of appropriate technology should not be much of a concern.
Timely Completion of the Project
Since the government of Mozambique is directly involved in this project, therefore, it would
involve bureaucratic procedures to comply all the legal and legislative requirements of the state
and the Mozal project is subject to approval by the government of Mozambique thereon. Hence,
the project would be exposed to extensive delays in the meantime. In contrast, Mozambique
exists as a weak economy and lacks sufficient infrastructure to provide a favourable sight to the
project therefore, the project would probably stuck with delays in its completion
However, in order to avoid unconditional delays the company is seeking prior permission of the
state to grant construction permit. Thus an agreement has been signed with the South African
government to address risks associated with delays. Also there has been infrastructure
development for electricity supply by Eskom and EdM.
Operational Risks
Further, the Mozal project would be exposed to operational risks, because 33% of the total
production cost will be the alumina and the prices of alumina are readily fluctuating which will
lead to high volatile cost of production, hence, the operations would be exposed to fluctuations in
the price of alumina. Meanwhile, the availability of other raw materials such as petroleum and
coke, would carry a considerable operational risk and similarly the labor issues in a new country
would result in operational risks.

Operational risk has been mitigated through a mechanism between input prices of alumina and
the output price where the input prices are function of London Metal Exchange aluminium
prices. Also 25 year contracts have been made for supply of alumina and electricity. Skilled
labour and management expertise issues will also be solved by bringing people from South
Africa.
Commodity Price Risk
In case a similar project of such a large scale is underway in some other part of the world, this
can result in excess supply of Aluminium in the market resulting in a supply glut and causing
prices of aluminium to fall, contrary to its historical prices (As has happened in steel industry.)
This is a significant risk posed to the future revenue of Mozal project.
Country risk
The country is poor and underdeveloped. There is high risk of a civil war. Political instability is
also high. When this project was being conceptualised, the Government was only 3 years old and
was inexperienced. There was high indebtedness and legal ineffectiveness. This exposed the
project to high country risk.
The government was taking steps to mitigate this risk. It had applied for entry into Highly
Indebted Poor Countries (HIPC) Debt Initiative. It also signed the Investment Protection and
Promotion Agreement with the South African government.
Funding risk
Alusaf and IDC were funding only 50% of the project and ownership of the remaining 50% was
yet to be determined. They were still looking for an industry participant to join the deal and share
the output.

In addition to these:

Mozambique ranked last in terms of road infrastructure among 20 African countries.

Funding from IFC is essential and if IFC backs out of the project then it would be
difficult to find other bank or financial institution that will finance the project.

3. Will the sponsor be able to finance the deal?

Sponsors planned to finance the project using a combination of equity, subordinated debt and
senior debt. Exhibit 4 provides details of planned sources and uses of funds.
Equity: Alusaf planned to provide $125mn in equity. Same amount was planned by Industrial
Development Corporation (IDC) of South Africa. Alusaf was the aluminium subsidiary of the
GenCorp group, a South African natural resource company. IDC was a $3.6bn government
owned development bank of South Africa.
Both sponsors were looking for one or more equity partners to invest another $250mn.
Mitsubishi Corporation, $78 bn Japanese Industrial Conglomerate, was a prospective candidate
at the time.
Subordinated Debt: $65mn of subordinated debt would come from IFC and $85mn from other
development institution.
Senior Debt: Senior debt holder would provide $680mn. IDC and Coface, a French export credit
agency (ECA), would arrange $540mn of finance. ECA were bilateral organization that insured
creditors in an effort to promote domestic exports. IDC was in discussion with CGIC, South
African ECA to provide insurance for $400mn of senior debt. Coface to provide 85% cover for
loans made by French banks.
Development institution like IFC will provide the final $140mn in loans.
Financing the deal

Deal was structured in a way to protect creditors investment. IDC was trying to provide ECA
insurance for lenders. This type of insurance would protect creditors against losses resulting from
commercial insolvency and political risk like war, expropriation, breach of contract etc.
Still, banks were not interested in financing the Mozambican project, specially a limited recourse
deal. For them IFCs involvement was really necessary. IFCs appraisal uncovered informations
about the project, sponsors and host nation that might not be easily available to other lenders.
Therefore, it was critical for sponsors to have Mozal on board.
IFCs appraisal of the Mozal project concluded that it had acceptable financial and economical
rate of return. According to appraisal project would increase exports by $430 mn and GDP by
$157mn (by 9%). Project would also generate jobs and develop the infrastructure
The structure of the deal seems to be viable and favourable for the success of the project as also
appraised by IFC. The structural and institutional approach to risk management by the sponsors
discourages sovereign interference which would encourage lenders to be a part of the deal. Still,
having IFC on board was critical for sponsors for financing the deal.

4. How does IFC involvement affect the deal? Will the IFC and the sponsors share similar
objectives?
IFC effect on the deal:

IFC brings credibility to the project and provides reassurance to potential lenders.

Environment and Social Impact assessment during the project appraisal stage.

IFC is known for the quality of due diligence in high risk projects.

It has played leading role in structuring the legal and financial contracts and acquired the
reputation of Honest Broker- Being fair to all parties.

Help in other aspects of the deal like the integration of the diverse legal system followed
in Mozambique and other countries.

Completion guarantees: They could also help to structure the contractual terms to define
financial and technical performance.

From the financing angle:

o IFC provided loans with longer maturities matching the long project lives.
o It was willing to lend on subordinated basis.

o IFC gave greater emphasis to development benefits.

IFC played a big role in preventing adverse sovereign action and its involvement reduces
political risk.

Objectives of IFC and the sponsors:

Govt of Mozambique: It was actively trying to improve climate for private sector
investment and take the country on the path of growth after several years of civil war.
IDC: Sustainable development of South Africa by promoting entrepreneurship and
private enterprises
IFC: Promotion of private sector investments in developing countries as a way to reduce
poverty and improve peoples lives
Alusaf: Returns from the project, proximity to Hillside smelter, inputs at attractive rates
Eskom: Wanted to expand its operations outside SA and utilize its excess capacity as an
opportunity to provide smelter with power