Subject: quick answer Date: Fri, 22 Feb 2002 13:09:21 -0500 From: Ben Esty To: "Campbell R. Harvey" Cam, First, I am very happy to hear the Chad-Cameroon case went so well. It is a very interesting and important deal in the world of project finance. With cases like that one, Mozal, Petrozuata, I trust you can understand why I like studying project finance/emerging market finance and writing these cases. Your question regarding on vs. off-balance sheet is a good one, but not one with a simple answer. I do not know of a good place to refer you to either. I am in discussions with a large oil and gas company about writing a case on their reporting/disclosure strategy--given all the current interest, it seems like a timely case to write. The on/off balance sheet decision is mainly a function of both ownership and control. Project finance for a single sponsor with 100% equity ownership results in on-balance sheet treatment for reporting purposes. But....because the debt is a project obligation, the creditors do not have access to corporate assets or cash flows (the rating agencies view it as an "off credit" obligation--in other words, not a corporate obligation). Even though people refer to PF as "off-balance sheet financing" it can, as this example shows, appear on-balance sheet. A good example is my Calpine case where the company has financed lots of stand alone power plants. In the aggregate, the company showed D/TC = 95% on a consolidated basis. With less than 100% ownership, it gets a lot trickier. Many projects are done with 2 sponsors each at 50%. In this case, they both can usually get off-balance sheet treatment for the debt and the assets. Instead, they use the equity method of reporting the transaction (with even lower ownership, they use the cost method of reporting). All of this changes if they have "effective control" which is a very nebulous concept. (with 40% ownership but 5 out of 8 directors you might be deemed to have control). Even if you do not have to report the debt on a consolidated basis, there are often lots of obligations that do need to be disclosed. For example, if you agree to buy the output of a project, that should be disclosed as a contingent liability in the footnotes to your annual report. There are differences between tax and accounting conventions. My view of Enron, partially based on the case I wrote with Peter Tufano on and Enron power plant (valuing the plant as an exchange option), is that they got very aggressive in pushing things off-balance sheet even where they had effective control. In addition, they may not have reported all of their contingent obligations related to projects and other investments. It's far too early to see what was aggressive interpretation of accounting rules, and what was outright fraud. I think there was some of both. What's interesting, however, is the fact that only the "hard assets" (power plants, pipelines, and reserves) have any value. The "asset light" strategy really unfolds quickly when credibility is jeopardized. Ben PS: I have another new case that's just about done that I think you might like. It's a 2 part case on BP Amoco's investments in the Caspian oil fields. The A case is a policy statement on when and why BP used project finance. The B case gives students a chance to apply the policy statement to a real financing decision. I am almost done with the Teaching note and would be very curious to get your quick comments on it if you have any time. At 11:44 AM 02/22/2002 -0500, you wrote: >Ben, >The Chad-Cameroon case was a great hit in my class. All my students know you. >One question that I got (in general throughout my discussion of project >finance) was whether the project finance was "off balance sheet" stuff - i.e. >the same type of issues that got Enron in trouble. I would be interested in >your views. > >-Cam >p.s. I have made my students aware of the paper with Bill > > > >Ben Esty wrote: > > > Cam, > > > > I am writing to check on three things: > > > > First, I wanted to make sure you got the package of stuff I sent in > > December. I direct your attention to the Chad-Cameroon case which is > > getting a lot of attention (potentially the most important project in the > > last 5 years). Also the A2 Motorway case (in Poland) is a good case to > > discuss risk management--internal structuring of projects. It gives a very > > detailed look at all the "financial engineering" that goes on inside a > > project company. > > > > Second, I wanted to thank you and the RFS referees for your comments on my > > "syndicate structure" paper with Bill Megginson. We have done a major > > revision, in large part due to those comments, and now have a new draft. I > > am attaching a PDF copy for your interest or for your Emerging Market Corp > > Fin web site. I recently published a related case study in the JACF (on > > the syndication of the HK Disneyland loan). > > > > Finally, do you have any problem with me asking my students to watch some > > of your video clips from your Emerging Market Corp Fin web site? I was > > thinking of assigning a few that deal with calculating discount rates in > > emerging markets. > > > > Hope all is well with you. > > > > Ben > > > > Prof. Benjamin C. Esty > > Morgan 381 > > Harvard Business School > > Boston, MA 02163 > > Phone: (617) 495-6159 > > Fax: (617) 496-6592 > > > > ------------------------------------------------------------------------ > > Name: Esty-Megginson Paper.pdf > > Esty-Megginson Paper.pdf Type: Acrobat (application/pdf) > > Encoding: base64 > > Download Status: Not downloaded with message > >-- >Campbell R. Harvey >Fuqua School of Business >Duke University >Durham, NC 27708 USA >http://www.duke.edu/~charvey >+1 919.660.7768 Office >+1 919.660.8030 Fax >+1 919.349.7430 Cell Prof. Benjamin C. Esty Morgan 381 Harvard Business School Boston, MA 02163 Phone: (617) 495-6159 Fax: (617) 496-6592