Athens - BEST

5/25/2018 Athens - BEST

1/27

Athens Ring Road(Attiki Odos)

28/03/2012

G 2


2/27

Gro p 2

Executive Summary

The Athens Ring Road Project, a 65 km long highway crossing Athens from west to

northeast, was deemed to be necessary because of increasing congestion, traffic and pollution

in and around the city and was seen critical for Greece to win the bid to host the 2004

Olympic Games.

Main challenges consisted of funding the project and the size and complexity of the project.Greece, burdened with a high budget deficit, had limited access to funds and the road was

considered technologically advanced, leading to technical and execution risk. Furthermore,

inexperience with such large and complex projects and legal difficulties with affected

municipalities, which needed governmental intermediation, complicated the project.

Deviations from the projections in key drivers of revenue of the project could have significant

implications for the returns of the private and public sector.

The proposed concession structure helps to mitigate some of the risks by allocating these to

the party which seems to be most capable of dealing with it. Using a Special Purpose Vehicle

makes the states creditworthiness less relevant, assuming a public equity contribution of just

25% At th d f 2023 th i t t hi f th j t t th


3/27

25% At th d f 2023 th i t t hi f th j t t th

Table of Contents

Problem Statement ............................................................ ................................................................. ............ 4

Project Finance and Public Private Partnerships......................... ....................................................... 5

Risks associated with the Athens Ring Road project ............................................................. ............ 8

Proposed Deal Structure ............................................................. ............................................................... 10

Financial returns for equity holders ..................................................................................................... 13

Key drivers of Returns ...................................................... ................................................................. ......... 15

Traffic/day: ................................................................................................................................................ 15

Price and Operational Cost: ................................................................................................................. 15

Leverage: ..................................................... ................................................................. ............................... 16

Potential investors ................................................................................................................... .................... 16

Alternative scenarios .................................................................................................................................. 17

All equity financed scenario ................................................................................................................ 17

Higher cost of debt scenario ............................................................ .................................................... 18

Alternatives to higher cost of debt .......................................................... .......................................... 19

Appendix .......................................................... ................................................................. ............................... 23


4/27

Problem Statement

The Athens Ring Road project aims to construct a 65km highway, crossing Athens from west

to northeast. Increasing traffic and high pollution in and around the city of Athens were the

main reasons for stronger pursuit of realizing this project. Moreover, the highway was

considered a major step to win the bid for the 2004 Olympic Games to accommodate the

transportation needs of athletes and spectators during the games. This event could have very

positive consequences for the whole Greek economy.

Funding was considered one of the major challenges for this project. The high deficit of the

Greek government made governmental funds almost impossible. Furthermore, the project was

supposed to be very complex given that almost all the construction of the highway,

interchanges, bridges and tunnels would have to be made in the urban setting of Athens,

which involved numerous stakeholders, including 33 municipalities. The highway was even

considered to be technologically advanced, meaning that it was necessary to attract foreign

construction firms, because local Greek construction firms lacked knowledge for such

advanced projects. It was also the first time that such a large and complex project would be

d t k i G


5/27

Project Finance and Public Private Partnerships

The growth of project finance over the last two decades has been driven mainly by the

worldwide process of deregulation of utilities and privatization of public-sector capital

investments. This took place in developed countries as well as in the developing world.

Although a generally accepted definition of project finance does not exist, there are some

main characteristics of this specific way of financing that can be highlighted.

Project finance can be defined as a way of financing the investment in a single-purpose capital

asset with a limited life. This includes as well the creation of a legally independent

organization which is financed with non-recourse or limited non-recourse debt and equity

(from corporate entities called sponsors) in order to manage and execute the project.

This definition points out the major characteristics of project finance. The main feature is the

creation of the legally independent organization, the Special Purpose Vehicle (SPV). The SPV

has a limited life (usually the duration of the project, i.e. 20 to 30 years), it is usually highly

leveraged, owns the projects assets and is the formal borrower under all loan documents so

that in the event of default or bankruptcy, sponsors are not directly responsible. Instead, their


6/27

successfully managing them. For instance, a fixed-priced construction contract with several

penalties for delays shifts the construction risk to the contractor instead of the SPV or itslenders. The next chapter will provide a deeper insight of risks and their mitigation in the

specific case of the Athens Ring Road project.

A Public Private Partnership (PPP) is formed when public and private entities (one or more

private entities) decide to collaborate in order to answer to public needs in the most effective

possible way, by sharing resources, risks and benefits. The partnership is called hybrid

(hybrid PPP) if other organizations are involved such as the European Union or the World

Bank. In a PPP project, the public sector entity transfers land, property or facilities controlled

by it to the private sector entity (with or without payment in return) usually for the term of the

arrangement. The private sector entity builds, extends or renovates a facility while the public

sector entity specifies the operating services of the facility. The services are provided by the

private sector entity using the facility for a defined period of time (usually with restrictions on

operations standards and pricing).

These projects may include publicly used motorways, toll roads, power plants,

t l i ti i f t t t l h l b ildi i t f iliti t


7/27

monopolies. The high fixed and financing costs cause entrance barriers for other operators if

the nature of the project even allows competition. This means that these projects are often

providing such essential services that they cannot be replicated, which leads as well to certain

price insensitivity (inelastic demand). These combined features result in stable cash flows

which allow the projects to be considerably high levered. At the same time, infrastructure

investments are able to provide inflation hedge. As infrastructure assets are real and tangible,

their replacement costs increase naturally with inflation and thereby protecting their value. On

the other hand, some projects provide cash flows which can be directly linked to inflation

through increasing fees (such as toll roads).

With reference to the risk-return pattern of this asset class, one needs to distinguish between

early stage and mature infrastructure assets. Mature infrastructure assets like established

airports, mature power generation or telecommunication represent established revenues with

total return expectations around 10 to 14% and a moderate risk profile. Early stage

infrastructure assets like pipeline construction projects have an expected total return of 18%

or even higher. Their respective risk profile is higher, having a risk-return characteristic

similar to private equity.


8/27

In project finance, the costs of financial distress tend to be lower. This results from the

negotiation between financiers which lead to a detailed predefined sources and uses of funds.

This and the generally stable cash flows make it as well possible to achieve higher levels of

leverage than those which are usually seen in corporate finance. The higher level of leverage

leads to possible higher returns for shareholders. In addition, risk allocation is carefully

evaluated and negotiated on the basis of the advantages that each party has by being exposed

to these risks. As a consequence, the risks are allocated efficiently at the lowest possible cost.

On the other hand, financial structuring in project finance tends to be very costly due to its

complexity. For this reason it requires a specific scale and is only adequate for large

investment projects. Moreover, due to the instance that these projects are one time, meaning

for a specific purpose, the involved debt and equity have usually a very low liquidity. This

feature should be reflected in the expected return for the investor. This can be seen as some

sort of liquidity risk premium.

Risks associated with the Athens Ring Road project

In a project finance scheme, effective project risk analysis is key to ensure the projects


9/27

technical infeasibility of construction or a simple underestimation of costs of any input are a

real threat to the execution and profitability of the project, given that capital expenditures

become highly inflated. This originates the risk about the costs of the project and a possible

budget overrun.

Allied to these execution risks are also some legal risks. The Ring Road would be constructed

in the urban areas of Athens covering 33 municipalities. The bureaucracy involved in dealing

and negotiating with all 33 municipalities is extremely extensive and could delay the start of

the project (in the worst case even prevent the project). At the risk of delaying the

construction process of the project, and consequently increasing the uncertainty surrounding

the final outcome of the initiative, this risk factor should be controlled by the public sector.

Further legal issues are imposed on the public sector in the event of a concession agreement

being reached. It would be the first major PPP deal in Greece. This would add the risk and

concern about the relative absence of specific legislation regarding PPP contracts.

A further main issue surrounding the project is its financing. The highways estimated total

construction and financing cost ranged from EUR 1 billion to EUR 1.5 billion. This is a very

high capital requirement which puts additional pressure on the limited Greek budget on one


10/27

This issue is further linked to another sensitive matter that is corporate governance. As in any

principal-agent relationship, there are considerable differences in incentives that drive each

party. Parties involved range between society, municipalities, private sector, banks and the

Greek government. This has the potential to generate considerable conflicts of interest. A

specific incentive and compensation scheme should to be designed to align interests. It must

allow for a thorough monitoring throughout the project as well as describe the control and

obligations of each party. Harmonized corporate governance is essential for the efficient

operation of the project and comprises the most important intangible risks of all.

Another source of risk is whether public demand for the Ring Road would be strong enough.

The single revenue source would be through toll-collection fees. Shortcoming a certain level

of traffic represents a considerable risk on the projects ability to repay its debt obligations

and its ongoing operational cost. At the limit this could even put in question the projects

feasibility. A sensitivity analysis on this topic will be conducted later to evaluate the impact of

this risk in the returns of equity-holders.

Finally, there are also some external issues that could affect the Athens Ring Road project.

Above all the soon-to-be-held Greek elections create the biggest uncertainty: political risk.


11/27

in m

ProjectCost

EquityInvestment

(%) EquityInvestment

DebtRaised

(%) DebtRaised

1996 200,0 70,0 35,00% 130,0 65,00%

1997 270,0 90,0 33,33% 180,0 66,67%

1998 250,0 60,0 24,00% 190,0 76,00%

1999 250,0 80,0 32,00% 170,0 68,00%

2000 190,0 70,0 36,84% 120,0 63,16%

2001 175,0 75,0 42,86% 100,0 57,14%

Exhibit 1 Proposed Deal Structure

In 2002, the year when operations start, generated revenue would first be used to pay

operational and maintenance expenses and then the debt service, according to a pre-

established debt-service schedule. All the remaining profit would be distributed as dividends

to the private shareholders (for a more detailed overview, refer to the chapter: Financial

returns for equity holders).

The single revenue source of the Athens highway will be from toll-collection fees. These fees

are linked to inflation and expected to increase annually according to this rate, imposed by the

government. Attiki Odos SA owns and operates the Athens Ring Road for 22 years. At the

d f thi i d th hi f th Ri R d ld b t f d t th G k


12/27

We believe that this deal structure allows for a proper mitigation of the enumerated risks. First

of all, the control of the entity is shared between the two parties, allowing for a more effective

distribution of responsibilities. Design, construction, operation and maintenance are attributed

to the private sector which has a more efficient managerial capability of dealing with these

tasks. While the legal circumstances surrounding the project are attributed to the government

which is a supreme entity and can perfectly mitigate those risks. In other words, each party is

responsible for the tasks where its natural strengths lie.

The financial burden of the Ring Road is also distributed among the public and private sector,

with a higher burden being imposed on the latter. This is a better outcome for the Greek

government, as due to its high budget deficit, and the need to meet the EMU convergence

criteria, made the public financing of the entire project undesirable. At the same time this

capital commitment contributes for an alignment of incentives between the two parties, as the

private sector has the biggest interest in effectively managing the highway. Further

contractual agreements, like the DSCR of 2 during the operational life of the project further

contribute for the alignment of incentives and for the operational feasibility of the project.

Private sector would have the incentive to delay debt repayment in order to increase dividends

i d d b t it t b t Th DSCR i t ll ti thi t


13/27

Financial returns for equity holders

In order to estimate the financial returns for the private and the public sector, we built the

necessary cash flows from the year 1996 until 2023, when the project will officially be

handed over to the Greek government. The concessions structure proposed by Papadopoulos

consists of 67% debt and the remaining in equity throughout the first five years, adding up to

the total cost of EUR1.335 billion.

There is no specific information about the division of equity between private parties and the

Greek government. A 25% stake from the government seems a reasonable assumption, since

the government needs to have a substantial amount of control over the project, especially to

deal with the 33 local municipalities. Furthermore, from the private investors point of view,it

is not very likely to agree on a concession, where the government takes ownership after theend of the contract and generates a significant return, without having invested at the beginning

of the project. Additionally, the Greek government is expecting to obtain funding from the

EU, making the whole project a hybrid PPP. Therefore, considering this structure, both

parties, public and private sector, have to provide financing to overcome initial investment in

th fi t fi f 1996 til 2001


14/27

In the base case scenario, assuming a cost of debt of 8%, the debt is paid back within the year

of 2018, meaning that from that point forward, all net operating income is considered as cash

flow to the private investors. By setting the Net Present Value of all cash flows for private

investors to zero, we can estimate the discount rate to reach this scenario, which equals the

internal rate of return (IRR) of the project. This leads to an IRR for the private sector of

20.76%. The calculations for the cash flow can be seen in greater detail in Appendix 1.

The public sectors IRR is calculated with the help of the terminal value of the project in

2023. Assuming a cost of capital of 8%, which represents the worst case scenario within the

range of 6-8%, and a growth rate which is equal to the inflation rate of 3%, we can calculate a

terminal value. In the base case scenario, the terminal value is EUR 1,005.76, leading to an

IRR of 14.80%. The IRR from the public sector just takes into account the initial investment

and the terminal value, because all cash flows during the contract period are paid to the

private sector. A lower cost of capital leads to a strong increase in the terminal value and has

therefore favorable implications on the public sectors IRR, as demonstrated in the two

exhibits below:

Exhibit 3 Table: Terminal value of project with different costs of equity


15/27

Key drivers of Returns

The internal rate of return for equity holders is very sensitive to some criteria that lead to the

final cash flows and consequently to their return. In order to check the robustness of the

calculation, a sensitivity analysis of the key drivers will show the impact of changes in the

variables. To make this analysis viable, we assume a flexible debt service schedule, so that the

main covenant of the debt holders, that DSCR is equal to 2, can be maintained in every year.

This may lead to longer debt repayment duration in some scenarios or even outstanding debt

after 2023, which will have a negative impact on the IRR of the public sector. Nevertheless,

this assumption seems more reasonable than violating the covenant in scenarios, which have

less favorable components than the case base scenario.

Traffic/day:

Traffic is an important variable especially for the internal return of the private sector. The

amount itself as well as the average increase per year directly affects the revenue and

therefore the cash flow received by private investors. If traffic is not as high as projected, they

will gain lower returns. Public returns are not affected, because the terminal value does not

h i h diff i D h f h h i f 220 000


16/27

because of Greek government and EU implementation, who try to fulfill their long-term

targets3.

Leverage:

The proposed structure by Papadopoulos suggests a capital structure of 67% debt and 33%

equity. Small changes in this structure result in differing IRRs for the private and the public

sector. The higher the amount of debt is, the more impact has the leverage effect, resulting in

substantially higher internal returns for the private sector, as a lower up front capital is

required. But with an equity stake of 15%, the debt will not be able to be repaid until 2023,

resulting in a substantial reduction in the IRR for the public sector as we assume that all the

remaining debt outstanding would be repaid by the government4- which is even lower than its

cost of capital. In general, the IRR for the public sector is less sensitive to changes in the

capital structure, because the terminal value is in most scenarios constant. An overview of

several different structure propositions can be found in appendix 4.

Potential investors

A f d h h i di i f d l d li Thi j


17/27

would have to be extremely large therefore only a few could enter in this investment:

examples are pension and endowment funds. A recent trend in the market is the creation of

funds specialized in infra-structure projects; several of these could invest in this project. This

would allow individuals and institutional investors, as well as funds of funds, to invest in

these infrastructure funds and thus indirectly own a position in the project.

Alternative scenarios

All equity financed scenario

If the Athens Ring Road project was to be all equity financed, maintaining the same structure

of equity (25% Greek government and 75% private sector5), it would yield an IRR of 11.70%

and 15.24% for the public and private sector, respectively.

Exhibit 5IRR of base case scenario and all equity financed project

IRR Base Case All equity

Private 20,76% 15,24%

Public 14,80% 11,70%


18/27

Higher cost of debt scenario

Assuming the base case scenario (project financed with a debt to capital ratio of 67%), if the

cost of debt financing was higher at 10% (up from 8%), the interest expense and consequently

the cumulative debt and interest would increase. The effect of these additional costs would not

have a significant impact in the returns for the private sector, since IRR would only decrease

to 20.15%.

On the other hand, there would still be debt outstanding of EUR 484 million by the end of the

concession period. Since it is assumed that the ownership of the project would be transferred

to the government in 2024, this means the state would have to bear the remaining debt costs.

If we deduct these outstanding costs to the perpetuity (stream of cash flows for the

government), the government would have an IRR of only 7.70%. If we assume a cost of

capital for the government of 8%, this would mean the project would yield a negative Net

Present Value. Below we can see more clearly the effect of different costs of debt financing to

the returns of both the private and public sector. It is important to mention that in these

computations we have changed the debt repayment schedule in order to meet a debt service

coverage ratio of 2.0 which is required by debt providers.


19/27

changes a little over than one percentage point. This is clearly not the case for the Greek

government: whenever there is outstanding debt by the end of the concession period, the state

has to assume this cost and this affects its rate of return. This happens for a cost of debt of

10% and higher, and for these cases the IRR is below the cost of capital of 8% for the

government (marked in green line in the chart). If this was a conventional project decision

taken within a firm, it would likely be rejected since the basic NPV rule is to reject projects

which return a negative NPV, which means the project would actually be destroying value,

rather than creating value. However, since this is a project carried by the government, we

should take into account that there are other objectives involved other than monetary, such as

increasing society well-being and reducing traffic and pollution, which could also impact the

decision-making process.

Alternatives to higher cost of debt

As we have seen earlier, if the cost of debt was 10% in the base case scenario, the government

would be the most affected between the equity holders, making a monetary loss in this

investment. In order to avoid such situation to happen, we could propose the Greek

id h di i i h ld i i hi i k


20/27

private entities able to undergo such a large investment. Also the return might not be

sufficient to convince private investors to commit with such a large equity portion. The lower

rates of return are generated by the decrease of the leverage effect, and the higher initial

equity commitment (See appendix 6 for full computations).

Finally, our third suggestion would be to renegotiate the debt service coverage ratio with the

debt providers, in order to pay back the debt more quickly. Assuming a scenario where

sponsors could bring the DSCR down to 1.5, debt would be fully repaid by the end of 2016.

The government could maintain its initial rate of return unchanged at 14.8%, since it would

commit the same level of initial equity and earn the same perpetuity of cash flows. On the

other hand, a lower DSCR would mean more cash flow allocated to debt holders than equity

holders in the first years of the concession, until debt is repaid in full. Taking into account the

concept of time value of money, higher cash flow streams in later years do not necessarily

mean a higher return. In fact, the IRR for private investors would decrease to 17.58% as a

result of a lower rate of dividends in the first years. This scenario makes the project less

attractive to private investors, although still very close to the above mentioned hurdle rate of

18% for early-stage infrastructure investments. Alternatively, a higher cost of debt financing

ld ff h f h G k (S di f f ll i )


21/27

Conclusion and Recommendation

The execution of the Athens Ring Road project would definitely lead to an increase of social

welfare. The establishment of the ring road is seen as crucial for Greeces bid to host the 2004

Olympic Games which would obviously lead to further economic growth in the country.

The proposed concession structure through a PPP can thereby mitigate some of the major

risks. Though not all of the risks that may arise in this project can be mitigated, the design,

construction and operational risk will be mostly shifted to the concessionaire (private sector)

while the government (public sector) will handle the legal issues with the municipalities.

Furthermore, the state could reduce the financial risk which emerges from the high investment

costs and the government deficit as it will only contribute a low equity stake in SPV (in our

assumptions 25%).

The proposed capital structure of 33% equity and 67% debt for the project will lead to

attractive returns to both the private and public sector. Based on the projected cash flow

stream, the assumed cost of debt of 8% and the covenants, the private and the public sector

can expect an IRR from this project of 20.76% and 14.80%, respectively. In the perspective of

i i hi j d i i h h i ll d


22/27

these options, one has to consider that it has to be as well appealing for the private sector. We

would recommend the extension of the concession period as it yields the highest IRR for the

private entity, 20.32%.

We have discussed alternatives that consisted in changing the DSCR, leverage and concession

period. While doing that, for simplicity purposes, we assumed that it would not change the

cost of debt but, in reality, these changes would likely impact the cost of debt; for instance,

just by decreasing leverage the cost of debt would decrease significantly.

To conclude, the main investors in such infrastructure projects are expected to be - besides the

pure infrastructure funds of banks or private equity firms - institutional investors such as

pension funds and insurance companies which are liability driven and usually seek for high-

duration and strong cash flow stream investments.


23/27

23

Appendix

Appendix 1: Cash Flow computations for base case scenario


24/27

Appendix 2: Private Sector Sensitivity Analysis (Traffic per Day and Increase per Year)

Traffic per year (DSCR = 2)

IRR 160.000 170.000 180.000 190.000 200.000

Increase

peryear

2.500 18,03% 18,86% 19,63% 20,31% 20,90%

5.000 19,04% 19,67% 20,24% 20,73% 21,13%

7.500 19,57% 20,07% 20,52% 20,92% 21,22%

10.000 19,89% 20,32% 20,70% 21,04% 21,28%

12.500 20,11% 20,48% 20,81% 21,08% 21,30%

15.000 20,27% 20,59% 20,88% 21,14% 21,32%

17.500 20,37% 20,68% 20,94% 21,16% 21,34%

20.000 20,48% 20,74% 21,00% 21,18% 21,37%

Appendix 3:Private Sector Sensitivity Analysis (Inflation Rate and Operational Cost)

Inflation rate (DSCR = 2)

IRR 1,0% 2,0% 3,0% 4,0% 5,0% 6,0%

osts

5,0% 19,70% 20,62% 21,55% 22,47% 23,38% 24,28%

7,5% 19,27% 20,20% 21,13% 22,05% 22,97% 23,88%

% % % % % %


25/27

25

Appendix 5: Cash Flow computations for longer concession period with cost of debt of 10%


26/27

26

Appendix 6: Cash Flow computations for debt to capital ratio of 50% with cost of debt of 10%


27/27

27

Appendix 7: Cash Flow computations for DSCR of 1.5 with cost of debt of 10%

Athens - BEST

Documents

Transcript of Athens - BEST