PPP case study: Anyang & Buchon plants, South Korea Raymond Bourdeaux The World Bank St. Petersburg – May 22, 2008.

PPP case study: Anyang & Buchon plants, South Korea

Raymond Bourdeaux

The World Bank

St. Petersburg – May 22, 2008

The Assets: a very complex set up

Heat Only BoilerHeat Exchanger

Heat Accumulator

Combined Heat & Power Plant

Heat Pipe

Heat

Incinerator

Heat

Electricity

ConsumerHeat Exchanger

Heat

Hot Tap Water Heating

The Assets (cont’d)

Anyang BuchonCapacity electric (gross MW) 478 473CHP heat capacity (Gcal/h) 437 410Km pipe 300 180Households 105,000 69,000Fuel LNG/LSWR LNG/LSWR

% of DH customer in Korea

20%

80%

Anyang andBuchonOther DHcustomers

Capacity generation in Korea

2%

98%Anyang andBuchon

Othergeneratingcapacity

Huge market potential for privatisation

Mandate and Rationale

• December ‘98: Government launches transaction advisors search

• Appointed in February ‘99 by Kepco & KDHC to:• undertake 100% sale (assets sales) of :

– 2 gas fired power stations (2 * 450MW) producing electricity and heat (combined heat & power “CHP”) in 2 different locations, Anyang & Buchon

– 2 district heating (“DH”) networks (about 130 000 households services each) adjacent to CHPs

• Rationale– IMF pressure for privatisation and raising cash– KDHC privatisation plan– “logical” fit of CHP & DH systems– “teaser” for Kepco privatisation– get rid of “difficult assets” prior to privatisation

• Internal agreed strategy with Client : let’s do it , price is not the top consideration, as this will be a difficult sale

2. The Challenges

First the good news..

• Not a mammoth transaction: early price range between 400m and 1bn USD

• Relatively well managed (no need to significantly reduce work force)

• Relatively (new) existing assets, no requirement for significant extension and/or refurbishment

• Requirement to raise acquisition finance, not project finance

Specific business characteristics of Anyang and Buchon

• “Captive customer basis and long lead time gives good visibility for Heat demand projections.

• The obligation to produce heat implies an obligation to produce electricity regardless of the economic rationale to produce electricity (must run status).

• As a result the plants are likely to require minimum electricity offtake at certain time equivalent to minimum 40-50% plant load factor .

Strategic Considerations: Commercial

Electricity Issues

Kepco is quasi monopoly: no market now

move toward pool market at a later (unknown) date means Long Term Power Purchase Agreement not acceptable

“Total fuel pass through to Kepco” would not be fair

merit order position is not straight forward for a “must run” generator

liberalisation of Liquefied Natural Gas market is unclear

District Heating Issues

District heating business is regulated

current price facilitate expansion but is based on “cheap” heat

local monopoly for existing network, but market risk for expansion

limited ability to push fuel price risk to end user

price regulation to be changed but unclear how

The Challenges

• Contractual structure:

• must run?

• fuel pass through?

• PPA vs pool?

Electricty vs heat demand

0

50

100

150

200

250

300

350

400

1 3 5 7 9

11 13 15 17 19 21 23

hours

Gca

l/h

r

0

5000

10000

15000

20000

25000

30000

MW

h

December Heat

August Heat

December Electricity

-

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

450.00

500.00

- 100.0 200.0 300.0 400.0 500.0

Electrical output (MW)

Dis

tric

t h

ea

tin

g o

utp

ut

(Gca

l/h

r)

• Allow operational flexibility and controlling must run states

• Managing unions and employee position and achieving transfer to private sector at good price

• Maximise value and minimise scope for change in contracts

• Foreign investment vs. no foreign exchange rate protection

• Minimise future KEPCO liabilities and maximise value

Strategic considerations; objectives?

Strategic Considerations: Process

• 1 or 2 Sales?

• Separate sales of DH and CHP would not maximise speed of transaction

– negotiate steam purchase agreement (conflict)

– investors with DH experience have electricity experience

• Separate sales of DH & CHP in 2 separate geographical entities would not maximise value:

– 900 MW is acceptable to investors

– 2 sales means 2 parallel bidding processes

• Estimate future cash flows?

• Presenting reasonable picture of future operating regime

• Price evolution for district heating in a new regulatory framework

• Future district heating expansion in a “non integrated environment”

• PPA for set period vs. indefinite obligation to supply heat

• Financial modelling refines price between 400 and 600m USD (allowing foreign exchange protection estimated to be worth between 50-70m USD)

The Challenges (cont’d)

2. Requirement for a successful sale: predictable cash flows

-200

-100

0

100

200

300

400

- 2000 2005 2010 2015 2020

Fuel Costs

bln Won

Cash flow

O&M costs

year

?Pool start

ANYANG/BUCHON LIKELY CASH FLOWS

SALE

PPA

FSA

Liberalisation fuel imports

Strategic Considerations: Process (con’t)

• Contractual strategy has long term impact on players

– existing contract for heat sale between Kepco and KDHC sets precedent for transfer price for heat

– the higher the PPA tariff the more KDHC will benefit

• LT won market not tested : FX protection?

• Acquisition vs. project financing vs. on balance sheet

The challenges: issues nobody wanted to talk about

• How can it be done without Technical or Legal advisors?

• Implicit negotiations between KDHC and KEPCO

• Government expectations in relation to impact of risk allocation on prices?

• Quality of the Data room?

• Realism of the bid process timetable?

• Flexibility to negotiate key terms if they are flagged by investors?

• Overall Government commitment to transaction success?

• Transparency of the prequalification and short-listing process?

• Short term PPA (1year)

• Automatic renewal until

establishment of pool market

• Contract for difference

in future

• Partial fuel pass through structured to provide incentives to low electricity production at low demand time

• Recognition of must run obligations but

under operational model

JOINT FINANCIAL ADVISERSJOINT FINANCIAL ADVISERSCONFIDENTIAL 18

0

300

- 2000

Fuel Costs

bln Won

O&M costs

years

Electricity Revenue

SALE

Contract forDif ferences

PPAPool revenues only, No CFD

Pool functional

Solutions

• Getting the right price:

• Maximising investors interest

• Critical mass:

– O&M savings– Spare savings– Market share

• Competitive tender with no deviation criteria

• Allowing free hand on financing

• Feedback between first and second rounds

Solutions (cont’d)

Gas play

Electricity play

District heating play

Commercial Structure: District Heating

• 1. Obtain written letter from MOCIE on “fuel pass through” concept on DH price to end users

• 2. Obtain assurance of growth possibility by securing licenses

• 3. To the extent possible, provide strong rationale for growth story (expansion plan)

– limited regulatory protection means that only serious DH players will have tools to properly value the assets

Solutions for Fuel Supply Agreement (cont’d)

• Medium term rather than matching PPA

• Draft form for investors fine tuning

Existing FSA with

KEPCO

Future liberalization

LNG play for

investors

Overview of the Deal Timetable: What the Government was prepared to hear

Preliminary non binding bids received (6 weeks)

Information memorandum/ financial model sent to potential investors

Detailed due diligence, meetings and site visits (6 weeks)

Shortlist of bidders announced

Binding Bids received

Winner announced; agreements signed

Closing; funds received by KEPCO/ KDHC (3 weeks - 2 months) depending on sale structure

June SeptemberAugustJuly October

Phase I Phase II

• 40 investors contacted early on and marketed/updated regularly (once a week)

• request for prequalification sent to interested parties and published on net

– objectives: - select “large number” of potential candidates (either as leader in consortium or as potential consortium partner)

– ensure high visibility to further Government continuing commitment

• Pre-selection criteria: know how (district heating, LNG fired power stations, commitment to Korea and financial capabilities)

• 23 parties pre-selected

Marketing the Sale: Initial Steps

Marketing the Sale: Info Memo

• Info Memo sent to shortlisted parties with request for preliminary proposals demonstrating:

– key capabilities (financial and technical)

– level of commitment (understanding of business plan, treatment of employees due diligence requirement, conditions for closing)

– willingness to commit to a price and list of “subject to”

Marketing the Sale: Info Memo

• overview of Korea & Economy

• DH and electricity sector description

• description of facilities

• description of main contractual terms

• projections going forward and assumptions

• personnel and organization

• financial model

• In the meantime, preparation of a data room

Shortlisting Serious Bids

• Out of 23 pre-selected, 12 companies grouped forces into 6 consortiums ® 6 bids:

– AES (US)

– Singapore Power (Singapore)

– Dalkia (France) / Sithe (US) Kukdong city gas / Kukdong oil (K)

– British Gas (UK) / Daesung Industrial co (K)

– Enron (US) / SK corp (K)

– Tractebel (Belgium) Samchully (K)

Please wait while we are experiencing some technical difficulties…

Some problems with the process…

• Wide price range in views of uncertainty (price with conditions)

• Price is below expectation of Government, but fully expectable in view of the short due diligence process and uncertainties

• Complaints in relation to the short time table for due diligence

• common elements for additional requirements in contractual / sale process: the contractual risk structure was not fully acceptable

• No way the full price will be paid within the time frame the Government wants

Next Step in selection process

• Full due diligence (2-3 weeks) for shortlisted parties

• Unconditional bid and fully marked up contractual documents (PPA, FSA, Asset Purchase Agreement)

• Preferred bidder selection and final negotiation

– close expected of year-end /beginning 2000

Actual timetable• Appointment of financial advisors: February 99

• Appointment of technical advisors April 99

• Appointment of legal advisors April 99

• Project launch : June 99 (request for prequalification)

• Prequalification dues (without forming consortium) June 25 99

• Prequalification received: July 10 99

• Info memo scheduled to be sent to selected parties: 25th August 99, sent end September 99

• Indicative bids (non binding) scheduled for Nov 15 99, delayed until 1 week October 99

• Shortlisting down to 4 to do full due diligence

• Bid submitted 15th December 99

Actual timetable

• Process collapses ended December 99

• Government announced new Re tendering 12th January 00

• RFP documentation sent to bidders on 8 March 00

• Due diligence from bidders March to May 26

• Bid submission and announcement of preferred bidder 31st May 00

• Negotiations 1st to 28th June

• Down payment of 10% of purchase price: 28th June 00

• Financial closed September 00

Relaunch of bidding process

• Revised documentation and more Government support

• Different mix of investors with much more local flavor

• Many bidders on first round drop out entirely and some new players:

• AES (US)

• LG Caltex (LG and Texaco), Texaco (US) and Kukdong city Gas (K)

• SK Corp (K) / El Paso (US)

• Daesang (K) / Osaka Gas (Japan)

And the winner is…

What is less well known

• Most conditions that came as market feedback on first round are accepted

• No significant difference in sale price achieved in view of the loosening of contractual conditions

• Sales is a conditional one with 10% down payment while negotiations are ongoing for closure scheduled later

• Financing plan based on Korean won with decreasing maturities (12 year maximum)

• A large portion of the bonds are placed with Korean Development Bank (state owned) who is being asked to “ be helpful” by Government

Everybody was happy in the end..

• GS Power was established in 2000 by acquiring generation and district heating facilities according to privatization policies. Through modernized combined heat and power plants and safe district heating facilities, GS Power sells electric power to KEPCO and supplies heat to 250,000 households in the Anyang and Bucheon areas.

• Based on the management techniques and technology of GS Caltex, which has led the Korean energy industry for 38 years, GS Power seeks innovative management and produces and sells quality electric power and heat. GS Power will continue to grow as an energy company with a globally competitive edge.

• Located in an urban center, GS Power strives for clean energy and only uses pollution-free fuel. The environment and safety are top priorities in the operating facilities. All the employees at GS Power make an effort to create a pleasant urban environment.

• We appreciate your interest and encouragement.

Life goes on in a privatized company

February 2008: refinancing of company with a 1.77bn Won: 5 year grace period and 7 year tenor

Some Lessons Learnt

• Thanks god there was no big competing transaction at the same time!

• The timetable cannot be completely imposed by the Government

• This is not just about the assets, but very much about the contracts around the assets

• Unrealistic expectation to risk allocation lead to frustration and (at best) re-tendering

• Investors appetite varies significantly with time. They can be frightened away even if the market potential is there

• Uncertainty is okay but within a manageable framework

• More upfront preparation upfront rarely hurt

• Listening to market under competitive pressure makes sense

• If the Government had followed the advisors advice, the process would have been shortened by one year.

• Large cross section of investors interested

• Innovative financing solutions

• Extensive transfer of risk

• Sale price achieved matching expectation

• Longer than anticipated timetable

• Show that KEPCO/KDHC/NOCCF are willing to execute ?? transaction

Outcome

PPP case study: Anyang & Buchon plants, South Korea

THANK YOU !!!

Raymond BourdeauxThe World Bank

[email protected]