Raising long term funds

There are situations however when the financing needs are unique. The Build, Build, Build thrust of the administration is one example

The Philippine economy, notwithstanding the recent noise about inflation and its malodorous effects, is still very much in good shape and is poised to continue expanding.

Businesses are strongly positioned and when a business has the good fortune of doing well, an expansion is the logical next step because achieving scale and dominance is what elevates a business into the big leagues.

An expansion, however, will need long term funding to match the capital expenditures for a variety of reasons that go hand in hand with an expansion, such as increasing the business’ capacity to produce more products, to integrate backwards to develop and strengthen the supply chain network, or, to widen the local, and even foreign, sales and distribution network in order to feed the growing market demand for its products. The buyout of a rival in order to consolidate the business’ market position is also a logical strategic move to undertake, particularly in a scenario wherein the industry growth is already stable and mature and a dramatic increase can only be achieved through an acquisition.

Such an expansion will naturally result in cash flow gaps in the business cycle. Significant capital spending will certainly require several years to achieve payback or the recovery of the investment in the expansion of the business. A successful business on the verge of an expansion will likely have a healthy cash buffer and may just fill the cash flow gaps by drawing on its reserves. However, not all businesses may have that good fortune and external capital fund raising would then have to be resorted to.

Borrowing short term (maturity of less than a year) to fund a long term need might be tempting because such accommodations tend to be relatively easier to secure from banks eager to lend to a successful business. A smart CFO will probably be able to negotiate for an unsecured short-term loan with a relatively low spread over the market benchmark.

However a smarter and prudent CFO, particularly that of a listed company, will probably want to ensure that the balance sheet will show the proper matching of assets and liabilities. In other words, the financing of the expansion should ideally be supported with long term money, certainly for as long as the number of years the business will need to recover the investment.

Your existing banking relationship is the logical source to secure a long-term loan. The bank, through your operating accounts, will have a good idea of your cash flow patterns and will derive comfort from what he has seen in the past. Although it is often, albeit jokingly, said that banks are fair weather friends, it is precisely for this kind of a situation that there is great value in concentrating your banking related needs, whether it be for your investments or simple current accounts, with one or two main bankers. The better the bank knows your business, particularly when you do not need its money, the likely the brighter the prospects are for its assistance when you need it.

There are situations, however, when the financing needs are unique. The Build, Build, Build thrust of the administration is one example. For the private corporations that participate in these projects, their funding requirements have long payback periods because the business dynamics are not just commercial in nature. The public need has to be factored in.

Toll or utilization fees, for example, for airports, power plants or roads cannot just be priced to what the market can bear without due consideration for what the general public can afford. As a consequence, the revenue stream of the business model is constrained necessitating extended payback periods of about 15 to 20 years. Not all banks, except perhaps for the top Unibanks, have the aptitude nor the appetite for the nuances for taking on financing a project from scratch.

The government banks, particularly DBP and Landbank, logically should be the best sources for these types of financing because that is what they are precisely mandated to do and they have access to developmental funding for such projects. Another natural source is the large international EPC contractors which provide a wide range of services from engineering, procurement, construction, operation and maintenance.

These EPC contractors also offer turnkey deals effectively providing the initial funds during the project’s development and construction phase. A turnkey arrangement typically is premised on a takeout commitment by a bank upon completion and turnover of the project. On the other hand, from a lending bank’s perspective, the risks are greatly mitigated with an exposure contingent on a fully operational project.

Finally, as the project stabilizes and cash flows become predictable, the capital market can be an effective source for long-term funding via the issuance of bonds that effectively securitize these cash flows. Such bonds would be an attractive investment instrument for institutions like life insurance companies looking for steady annuity income. Even the retail market could be tapped, particularly with a listed bond and a secondary market maker providing a liquidity mechanism for the investing public.

Until next week’s column, stay dry and safe….one big fight!

For any comments or questions, you can email me at bing_matoto@yahoo.com