SAN DIEGO — With high-risk capital-intensive projects like fertilizer, desalination and ethanol plants entering the municipal bond market sphere, analysts need to beware of red flags, said participants at the National Federation of Municipal Analysts conference.
Thursday’s appropriately titled, “Déjà vu or Deja Voodoo” panel also outlined safeguards for municipalities partnering with private companies to insure that environmentally-minded projects live up to their expectations.
The discussion centered on warning signs that the risk might be stratospheric and the projects aren’t likely to achieve high enough revenues to both survive and repay debt.
The topic was timely, coming the same week the Iowa Fertilizer Co. made an $1.2 billion offering of junk-rated tax-exempt bonds, said moderator Dean Lewallen, a vice president/senior municipal high-yield analyst with AllianceBernstein.
While some concepts, such as using ethanol and desalination to create energy or produce water, have been around for decades, it is a matter of decreasing, or being aware of the risk, as companies try to create projects at a greater scale than has been done before, Lewallen said.
One thing to watch out for: when the scale of the test model is so small that it doesn’t take into account issues that will occur when the plant is built to scale, Lewallen said.
The risk is high, speakers said, when dealing with new technology, but not all projects are created equal; and don’t count on the feasibility study to rescue you.
One slide listed four bond-financed projects that made panelists’ feasibility hall of shame: VisionLand, financed with $90 million West Jefferson Amusement Public Park Authority, Ala. bonds; Edinburgh Water Park, a $21.3 million Edinburgh, Texas Industrial Development Corp. deal; Great Platte River Road Archway, a $59.7 million Kearney, Neb. deal; and The National Sports Museum, $52 million New York Liberty Development Corp. deal.
Investors should consider whether the technology fits the core competency of the company, and whether the company has a track record in constructing these projects, said Michael Roye, a vice president/senior fixed income analyst for Columbia Management.
Better to invest in a project in which the company building the plant is constructing their 13th plant, not their first, Roye said.
Lewallen used the Great Platte River Road Archway in Nebraska as an example of one where the debt service never got paid – and likely never will.
The feasibility study included estimates based on cross-country travelers stopping there, but there was not a freeway off-ramp, he said.
The state had plans to build an interchange, which are now moving forward, but even that is not likely to result in debt service getting paid, Lewallen said.
Estimates were that if 1% of the people traveling across the country stopped, it would result in $80 million in revenues, he said. Even with the interchange, “it will cover the 30-year operating expenses, but debt service is zero,” he said.
A key question on these projects: is the equity piece enough to provide working capital, so that reserves exist to pay debt.
“You have to understand whether the project is going to blow up going forward,” Lewallen said.
Investors should look closely at the components of the stress test and make sure they are taking into account debt capital, he said.
Panelists said that they advise clients that the stress tests should not include debt service in the working capital calculations.
“We would never bring a project to market without a full year’s worth of reserves,” said George Longo, managing director of the project finance group for Raymond James.
Be leery of deals in which it appears that the manufacturer is gambling on new technology, Lewallen said.
“Watch out for projects where the technology is new and only tested through a scale model, but never tested at the scale the plant is going to produce at,” Lewallen said. “Inevitably when the plant is constructed, scale-up issues will occur.”
Most of all make sure that the company developing the project has skin in the game.
“When the corporate client has a lot more cash invested, it’s a better bet,” Lewallen said.
When developers are raising cash, most of the time it’s not their money, they are looking at making a small cash contribution, he said.
AllianceBernstein looks for clients who are already in the business, but are attempting to do more, he said.