A STRATEGIC APPROACH TO INFRA M&A - Sullivan ...
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FEATURES
A STRATEGIC APPROACH
TO INFRA M&A
M&A IN THE PROJECTS AND INFRASTRUCTURE SECTOR IS VERY ACTIVE AS DEVELOPERS, OPERATORS AND
INVESTORS SEEK TO RESTRUCTURE THEIR PORTFOLIOS TO POSITION THEMSELVES FOR PREVAILING GLOBAL
MEGATRENDS, SUCH AS ALIGNING WITH ENERGY TRANSITION OBJECTIVES AND TAKING ADVANTAGE OF
TECHNOLOGICAL SHIFTS. FOR EXAMPLE, THERE HAVE BEEN A NUMBER OF RECENT DIVESTMENTS BY OIL
AND GAS MAJORS TO SMALLER INDEPENDENT COMPANIES, AND INFRASTRUCTURE ASSETS AS A GENERAL
CATEGORY REMAIN VERY ATTRACTIVE TO PENSION FUNDS AND INSTITUTIONAL INVESTORS WITH FUNDS TO
DEPLOY IN SEARCH OF YIELD. BY JONATHON HANNAH, SPECIAL COUNSEL, SULLIVAN & CROMWELL.
The rise in infrastructure M&A has brought with Other factors can also play a significant role in
it increasingly sophisticated financing structures. the direction that a financing takes. For example,
Buyers of infrastructure assets may seek to are the teams structuring the financing at the
utilise leverage for a variety of reasons, including banks and advisory firms primarily acquisition
maximising returns on equity, particularly for or project finance practitioners, or do they have
financial investors, freeing-up offshore currency the flexibility to operate in both spaces? It is
reserves for Chinese SOEs or simply raising imperative that purchasers and their advisers
capital, in the case of independents. Financing of encourage flexibility from finance sources or the
these acquisitions requires melding of traditional financing may get held-up or derailed by an off-
leveraged buyout (LBO) acquisition finance with market approach in either space. Will the loan
elements drawn from project finance structures, be syndicated and, if so, will it be sold in the
and brings with it a number of unique features. leveraged finance market or the project finance
We examine the opportunities and challenges in market? Savvy and well advised purchasers may
this evolving market. strategically target their debt offerings to ensure
they benefit from maximum available liquidity,
Two distinct markets beneficial pricing or other favourable terms that
LBO finance and project finance each have well- a particular market or markets might offer at that
established frameworks that have developed time. Borrowers are also increasingly targeting
over decades. Those frameworks involve norms separate debt tranches at specific classes of non-
that are well understood by their respective bank investors who can offer bespoke financing
market participants and form the starting point solutions, albeit often at a higher cost and in
for a given transaction, but must be tailored to limited amounts.
the unique features of the financing and the The two markets have distinct advantages
sponsors’ and lenders’ commercial objectives. and disadvantages. Acquisition financiers will
For prospective purchasers looking to finance be accustomed to moving quickly in line with
a project acquisition, financings often draw the acquisition timetable, will expect lighter
characteristics from both paradigms. Blending operational covenants and can perhaps access
these two approaches into a hybrid structure can greater liquidity for some assets (at least in the
present opportunities and challenges. commercial bank market). Project financiers will
Determining how best to blend these generally be better versed in understanding and
characteristics requires a firm grasp of both accepting technical risk, market risk and political
approaches. The nature of the project being risk, and will often be able to offer longer tenors.
acquired will, of course, go some way towards A careful balancing exercise will need to be
informing the approach taken: an infrastructure conducted and a clear picture of the purchaser’s
project in Western Europe, where construction objectives and the fundamentals of the asset
has been completed and a successful operating being acquired should be used to determine the
history demonstrated, will have a financing optimal approach or blend of approaches to take.
package bearing many features of an LBO Sponsors may also wish to consider bifurcated
financing of an equivalent credit in other project company and holdco level financings,
sectors. In contrast, a mining or energy project with the acquisition consideration financed
in an emerging market that remains under
construction will likely bear many more of the
hallmarks of a traditional project financing, with
sponsors and lenders needing to grapple with
issues including political risk, completion risk, Determining how best to blend these
technical risk, market risk and environmental characteristics requires a firm grasp of
and social risk. both approaches
Reproduced from Project Finance International January 12 2022 55TABLE 1 - COMPARING PF AND LBO
Traditional Project Finance LBO Acquisition Finance Typical Hybrid
Recourse to sponsors Recourse until completion if Non-recourse Generally non-recourse
there are sponsor completion (post-completion)
guarantees, otherwise non-
recourse
Time to implement Relatively slower Relatively faster (based on Needs to meet acquisition
acquisition timetable) timetable
Security All asset security package Security over specified material Security package limited to
(including structured project assets based on agreed security actions within the control of
accounts), with few negotiated principles. Security granted at the purchaser as a condition
exceptions or before closing may be limited to first drawdown, with
to acquisition vehicle reasonable efforts obligation
to grant perfect customary
project finance security
package post-closing
Operational covenants Detailed operational and Relatively fewer operational Based on a project finance
reporting covenants and reporting covenants covenant package, but can
usually be adjusted to meet
purchasers’ reasonable
commercial objectives
Financial covenants Varies, but key covenant is Varies, but rarely any financial Varies, but key covenant
Debt Service Coverage Ratio covenants, other than a is generally Debt Service
(often on an incurrence-only springing leverage ratio on a Coverage Ratio (if any)
basis) and sometimes Loan revolver
Life Coverage Ratio
Tenor Long term debt: often 10-15 Short to medium term debt: up Varies depending on how
years to 7 years financing is positioned
Conditions to drawdown at Extensive, including all asset Certain funds; conditions Certain funds with limited
closing/commitments security and project/business- limited to those that are within conditionality
related conditions the control of the purchaser at
closing, without reference to
project company
Due diligence Detailed due diligence More limited due diligence, More limited due diligence,
process, with independent primarily based on sell- primarily based on seller and
lenders’ consultant reports for side reports and (where purchaser reports (although
certain key areas applicable) buy-side reports. some lenders may seek
Well established process of independent reports)
disclosure and reliance
separately from the project level debt in the LBO • The tenor of the debt, repayment profile and
and project finance markets respectively. For whether the purchaser wishes to push out the
example, when an MMG-led Chinese consortium loan life; and
acquired the Las Bambas copper project in Peru • The costs involved in prepaying such debt.
from Glencore, the financing involved a US$969m While prepayment fees, other than break
acquisition facility with a seven-year tenor for fees, are unusual in bank loan facilities, certain
the purpose of funding part of the acquisition export credit agency (ECA) lenders, commonly
consideration and a US$5,988m project facility the financiers of greenfield development projects,
with an 18-year tenor for the purpose of funding require these. In addition, some ECAs require a
on-going project costs. Both facilities were proportion of the margin to be paid upfront as
provided by a group of Chinese banks. a premium, which may not be refundable upon
Other highly structured financing prepayment. Bond financings usually have a no-
arrangements are becoming increasingly call period during which the redemption of the
common, often involving multiple tranches bonds would require payment of a make-whole
of debt with different terms aimed at specific amount, derived from a formula based on the net
investor classes. present value of scheduled interest and principal
payments. In any of these circumstances it may
Existing project debt be prohibitively expensive to refinance the
Before even considering the nature of the new existing debt, unless an alternative arrangement
financing in connection with an acquisition, can be negotiated.
a threshold question will be whether there is Many project financings, in common with
existing project-level debt in place and, if so, many leveraged financings, include change
whether the purchaser would like to maintain of control provisions or transfer restrictions,
that debt following completion of the acquisition particularly prior to the satisfaction of the
or intends to refinance it. A number of factors completion tests, and the lenders will often have
will play into this decision, including: a right to require prepayment unless either a
• Whether better economic terms might be waiver can be agreed with the banks or they opt
available in the market; not to exercise their prepayment right. Early
• Whether the terms of the existing financing engagement with the existing lenders will be
afford sufficient operational flexibility given the essential to understand the approach they will
purchaser’s intentions for the project; take. Where ECAs are part of the syndicate they
56 Reproduced from Project Finance International January 12 2022M&A FINANCING
may have less appetite for continued involvement will be structurally subordinated to debt at
following completion of the acquisition project company level. In the US, Holdco loans
than commercial banks given their different are frequently used in structures designed to
objectives, especially where financing was take advantage of tax-equity financing that is
originally provided on an export-tied basis – ie, available for certain infrastructure investments
financing of goods or services from their home but they have become increasingly common for
country, typically procurement of the plant and other reasons. Bifurcation of the financing in this
construction services – and construction has been way may be attractive where there is a desire to
completed, or where an equity participant from maximise leverage, benefit from optimal terms
their home country is exiting the project, but or to finance acquisition consideration separately
their approach can vary. from the project level debt.
Where existing debt is being refinanced, Holdco financing models have also been used
care should be taken to ensure that the in offshore wind projects in Europe and Asia,
process of refinancing is smooth, particularly for example in asset rotation models where the
where indemnities benefiting the existing developers may finance their share of capex on
lenders will survive completion. Again, their balance sheet, while institutional investors
additional considerations will apply where acquiring an interest in the project raise non-
ECAs are involved – as governmental or quasi- recourse project finance on their equity share.
governmental entities these lenders control Holdco financings can be utilised whether the
public funds and so often exercise a greater purchaser plans to maintain existing project level
degree of conservatism than commercial debt or to refinance it. However, existing project
banks might. ECAs will also generally require a finance debt, particularly outside the traditional
lengthier internal approval process, meaning that infrastructure space, can present challenges and
they may not be able to respond as quickly as will need to be carefully analysed to determine
the purchaser and seller would like. Experience whether a Holdco financing can be layered on.
of dealing with these entities is a significant In a Holdco financing, the financiers are repaid
advantage, allowing purchasers to anticipate and primarily from cash distributions that are made
address potential concerns and requirements by the project company. Most project financings
that might otherwise cause delays. If consent to will include conditions to making distributions
maintain an existing project financing in place with a full lock-up where these are not met.
cannot be obtained prior to closing, purchasers For some assets, cash sweeps are common and
might consider arranging a backstop financing, require all or a large proportion of distributable
perhaps as a bridge facility, that can be used to cash to be applied to repay the project
refinance the existing project debt should that be finance debt on an accelerated basis in certain
required. circumstances. This can lead to insufficient cash
being distributed to service the Holdco debt.
Holdco financings If a Holdco loan is put in place as part of a
Most LBOs involve debt being raised through coordinated financing effort at both project
a special purpose vehicle established to enter and Holdco levels, there will generally be
into the acquisition agreement (Bidco) or, less scope to reach agreement regarding minimum
frequently, by the target or project company distributions and cash-sharing arrangements for
itself – subject to prohibitions on using the assets the benefit of the Holdco financiers. However,
of a target company to finance the purchase where an existing financing is being retained
of its shares – financial assistance – in some it is unlikely to be possible to renegotiate the
jurisdictions. terms to achieve this prior to closing (and the
Holdco loans, also known as mezzanine sponsor will have limited leverage in negotiations
loans or back-leverage, involve finance being with existing lenders). In the absence of an
raised by an entity that sits above the project arrangement that makes a Holdco financing
company in the corporate structure and that bankable, it is likely that some form of limited
FIGURE 1 - HOLDCO AND PROJECT COMPANY MODELS
Holdco Loan
Lenders to Holdco Holdco Holdco financing security package
Repaid from Equity Distributions (subject to
distributions satisfaction of conditions)
Project Company
Project finance Project financing security package
debt
Lenders to Project
Company Revenues
Repaid from
revenues
Reproduced from Project Finance International January 12 2022 57sponsor support would be required, at least as refined during the detailed due diligence process,
a bridge through to a refinancing of the project although much will depend on the nature of
level debt on satisfactory terms. the asset and its stage of development. The
Holdco financings where there is a separate state of unease at “certain funds” provisions felt
financing at project level do not typically benefit by project financiers is often compounded by
from security over the shares in the project the more limited and expedited due diligence
company or its rights and assets, which would associated with an auction process. Where
be part of the collateral package granted to lenders might ordinarily benefit from detailed
the project financiers, but would instead have reports from their own advisers and several
security over the borrower of such financing months to consider and discuss the issues, they
(holdco) and its bank accounts. The ability to are often being asked to provide a commitment
enforce this security following a default without letter quickly and at an early stage in the process.
giving the project financiers the ability to enforce What is more, the SPA will usually restrict the
their security at the project level – which could borrower’s ability to add additional conditions
cut off the distributions that are the sole means later if issues are discovered by the lenders. The
of servicing the holdco loan (absent sponsor difficulty in obtaining firm commitments from
support) – will be critical. project financiers might steer purchasers toward
The terms of most project financings include the LBO market, although this can sometimes
transfer restrictions that could trigger an event be more expensive or only be available for
of default or mandatory prepayment if they are insufficient tenors. Those banks that can offer a
breached. The holdco financiers would typically hybrid product will be sought after and benefit
want any enforcement action that they take to from opportunities in the space. It is interesting
be expressly permitted under the project finance to note that these challenges can affect the price
terms, but that will be a matter for negotiation that is offered by purchasers in an auction and so
and may be contentious where significant value reduce the consideration received by sellers that
is attributed to the expertise of the sponsor as the place a premium on maximising deal certainty.
manager or operator of the project. Where there While there is no easy answer, purchasers
is no project level debt there will be much more can smooth the process by engaging with the
flexibility and an investor buying an interest in a lender group as early as possible in the process,
project would be able to pledge its shareholding ensuring that consultant reports can be shared
in the project company in favour of its lenders. with the lender group in good time before the
Notwithstanding the potential challenges final commitment is made and that consultants
where there is an existing project financing (and are available to answer questions and resolve
certain other issues that are beyond the scope of issues as early as possible in the process. While
this article), Holdco financings are a valuable tool purchasers may understandably be reticent to
in the toolkit of sponsors. spend time and money on this process before
winning the bid, this may be necessary where
Commitments a strong commitment letter is perceived as
The majority of disposals of project assets are important to the strength of the bid.
the result of a competitive auction process.
Participants competing to be the winning bidder Due diligence
are usually compelled to accept an obligation to The due diligence process is required to give
complete that is not conditional upon obtaining the purchaser and its lenders a thorough
financing. Sellers now generally expect a debt understanding of the project and its risks, so
commitment letter to form part of the bid that they can be evaluated, allocated and priced
package and will analyse the conditions to the effectively. While the scope of due diligence for
commitment in detail. The debt commitment an LBO financing varies considerably depending
is critical to deal certainty (for both seller and on the nature of the business and transaction,
purchaser), will affect the final selection of it is safe to say that it is more limited than for a
the successful bidder, and failure to ensure typical project financing. Sell-side reports often
that financing is available at closing can be form the bulk of the due diligence with limited
catastrophic. buy-side due diligence and even more limited
For this reason, purchasers typically insist that lender due diligence.
their banks provide a commitment to lend where In contrast, it is customary in the project
all the conditions are within the purchaser’s finance market for reports to be prepared by
control. This is known as a certain funds consultants engaged for the benefit of the
commitment, sometimes referred to as SunGard lenders. Such reports can be time-consuming and
provisions in the US. Where this approach is expensive to obtain and, in the case of at least
taken, the commitment letter will provide for a
comprehensive list of fundamental conditions to
funding and will not restrict the borrower from
drawing if these conditions are met.
This requires a major shift in mind-set for
Those banks that can offer a hybrid product will
project financiers accustomed to lengthy lists be sought after and benefit from opportunities
of conditions precedent that are verified and in the space
58 Reproduced from Project Finance International January 12 2022M&A FINANCING
the technical report, usually require a site visit. In package will be negotiated, the starting point
an acquisition where the purchaser has obtained tends to be the project finance blueprint (with
its own report on the project, engaging a second the obvious exception of holdco financings).
consultant to carry out what will effectively be In LBO financings, security over the acquisition
the same due diligence on behalf of the lenders vehicle is typically put in place on the closing
will usually be unattractive. It would likely also date, with a period of up to three months post-
be difficult to secure full seller cooperation closing in which to perfect security over the
to engage with a second consultant given the shares in material subsidiaries and other assets.
disruption and drain on time and resources for This can be a challenge for the acquisition of
the seller’s management this can cause. projects. First, projects typically comprise a single
In the context of project acquisitions, in our main asset, eg a mine, LNG plant or wind farm,
experience most lenders are ultimately able to with all or the vast majority of the project’s
take a pragmatic view and accept the sell-side cashflow generated under a handful of key
and buy-side reports as the basis of their own contracts. Lenders may be nervous about there
diligence, providing their coverage is sufficiently being a lengthy gap in taking security over such
broad and they are given reliance upon it. We key assets and contracts following closing.
have seen some lenders insist on separate reports Second, project finance lenders are accustomed
prepared for their benefit, particularly in the to all or virtually all security being granted at
case of the technical report for projects where closing and are therefore more troubled by
the perceived technical risk is high. Purchasers having outstanding loans that do not benefit
should consider agreeing the scope of reports at from full security than those versed in acquisition
the initial pre-qualification stage in the process finance. To address this, on some occasions
to avoid these issues arising later in the process. banks have sought second-ranking security that
When engaging consultants to provide any buy- automatically steps up to become first-ranking
side reports, it will also be important to ensure security at closing. In our view, this approach
that these can be relied upon by the financing could only survive a cost benefit analysis in very
sources. rare circumstances. Holdco financings would be
Much will depend on the timetable for the much more straightforward with no project level
acquisition and the competitiveness of the security granted.
sale process. A tight timetable and a highly
competitive process will require purchasers and Alternative financing options
their lenders to accept more limited diligence if Limited recourse financing will not be the right
they are to be successful. Every project will fall tool in all circumstances and other options could
somewhere on the spectrum for complexity and be more appropriate. A corporate purchaser
stage of development that will dictate the level of may wish to raise debt on its own balance sheet
due diligence that is necessary and appropriate, or fund the acquisition out of cash reserves.
and all parties will need to be pragmatic. If the purchaser is a substantial entity with a
strong credit, this debt may have lower fees and
Security margins, be unsecured and have more limited
Both LBO finance and project finance typically covenants – although it would usually be full
involve the taking of security over the target’s recourse to the purchaser’s business and assets
shares, assets and cashflows. In the case of project (in contrast to project level finance where post-
finance this tends to be quite rigidly applied, with completion recourse would be limited to the
“all-asset” security the paradigm and exclusions project).
from the security package specifically negotiated. Sponsors may also wish to consider bridge
For LBO financing, the security package is financing, with or without corporate guarantees,
generally based on a set of agreed security with a view to a later refinancing. One motive for
principles that reflect an overriding cost/benefit this is that significantly faster deal execution can
analysis and as a result is much more limited – be achieved as a result of the more limited due
although similar limitations can also apply on diligence process and simpler negotiation of the
certain project finance deals with strong sponsors covenant package based on the sponsor’s credit.
and a good credit story. Strong sponsors will It may also be possible to put in place a project
often try to limit the security package to share bond, for example a Rule 144A/Reg S structure,
security and security over bank accounts and to finance a project acquisition, perhaps with the
intercompany loans. back-up of a bank commitment to provide more
This tends to be a heavily negotiated area and certainty if the bond market is not available, at
there is no one-size-fits-all approach, but in our least on more attractive terms, at the time the
experience purchasers are typically able to secure acquisition closes. As an alternative, deals may
bank commitments that are conditional upon also be structured with the intention of a prompt
security within the control of the purchaser being refinancing of bridging bank debt in the capital
put in place at closing with a reasonable efforts markets.
obligation to put other security including any Although timing issues for issuing project
direct agreements in place as soon as possible bonds to finance acquisitions can potentially
after completion of the acquisition. While the be dealt with through the use of closing escrow
precise nature of the post-completion security account structures, other issues to consider, and
Reproduced from Project Finance International January 12 2022 59if possible build into SPA financing cooperation and new lenders in order to achieve a timely and
terms, will be driven by the high level of co- frictionless closing. Lenders and their advisers
operation in diligence matters required from the participating in this sector need to appreciate the
seller/the target, particularly in order to achieve requirements of a bid process and be prepared
the required standard of financial disclosure. to move forward on an acquisition finance
The level of diligence required to meet the timetable.
disclosure standards required in the bond While the timeline for an acquisition financing
markets, for both legal and marketing purposes, is generally shorter than that for a project
will most likely go beyond the level of diligence financing, where banks agree to rely on the same
typical in an M&A process. Although the exact due diligence reports as the purchaser there
disclosure package will be developed as a part of is really no reason why this process cannot be
an iterative and deal-specific process, it is likely, compressed to fit the typical acquisition finance
for example, that target management would need timetable.
to be available to assist with the due diligence This is not a market that all lenders will be
process, including preparing a description of comfortable operating in. However, we continue
the business, answering due diligence questions to see the emergence of new players on the
from underwriters and their counsel on the lender side that see good opportunities. More
target’s financials and operations, and potentially nimble private credit operators are becoming
preparing pro forma financial statements. In more experienced in assessing project risk and
addition to required financial statements (audited are able to provide bespoke products that can be
and management accounts), the target’s auditors tailored to meet the requirements of sponsors
would need to consent to the disclosure of audit and investors in a way that the traditional bank
opinions and delivery of comfort letters in the market in both the project and LBO spaces
required form, with bring-down at settlement of cannot.
the project bond. In our experience, where the sponsor and
lender side parties approach deals with the
Conclusions right mind-set, lenders and sponsors working
Financing the acquisition of projects and constructively together can reach pragmatic
other infrastructure assets requires sponsors solutions to the issues that arise. As more
and lenders to adopt a flexible and pragmatic and more deals are completed, each side’s
approach. Sponsors should consider how best expectations are becoming better understood,
to target their financing and be prepared leading to a more streamlined process.
to include features of both the project and The views expressed in this article are those
acquisition finance markets as well as proactively of the author and should not be attributed to
anticipating the requirements of both existing Sullivan & Cromwell LLP. n
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