Bidders, lenders and the public agency use financial models to determine a project’s financial feasibility from their perspectives. Financial models of the project produce indicators that help private bidders determine the potential value of the project, help lenders check the project’s capacity to repay debt, and help public agencies to determine the value of the concession or the amount of public subsidy that might be needed. Each party generally uses a financial model to test different scenarios of interest to it and their impacts on the indicators of interest (discussed in Chapters 7, 8 and 9).
A public agency may use a financial model in different ways during the project development and bidding phases. Initially, the public agency may use it to create a Shadow Bid that attempts to predict the bidder’s costs, financing structure and other assumptions, in order to determine its financial feasibility, e.g., whether the outcome, in terms of upfront public subsidies needed, or amount of toll revenue or availability payments required throughout the P3 term, is likely to be acceptable from the public agency’s point of view. For P3s involving availability payments, the model may be used to calculate the availability payment required to cover capital expenditures (known as "capex"), operating expenditures (known as "opex"), debt service and return on investment.
The financial model is used by bidders to structure the proposed financing and review the impacts of different financial options. The financial structure of a project has to be consistent with its risk profile. Financial structures are tested based on scenarios in which various risks occur. Varying input assumptions and different financial structures are tested to assess the impacts on the bidder’s projected cash flow throughout the project’s life-cycle.
Lenders also use financial models as part of their "due-diligence" process that involves the review and evaluation of project contracts and related risks. After financial close, the model continues to be used by lenders to analyze the changing long-term prospects for the project and risks and to track loan performance.
Throughout the term of the P3 contract, the model is used to price compensation payments required by the contract due to variations from base assumptions, and to calculate any refinancing gains that are to be shared between the public agency and the concessionaire.
Who Develops the Model?
Financial models are complex and should be left to modeling experts. Since there are three perspectives – those of the public agency, the concessionaire and the lenders – there could theoretically be three parallel financial models. While the public agency may develop its own "shadow" model for the purpose of creating a Shadow Bid for its Value for Money (VfM) analysis, a common approach is to use the model prepared by the preferred bidder after calibrating it against the public agency’s shadow financial model to ensure that the results are the same for the same assumptions. Alternatively, the public agency could provide a template financial model to be used by all bidders to make comparison between bids easier.
It should be noted that although the data in the model is commercially confidential, the model needs to be independently verifiable and not subject to interpretation for several reasons. The public agency needs to be able to use it to check whether the bid is financially viable. If the model is to be used to calculate availability payments, it needs to be approved by both the concessionaire as well as the public agency. Finally, if compensation is to be required later due to changes, the impact of the changes needs to be measured against the outcome of the base scenario in the P3 contract to which both parties agreed.
Model Inputs and Outputs
Financial models are built using a standard spreadsheet program in Excel and are usually comprised of separate sheets for a user guide, inputs, calculations and outputs. All calculations involve estimates of future cash flows. Therefore, the reliability of the results depends on the validity of the data and assumptions used as input. Input and assumption sheets in the model gather all the input data necessary for the model, including documentation to back up the data. Inputs include:
Model outputs are summarized in results and summary sheets. They include the financial metrics needed by public agencies, lenders and equity investors (described in Chapter 7 – 9), as well as annual projections of:
Profit and loss accounts (income statements) and balance sheets are included in the model because tax payments are based on accounting results rather than cash flow. For example, deductions for depreciation affect the calculation of taxes, but not cash flow. The accounting results also affect the concessionaire’s ability to pay dividends. A balance sheet is usually presented with assets in one section and liabilities and net worth in the other section with the two sections "balancing." It is a good way to check the financial model for errors, since if the balance sheet does not balance there is a mistake somewhere.
The financial model allows the public agency, equity investors and lenders to calculate the effects of a series of cases under which the key input assumptions are varied. Using the financial model, it is possible to analyze the impacts of changes in assumptions or parameters on the financial metrics discussed in Chapters 7 – 9. Parameters that may be tested include:
By changing each or all of the above assumptions, it is possible to test the robustness of the financial structure under positive or negative risk scenarios, related to:
The financial model is generally run iteratively with different financial structures and assumptions to check the effects on the various metrics of interest to public agencies, lenders and equity investors that are discussed in the next three Chapters.