20090829 financing overview

C O N F I D E N T I A L Copyright © 2009 Mahender Bisht

August, 2009

Financing – Overview

Abu Dhabi

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Contents

I. Capital Structure

II. Financing Options

III. Financing Process

IV. Financing in Middle East

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Capital StructureThe Need for Capital

Investment

Capital assetsWorking capital

Raw materials and supplies

Labor Taxes

Revenue

Value Creation

The goal of a Firm is Value Creation

Value is measured by the Cash produced by a firm

A firm must generate Revenues to produce Cash

Revenue generation requires Capital to establish and operate the firm’s business

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Capital StructureSources of Capital

Owner’s Equity

External Capital

Internal Capital

Debt

Retained Earnings

Capital provided by the owner(s) of the Firm

Gives Owner(s) full claim on the Firm’s earnings, after payment to debtor(s)

Capital provided by a third-party

Allows first-claim on cash generated by the Firm

Obligation to repay a fixed amount by a certain date

Capital generated by the Firm and retained after payment to external capital providers

Most preferred source of financing, if available

Other sources of capital also exist, depending on business situation

‒ For example, factoring (selling account receivables), asset liquidation, working capital (delaying supplier payments, securing advance payments from customers) etc.

A Firm’s Capital requirement can be met externally or internally

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Capital StructureCost of Capital

Equity Debt Retained Earnings

High financial cost – equity holders carry high risk and hence demand appropriate payment

Introduces agency costs

‒ Managers may select negative NPV projects over positive NPV projects to minimize own effort and risk

Lower financial cost than equity

Reduces agency costs

‒ Managers must choose projects that deliver returns sufficient to service debt

Introduces Bankruptcy costs

‒ Firm might be forced to liquidate assets or give-up control in case of missed debt-service payments

Increases firm value by amount of tax-deductible interest payment

Minimal financial cost

Reduces the dividend payment to equity holders

Introduces agency cost

‒ Managers may select negative NPV projects over positive NPV projects to minimize own effort and risk

Zero transaction costs and easily available

Given the availability of different capital sources, cost of capital becomes a key determinant for choosing the capital source

Cost of Capital has financial as well as non-financial aspects

Most preferred

Least preferred

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Capital StructureOptimal Capital Structure

The most appropriate measure of a Firm’s capital cost is the Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) measures the cost of each component of financing

– e.g. debt and equity– weighted by its relative size

WACC Value

WACC Value

The value of the firm can be thought of as a pie

The goal of the manager is to increase the size of the pie (from equity holder’s perspective)

Everything else the same, cost of capital employed can increase the value of the firm

70% Debt

30% Equity

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Capital StructureOptimal Capital Structure (contd.)

CapitalCosts

Debt as % of market value

Ke

Kd

WACC

A change in leverage changes the risk profile and Cost of Capital of the firm

Even though Cost of Debt is lower, the benefits of borrowing have to be weighed off against the cost of higher leverage

‒ Inability to service debt may lead to financial distress and ultimate liquidation

The Optimal Capital Structure minimizes the WACC and hence maximizes the firm value

Ke = Cost of EquityKd = Cost of Debt

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Financing OptionsDebt Finance

Basic loan – contract between a borrower and a lender (typically a bank)

Syndicated loan – contract between a borrower and a syndicate (group) of lenders

Typically short terms (less than 5 years) with principal repayment typically during the bond’s life (on a regular basis)

Can be publicly traded or be used as collaterals for other structured products by the lenders

Loans

Bonds

Lease

Issued by a Company (or Government) directly to Investors (or public)

Can be traded on public exchange

Typically longer terms (5 yr, 10 yr, 30 yr)

Typically principal repayment at the end of bond term

Typically an agreement with a between a buyer and a supplier to use assets without upfront payment

Repayment during the term of the lease

Can be Operating lease (off-balance sheet) if term is shorter than the useful life of asset leased

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Debt FinanceKey Characteristics of Debt

Fixed rate – guaranteed payment amounts throughout debt term

Floating rate – typically, reference rate (e.g. T-bonds) + spread

Zero coupon – no interest payments; debt sold at a discount to face value

Coupon / Interest rate

Security

Status

Coupon payment dates (monthly / quarterly / semi-annually / annually)

Principal repayment – at the end of term or with coupon payments

Secured debt: asset-backed, mortgage-backed

Non-recourse debt: claim limited to collateral used as security

Unsecured debt: no collateral

Payment schedule

Covenants / Call Provisions

Order in which creditors can lay claim on borrower’s asset in case of liquidation‒ Senior debt: Priority over other unsecured debt‒ Subordinated debt: Lower priority than senior debt‒ Mezzanine debt: Lower priority that other debt but higher than common shares

Agreements to protect debt-holders‒ Negative covenants restrict debtor from taking certain actions (e.g. issuing more

senior debt)‒ Positive covenants encourage debtor to take certain actions (e.g. use asset-sale

proceeds to buy other assets only)

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Equity– Basic types of equity

Preferred stock Common stock

– Basic characteristics of equity Terms of preferred stock

Liquidation value Dividend preference

Terms of common stock

Financing OptionsEquity Finance

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Financing processOverview

The process of obtaining Finance depends on the type of finance

As a first step, target capital structure (Debt / Equity ratio) must be defined– Appropriate finance (Debt or Equity) should be issued to meet capital structure

External equity is typically raised via – Initial Public Offering– Equity Private Placement– Private Equity / Venture Capital

External Debt is typically raised via– Debt Private Placement– Public Bond Offering

In this section, we cover the process of raising External Debt

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Debt FinancingProcess overview

Advisor selection Debt offering

Strategy & Preparation

Information gathering

Rating agency selection

Due Diligence

Rating agency presentation

Due diligence by Rating agency

Meeting with rating analysts

Strategy Issuance

Decide on debt requirements (size, maturity, service capability etc)

Secure approval from board of directors

Secure commitments from participants

Finalize issue size by tranche

Legal & financial documentation

Preparation

Appoint issue managers / underwriter

Prepare support materials

Prepare bid book

Rating decision

Information gathering

Due diligence

Rating agency selection

Credit Rating

The same process applies to both public and private debt placement

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Raising DebtWhat is Credit Rating?

A credit rating assesses the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities

– Sovereign rating: Assess the country credit risk; used as a point of reference for country borrowings from WB, IMF, ADB, IDB

– Entity rating: Risk rating of Corporate entities

– Instrument rating: Rating of the bonds issued by different corporations and municipalities

A credit rating tells a lender or investor the probability of the subject being able to pay back a loan

Poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates

Major Credit Rating Companies:– Standard & Poor’s– Moody’s– Fitch Ratings

Advisor selectionDebt

offeringCredit Rating

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Credit RatingBenefits of Credit Rating

Investors use ratings in several different ways, which provide value to Issuers also

For Investors, Credit ratings are:

– A source of additional certification

– A source that forewarns risk

– A guide for pricing securities

For Issuers, Credit ratings:

– Increase the investor population

– Encourage financial discipline within the organization

– Lower the cost of borrowing

– Provide a marketing tool

– Make foreign collaborations easy

In summary, Credit ratings benefit the industry as a whole

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Credit RatingThe process to get ‘rated’

Issuer / Borrower

Credit Rating Agency

Requests for a RatingAssigns analytical team, conducts basic research

Prepares documentsCollects additional

information

Rating presentations, site visits, management meetings

Communication of Rating to Issuers

Dissemination of rating / publication

Rating Committee assigns rating

Surveillance & Annual Review

Appeal Rating decision (if required)

Step 1: Strategy & Preparation

Step 2: Due Diligence

Step 3: Rating decision & Communication

Follow-up step: Constant Review

Obtaining a Credit Rating for the first time is a 3-step process

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Credit RatingRating methodology

Rating Agencies follow a rigorous methodology to assess Issuers seeking rating

– Financial and legal due diligence

– Site visits

– One-on-one meetings with management and key personnel

Following major factors are assessed in the Credit Rating process:

Non-Financial factors Financial factors

Earning & performanceIndustry Risk

Market position

Ownership & support

Management Evaluation

Corporate Governance

Cash flows

Capital & Debt structure

Funding & Flexibility

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Credit Rating MethodologyIndustry Risk assessment – Key considerations

Economic importance of the industry to the country

Potential for support

Employment significance

Industrial relations record

Significance of legislation: protective / harmful, relationship with government

Maturity of the industry

International competition

Barriers to Entry

Competitive situation domestically: monopoly, oligopoly, fragmentation

Nature of the industry: capital intensity, product lifespan, marketing requirements

Cyclic factors: demand, supply, implications for price volatility

Industry cost & revenue structure: susceptibility to energy prices, interest rate levels, government policies (subsidies etc)

Important developments and trends in the industry



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyMarket position assessment – Key considerations

Competitive position within the industry: size, market share & trend, price-setting ability

Major product importance

Product lives and competition

Degree of product diversification

Significance of R&D expenditure and of new product development

Geographic diversity of sales and production

Significance of major customers

Dependence on major suppliers and access to alternatives

Marketing needs

Distribution network, control and susceptibility to external factors

What are growth trends, and sources of growth?



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyOwnership & Support assessment – Key considerations

The specific issues include:

– Ownership of the entity

– Relationship with the owners, autonomy, control

– Financial strength of the owner(s)

– Potential for support and / or fund withdrawals

– Structure of ownership

– Other benefits: access to technology, products etc

– Access to capital markets



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyManagement evaluation – Key considerations

The specific issues include:

– Record to date in financial terms

– Corporate goals and outlook: aggressive stance, attitude to risk

– Experience, background and credibility

– Depth of management: key individuals, succession

– Record compared with peers



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyCorporate Governance assessment – Key considerations

The independence and effectiveness of the Board of Directors

Oversight of related party transactions that may lead to conflicts of interest

Board oversight of the audit function

Executive and Director remuneration

Complex holding company structures

Ownership by private individuals and families

Other aspects of Corporate governance whose impact on bondholders is less clear-cut – e.g. ownership by executives and directors



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyEarnings & Performance assessment – Key considerations

Consistency and trend of core earnings

Earnings mix by activity and geography

Exceptional and extraordinary items: non-recurring impacts of past earning levels

True earnings available for cash flow: equity accounting, restrictions on profit repatriation

Internal growth vs acquired earnings

Profitability and protection measures

Profit margins

Interest and pre-tax coverage measures

Dividend cover, payment levels and future policy

Taxation situation – effective tax rate, specific relief

Sufficiency of retained earnings to finance growth internally



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyCash Flows assessment – Key considerations

Relationship of cash flows to leverage and ability to internally meet all cash requirements is evaluated. The volatility of cash flow over time and the impact of seasonality on cash flow is also assessed

The specific issues include:– Adequacy of cash flows to maintain the operating capacity of the business: working capital

levels, replacement of fixed assets etc– Contribution from cash flow towards expansion – major capital spending projects, acquisitions– Discretionary spending included in cash flow including advertising, exploration, research &

development, etc– Volatility of cash flow over time– Relationship between cash flow and total debt– Restrictions on cash flow: limits on repatriation, potential tax effects, access to dividends from

subsidiaries– Liquidity levels and fluctuations: seasonality, sensitivities– Working capital management and measurements



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyCapital & Debt Structure assessment – Key considerations

Debt / Equity measures: historic, present and projected

Leverage (total liabilities / equity) measures: historic, present and projected

Sensitivity analysis on projected levels

Seasonal variations

Coverage measures on interest and leasing

Adjustment for off-balance sheet items

Appropriateness of capital structure for the business: over-reliance on short-term funding, sensitivity to interest rate changes

Debt structure: Type, maturity, currency, service schedule, covenants, security, default clause



Market position

Ownership & support



Cash flows



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Credit Rating MethodologyFunding & Flexibility assessment – Key considerations

Flexibility of planned financial needs: capital spending, dividend levels, acquisitions etc

Ability to raise additional financing under stress

Back-up and standby lines of credit: periods and covenants of underwriting facilities and committed lines, bank relationships generally

Ability to attract capital: shareholder make-up, access to equity markets

Capital commitments

Margin of safety in present and planned gearing / leverage levels

Asset make-up: nature of assets and potential for reductions or disposals under stress, scalable units

Off-balance sheet assets and liabilities: goodwill or other intangibles written off, undervalued assets, pension under funding



Market position

Ownership & support



Cash flows



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Credit RatingDue diligence – Documents required

Indicative summary of required documents

Company Profile Financial Section

Overview of Company history

Shareholder structure

Corporate organizational and legal charts

Breakdown of main business areas (Revenues, Earnings, Cash flow, Assets)

Information about specific projects

Detailed description of the Media / Real Estate sector in the region, including legal framework evolution

Management and future strategy (e.g. growth ambitions)

3 years (ideally, but Rating Agencies flexible on this point) of consolidated IFRS audited financial accounts, including P&L, Balance Sheet, Cash Flow Statement and notes

Consolidated Business Plan for the next 5 years, including assumptions, management discussion and detailed description of P&L, Cash Flow and Balance Sheet projections

Description of capital expenditure plans and funding policy

Description of cash management policy and liquidity overview (existing bank credit lines etc)

Overview of financial contingencies

Current and target capital structure

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Raising DebtDebt Offering process

Issuer / Borrower

Underwriter

Secures Board of Director approval

Proposes best debt structure

Draft offering prospectus

Identify potential investors / and host road show

Prepare bid book / record orders

File registration statement with listing body (if required)

Step 1: Strategy

Step 2: Preparation

Step 3: Issuance Decide size of issue and final price

Define an issue price (guide)

Complete legal and financial documentation

Issuing debt (or any public security) is a complicated and tedious process

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Debt OfferingGeneral cash offering

Almost all debt is sold in general cash offerings

There are two methods for issuing securities for cash:

– Firm Commitment Under a firm commitment underwriting, the investment bank buys the securities outright from

the issuing firm Obviously, they need to make a profit, so they buy at “wholesale” and try to resell at “retail” To minimize their risk, the investment bankers combine to form an underwriting syndicate to

share the risk and help sell the issue to other investors / public

– Best Efforts Under a best efforts underwriting, the underwriter does not buy the issue from the issuing firm Instead, the underwriter acts as an agent, receiving a commission for each unit sold, and

using its “best efforts” to sell the entire issue

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Date Issuer Credit rating * Amount Term (years) Coupon Spread

Mar 2009 Abu Dhabi Government Aa2 / AA / AA $ 1,500 million 5 yr (Apr – 2014) 5.500 % T + 400

Mar 2009 Abu Dhabi government AA2 / AA / AA $ 1,500 million 10 yr (Apr – 2019) 6.750 % T + 420

May 2009 Mubadala Development Co. Aa2 / AA / AA US $1,250m 5-yr (May – 2014) 5.750 % T + 395

May 2009 Mubadala Development Co. Aa2 / AA / AA US $500m 10 yr (May – 2019) 7.625 % T + 462.5

May 2009 Aldar Properties A3 / A- / NR US$1,250m 5-yr (May – 2014) 8.750 % N/A

Jun 2009 Tourism Development &

Infrastructure Company (TDIC)

Aa2 / AA / AA US$1,000m 5-yr (Jun – 2014) 6.500 % T + 390

Jul 2009 Dolphin Energy Ltd. Aa3 / NR / A+ US$ 1,250m 10 yr (Jul – 2019) 5.888% T + 337.5

*: Ratings are provided for Moody’s / Standard & Poor’s / Fitch

Saudi Arabia;

20%

Dubai; 40%Rest of UAE; 24%

Egypt; 4%

Lebanon; 3%

Other; 9%

Abu Dhabi; 56%

Qatar; 36%

Bahrain; 6% Saudi Arabia; 2%

2007 - 2008 2009 YTD

Abu Dhabi borrowers have been the most active in the market (2009 YTD)

Debt-Financing in Abu Dhabi2009 YTD major activity

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Credit Rating – Aa2 / AA / AA

‒ Abu Dhabi’s revenue expected to be stable (dividends from ADNOC and ADIA)

‒ Will maintain budget surplus, if oil price exceeds $40

Total bond programme - $10 bn

‒ Issue over-subscribed: Total interest $7bn

‒ $3bn raised in Mar 2009

‒ 2 tranches of $1.5bn each (one 5-yr and another 10-yr)

‒ Pricing(1):

‒ 5-yr bond priced 400bps above US treasuries

‒ 10-yr bond priced 420bps above US treasuries

Bond purpose:

‒ General government budget expenditures

US; 25%

Europe; 42%

Middle East; 21%

Asia; 6%Other; 6%

US; 57%Europe; 28%

Middle East; 8%

Other; 7%

US$1.5bn 5-year tranche


Abu Dhabi GovernmentUS $10bn Sovereign Bond Programme

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‒ Rating achieved on the backing of Abu Dhabi government

‒ Comparables receive lower rating

‒ E.g. Blackstone group has S&P ‘A’ rating (2 levels below best) despite strong earnings and $91bn assets under management

$1.75 bn bonds issued

‒ 5-yr $1.25bn issue at 395bps(1) over US treasuries

‒ 10-yr $500m issue at 462.5bps over US treasuries

‒ Offering managed by Citibank, Goldman Sachs & Royal Bank of Scotland

Purpose

‒ Project financing (acquisitions, investments)

US; 24%

Europe; 42%

Middle East; 28%

Asia; 6%

US; 43%

Europe; 39%

Middle East; 12%

Other; 6%


US$500mn 10-year tranche

Mubadala Development Co.US $1.75bn offering

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Credit Rating – A3 / A- / NR

‒ Rating reflects its strong market position in Abu Dhabi & large land bank


‒ 5-yr maturity with 8.75 percent fixed-coupon

‒ Higher coupon than Abu Dhabi Sovereign & Mubadala bonds

‒ Offering managed by Goldman Sachs, Barclay’s Capital, NBAD and ADCB

Purpose

‒ Construction project execution

Aldar PropertiesUS $1.25bn offering

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‒ Rating achieved on the backing of Abu Dhabi government

$1.0 bn bonds issued (debut issue)

‒ 5-yr bond @390 bps over US treasury

‒ Offering managed by HSBC Holdings PLC, Banco Santander Sa, Bank of Tokyo Mitsubishi

Purpose

‒ Fund infrastructure development projects

US; 30%

Europe; 33%

Middle East; 25%

Asia; 12%


Tourism Development & Infrastructure Company (TDIC)US $1.0bn offering

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Credit Rating – Aa3 / NR / A+

‒ Rating reflects existing capital structure (70:30 debt:equity) and ownership structure (51% Mubadala, 24.5% Total & 24.5% Occidental)


‒ Part of total debt package of $4.1 bn (incl. $1.6bn debt facility and $1.2bn co-lending from Total & Occidental)

‒ 10-yr bond @390 bps over US treasury

‒ Offering managed by Royal Bank of Scotland (RBS), BNP Paribas, Abu Dhabi Commercial Bank, National Bank of Abu Dhabi

Purpose

‒ Refinance $3.45 bn loan secured in 2005

‒ Finance construction costs of Taweelah-Fujairah gas pipeline (70% of total costs)

Draft – For Discussion Only

Dolphin Energy LtdUS $1.25bn offering

20090829 financing overview

Documents

capital source cost

capital structureii

firms capital cost

debtors capital

firms capital requirement

capital structurethe

payments debt

debtservice payments