Scorched Earth Finance

by Dave Forest
August 10, 2010

One of my favorite journals is Project Finance. Having recently raised $25 million for a mining project, and now looking at a bigger raise for another, it's a subject I find fascinating.

But equity financings are a pale cousin to the debt market. Debt deals are infinitely more complex, multi-faceted, creative and interesting.

One recent debt deal intrigues me. A $1.2 billion 12-year project financing completed by Australian iron ore developer Karara Mining.

This is a serious deal. It's a big chunk of cash, and a long timeline. Usually financing banks are fairly skittish and conservative with such lending. Especially with mining projects (which have a reputation of coming in over-budget and off-schedule). And especially with companies like Karara that have no other serious assets against which to secure the loan.

Given all these issues, banks would usually take "a pound of flesh" in the form of higher interest rates on the project loan.

Here's the interesting thing. Karara's $1.2 billion loan comes at just 200 basis points (that's 2% for anyone who doesn't speak project finance) over six-month Libor.

This is an incredibly competitive rate for a project with no cash flow. Many oil and gas deals (which are seen as generally quicker to profit and therefore less risky than mining) can't get 200 basis.

Here's the reason Karara can. The company is a 50/50 joint venture between Australia's Gindalbie Metals, and Chinese steelmaker Ansteel. The Chinese connection is critical. Because the project loan is coming through a syndicate of Chinese banks, lead by Bank of China and China Development Bank.

There's another interesting aspect to this financing. Ansteel has agreed to guarantee the entirety of the loan. Despite the fact they only own 50% of the project. In effect, they're putting themselves on the line for their partners (although they do hold a mortgage over Gindalbie's shares in Karara as security against the former's share of the loan).

Both Ansteel and the Chinese banks are taking on a considerable amount of risk at an unusually low price. Could this be a competitive strategy? By providing such cheap financing, Chinese-backed projects will be some of the quickest out the gate. Meaning preferred access to services and infrastructure.

Projects financed through non-Chinese channels may take longer to get going. Delaying development.

In this way, the Chinese are implementing a "scorched earth" finance policy. You might hurt yourself a little in the form of bad loans with insufficient cover. But you do much more damage to your competitors, out-financing them into a difficult spot.

Not a bad strategy if you're concerned with securing supply of natural resources.

Here's to project finance,

Dave Forest