PROJECT COMPANY IN PUBLIC PROJECT FINANCE

Mutui Peter

1.1. Introduction Project Finance

Yescombe, (2013) defines Project Finance (PF) as the raising of finance on a limited
recourse basis, for the purposes of developing a large capital-intensive infrastructure
project, where the borrower is a special purpose vehicle and repayment of the financing
by the borrower will be dependent on the internally generated cashflows of the project.

It is a loan structure that depends mainly on the cashflow from the project for repayment.
In this financing arrangement the asset assets, rights, and interests to the projects are held
as secondary collateral. It is usually attractive to the private sector because entities can
finance major projects off-balance sheet (OBS).

Pinto (2017) defines project finance as the process of financing a specific economic unit
that the sponsors create, in which creditors share much of the venture’s business risk and
funding is obtained strictly for the project itself. Project finance creates value by reducing
the costs of funding, maintaining the sponsors financial flexibility, increasing the leverage
ratios, avoiding contamination risk, reducing corporate taxes, improving risk
management, and reducing the costs associated with market imperfections.

Pinto (2017) overserves that over the last 35 years, PF has been an important source of
funding for public and private ventures around the world. It is most commonly used for
capital-intensive facilities and utilities such as power plants, refineries, toll roads,
pipelines, telecommunications facilities, and industrial plants with relatively transparent
cash flows, in riskier than average countries, using relatively long-term financing.

This definition emphasizes the idea that lenders have no claim to any other assets than the
project itself. Therefore, lenders must be completely certain that the project is fully
capable of meeting its debt and equity liabilities through its economic merit alone.

The success of a PF transaction is highly associated with structuring the financing of a

project through as little recourse as possible to the sponsor, while at the same time
providing sufficient credit support through guarantees or undertakings of a sponsor or third
party so that lenders will be satisfied with the credit risk 2. Finally, the allocation of
specific project risks to those parties best able to manage them is one of the key
comparative advantages of PF.

1.2. Parties to Project Finance

Project finance deals are usually complex and several parties are involved in the
implementation of the project. These parties include government agencies, project sponsor
(s), project company banks and other financial institutions, experts, suppliers, off-taker(s)
and other third parties depending on the complexity of the project as shown in figure 1. At
the center of PF agreement is the establishment of the Project Company which is
commonly referred to as the Special Purpose Vehicle (SPV). The Project Company (SPV)

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 is an entity that is financially and legally independent from the sponsors, meaning that it
is a standalone entity.

Figure 1: Structure of Project Finance

Source: Pinto (2017)

1.3. Project Company and its Justification in Project Finance

According to Andrew (2006), the core of a project financing is typically the Project
Company (SPV). It comprises of the consortium shareholders (such as contractors or
operators who may be investors or have other interests in the project). The SPV is formed
specifically to build and operate the project.

1.3.1. Justification of SPV in Project Finance

The lifecycle of the SPVs often running into decades, can “out survive” their initial owners
who frequently transfer them to other ones. By doing so, the SPVs enable to transfer a
plenty of assets, liabilities and capabilities collected and developed during their entire
lifecycle. For example:
➢ Tangible assets such as the infrastructure resulting from the project endeavor;
➢ Intangible assets such as licenses, patents, etc.;
➢ Financial assets and liabilities;
➢ Operating personnel;

Project financing is “limited” or “non-recourse” to the shareholders. In the case of non-

recourse financing, the project company is generally a limited liability special purpose
project vehicle, and so the lenders' recourse will be limited primarily or entirely to the
project assets (including completion and performance guarantees and bonds) in the case

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 of default of the project company. Thus, the existence of SPV in Project financing can be
justified because of the following three key reasons, (Brookes, N. et al):

a) It is a fenced entity. SPV is a “self-fenced organization”. There are legal and financial
mechanisms to isolate assets, liabilities and risks associated to the SPV. This is
essential for most of the SPV activities.
b) It has limited and pre-defined purposes. SPVs are designed to pursue specific
objectives and are usually constrained by their lifetime. In legal terms they have scope
limitations; the purposes are constrained by the limitations in the statute or financial
and contractual mechanisms. In some projects, the limitation of the purpose is set by
specific documents such as: the shareholders agreement and the certificate of
incorporation. In other projects the SPV, after delivering the original purpose, changes
its status and can assume another form of entity. Once the SPV ceases to follow limited
and predefined purposes, it stops being an SPV.
c) It has a legal personality. The SPV is a legally recognized entity, such as: trusts,
partnerships, limited liability partnerships, corporations and limited liability
companies. The legal characterization is country specific e.g., in Switzerland SPVs
are always trust, in Argentina SPVs take the form of mutual funds, trust or corporation,
etc. The legal personality is an essential status to enable the previous two
characteristics.

1.4. Ways of Incorporating Project Company

The SPV is created as an independent legal entity, which enters into contractual
agreements with a number of other parties necessary to the project. The contracts form the
framework for project viability and control the allocation of risks. It enters into
negotiations with the host government to obtain all requisite permits and authorizations,
ESCAP, U. (2008).
Most commonly, SPVs are in the form of a subsidiary company with
an asset, liability and legal status that ensures independence and makes the
SPVs obligations secure even if the parent company were to become insolvent.
Conversely a parent company can use an SPVs to finance a large project without putting
the entire business at risk.

SPVs can also be used for partnering and joint ventures with the shareholding reflecting
the participants contributions. It can also allow investors opportunities which would not
otherwise exist, creating a new source of revenue generation for the sponsoring firm.

SPVs in the form of limited companies, partnerships or trusts can be registered outside the
country of operation, and this can be used as a strategy to avoid tax that would otherwise
be payable.

The creation of an SPV can sometimes lead to lower funding costs when the assets to be
purchased and owned by the SPV are judged by lenders to be a greater quality of collateral
that the credit quality of the sponsoring corporation.

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QUESTION TWO
2. Identify at least three projects in Kenya financed through project finance and describe the
structure.

1. Introduction
According to the website of Public Private Partnerships (PPP) Directorate of Kenya, there were
64 projects in Kenya financed through project finance as at May, 2021. These projects were
spread across 9 sectors of which Transport and Infrastructure sector had the largest share of 21
projects. Education and water and sanitation sectors came second and third with 14 and 10
projects respectively. Other sectors with projects financed through project finance were Health
(6), Energy and Petroleum (5) and many others as illustrated in Figure 2: PPP Projects in Kenya

Figure 2: PPP Projects in Kenya

Water and Sanitation 10

Transport and Infrastructure, Privately Initiated… 2
Transport and Infrastructure 21
Tourism, Trade & Industrialization 3
Privately Initiated Investment Proposals (PIIPs) 2
Health 6
Energy and Petroleum 5
Education 14
Agriculture, Livestock & Fisheries 1

0 5 10 15 20 25

Number

Source: PPP Directorate website, 2021.

2. Projects in Kenya Financed Through Project Finance

The following three projects were selected from the PPP Directorate website for the purposes
of analyzing their structure, that is:

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 a) Quantum Power Menengai Geothermal Power Project;
b) Kenyatta University Students Hostels Project;
c) Nairobi – Thika Highway Improvement Project

Summarized below the structure of the three projects.

Table 1: Quantum Power Menengai Geothermal Power Project

PROJECT SUMMARY NOTE
Project Description The Project involves development of a 35 MW Geothermal Power
Plant at the Menengai Geothermal Field in Nakuru County, Kenya
under Build-Own-Operate (BOO) model (the Project). The Electricity
generated will be evacuated through a 13 km 132 kV transmission line
which has been completed and energized by the Kenya Electricity
Transmission Company Limited (KETRACO).
Borrower and Sponsors The sponsor is Quantum Power Group (via a wholly owned subsidiary;
Quantum Power East Africa Ltd (QPEA), a Pan- African Industrial
Investment Platform focused on power generation, energy and related
infrastructure. Quantum Power Group is 100% owned by Quantum
Pacific International Limited – an international energy company with
USD 6 billion in assets. The Sponsor has set up a Project Company
(Quantum Power East Africa GT Menengai – QPEA GT) to execute
the project. QPEA is focused on investing in energy and power in
Africa, including Kenya, Tanzania, Uganda, Burundi and Zambia,
among others.
Cost Structure and The total project cost is USD 97.8 million, to be financed with a debt-
Financing Plan to-equity ratio of 75:25. QPEA and its partners will provide the equity
and the senior debt will be provided by AfDB, Climate Technology
Fund (CTF), Trade and Development Bank (TDB) – formerly PTA
Bank, and Finnfund.
Role of the Bank The Bank is the Mandated Lead Arranger (MLA) for the debt financing
for Project. The Bank will provide up to USD 29.5 million of senior
debt with a maturity of 16 years including 2 years of grace period from
its own resources. The Bank has also mobilized USD 20 million from
CTF, USD 18 million from TDB (PTA) and USD 5.8 million from
Finnfund. The Bank’s Board also approved a Partial Risk Guarantee
(PRG) in 2015 to backstop Geothermal Development Company (GDC)
and Kenya Power and Lighting Company Limited (KPLC) contractual
payment obligations on the project.
Implementation After an international competitive bidding (ICB) process by GDC,
Arrangements QPEA was awarded the concession to finance, build and operate the
Project. The Project Company signed a long term (25 years) take-or-
pay Power Purchase Agreement (PPA) with KPLC and a Project
Implementation and Steam Supply Agreement (PISSA) with GDC.
KPLC will pay a tariff of 5 US c/kWh to QPEA GT for the generated
electricity. KPLC will also pay 2.0 US c/kWh directly to GDC for the
steam. GDC, a wholly owned government of Kenya entity, is

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 responsible for drilling, producing and delivering a pre-agreed quantity
and quality of steam to the power plant. The Bank has supported
GDC’s drilling program.
Environmental and Social The project has been assigned a category 1 in line with the guidelines
Aspects within the Bank’s Integrated Safeguard System (ISS) for all power
generating plants exceeding a generating capacity threshold of 30MW.
To comply with the policy requirements of this category 1 rating,
QPEA GT updated (in February 2015) an initially prepared
Environmental and Social Impact Assessment (ESIA) prepared by the
project initiators GDC in September 2013. The updated ESIA has been
approved and issued and NEMA license. An Abbreviated Resettlement
Action Plan (ARAP) has also been prepared and implemented for a
13km 132Kv T-line, which is an Associated Facility by KETRACO in
December 2013. The original GDC and updated QPEA GT ESIAs have
been reviewed by the bank and a summary has been prepared and
posted on the Bank’s website.
Market Kenya’s power generation installed capacity in 2017 was 2,354 MW
and is expected to grow to 3,570 MW in 2020 and 9,521 MW by 2035
according to the Country’s Least Cost Power Development Plan (2015-
2035), prepared in October 2016. In light of the country’s high growth
rate, power consumption is expected to increase drastically. Power
generated in Kenya will be used for domestic consumption and to
support the Government’s flagship projects such as the LAPSETT Oil
Pipeline and refineries, Konza Techno city, Special Economic Zones
as well as export to the neighboring countries such as South Sudan,
Uganda and Tanzania. The electricity demand is projected to grow
annually at between 6% (low Scenario) and 10% (GoK Vision 2030
scenario).

Table 2: Kenyatta University Students Hostels Project

PROJECT SUMMARY NOTE
Project Description The project involves construction, operation and maintenance of a
student Hostel Complex within the University. It is proposed that the
hostels will cater for undergraduate and postgraduate students.
Project Site and Partners Kenyatta University Main Campus PPP BOT basis PPP Terms Private
party to design, construct, finance and operate the students’ hostels
Parties KU and Africa Integras (Kenya LLC) PPP project term 25 years
Payment mechanism Fixed rental
Name and deliverables of IFC was appointed by KU to provide Transaction Advisory Services to
Transaction Advisor introduce private sector participation in the provision of students’
accommodation under a PPP. The development will also incorporate
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 resource efficiency improvements (green buildings). IFC is supported
by specialized consultants; Motts MacDonald as technical consultants
and Hamilton Harrison & Mathews Advocates as legal counsel. Scope
IFC undertook the preparation, design, and implementation for the
private sector participation in the Project by attracting one or more
private sector investors with established financial standing and
experience in the development, management, operation and
maintenance of student hostels or related facilities.
Project Cost Kshs 1,165M (USD14.13M) Capital Required KES2.4Billion
(USD28.5M) Capital Financing Private debt and equity (70:30) Return
on Equity 15%
Financing Structure 1. Financing
The model has assumed that the private operator will fund the
project using debt and equity. For the base case, the model assumes
that the debt-to-equity ratio is 70:30.

2. Cost of Debt Assumption

The lending rate for the long-term debt has been assumed at 15%
and the loan tenure is 15 years based on information obtained from
Housing Finance in Kenya. The project is able to cover its
minimum Debt Service Coverage Ratio (DSCR) of above 1.2 post
construction period and through the entire PPP project term.

3. Equity assumptions
The model assumes that a real equity IRR return of 15% will be
attractive for equity investors. Based on market soundings and our
experience in the region, this is the return an investor raising share
capital for a similar project in Kenya would expect to earn over the
PPP project term. The equity IRR is calculated on the expected cash
flows to equity investors, and represents the return on investment
realized by the shareholders. The model calculates the equity IRR
on the following cash-flows:
a) The equity investment made by the investor during the
construction period
b) The net return attributable to the shareholders during the
PPP project term period Since the equity IRR represents the
estimated return on investment of the private party, it is
taken to be a good indicator of the financial attractiveness
of the project.
Rationale for Selecting the A feasibility study, which involved assessing the most feasible site as
Project for Development well as appraising the project’s technical, financial, legal, financial and
as a PPP environmental aspects, has been carried out. The feasibility study has
found out that delivery of this project as a PPP provides the best Value
for Money (VfM) to the University as contrasted to a publicly delivered
project. This will result from private sector innovation in developing

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 the facilities as well as efficiencies in operating and maintaining the
hostels.

Table 3: Nairobi – Thika Highway Improvement Project

PROJECT SUMMARY NOTE
Project Location Nairobi Metropolitan Area
Borrower Government of Republic of Kenya
Executing Agency 1. Ministry of Roads & Public Works-Kenya
2. Ministry of Transport-Kenya
Project Description ➢ Civil Works Nairobi – Thika Highway Improvement
➢ Civil Works for Nairobi City Arterial Connectors
➢ Consulting Services for Construction Supervision of the Civil
Works
➢ Consulting Services for Nairobi Metropolitan Transit System
(Nairobi Metro) Study
➢ Consulting Services for Private Sector Participation in Nairobi-
Thika Highway
➢ Consulting Services for Project Technical and Financial Audits
➢ Compensation and Resettlement of Project Affected People
Project Total Cost Total UA 175.10 million
➢ Foreign Exchange- UA 101.62 million
➢ Local Cost- UA 73.48 million

Bank Group Loan/Grant ➢ African Development Fund (ADF) Loan- UA 117.85 million
➢ ADF Grant- UA 3.15 million
➢ Other Source of Finance-Government of Kenya (GoK)- UA
54.10 million
Estimated starting Date of January 2008 – 36 months
Project and Duration
Procurement of Goods and The civil works contract will be packaged in three lots to be procured
works under International Competitive Bidding (ICB) procedures, with pre-
qualification of contractors
Consultancy Services ➢ Consulting services for Nairobi Metro studies and PSP in
Required and Stage of infrastructure and transaction advisory services will be acquired on
Selection the basis of a shortlist of qualified consulting firms following a
prequalification.
➢ Consulting services for project supervision is financed by GOK.
➢ The design consultant has been retained for the subsequent
supervision services.
➢ Project audit services will be procured on the basis of a short list of
auditing firms.

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REFERENCES

Andrew, F. (2006). Introduction to project finance (Essential capital markets).

Brookes, N. et al. Special Purpose Entities in Megaprojects. Transport and Urban Development,
Action megaproject TU, 1003.
ESCAP, U. (2008). Public-private partnerships in infrastructure development: A Primer.
Pinto, J. M. (2017). What is project finance? Investment management and financial
innovations, 14(1), 200-210.
Yescombe, E. R. (2013). Principles of project finance. Academic Press.