International Business Transactions: Financing Structure for Diario Limeno - Case Study Example

PPC Case Study Financing structure for Diario Limeno A. Current scenario analysis Financing requirements As per the PPC calculations, the total equipment cost would be $10 million. Above this there is a onetime system setup cost of $2 million which needs to be given to a Third Party Consultant (TPC) who will customize the systems as per Diario Limeno’s requirements. And finally there is the maintenance cost of $100,000 annually to be given to the TPC. Hence there is a fixed cost of $ 12 million that needs to be arranged for immediately if the deal needs to be facilitated. Financing purpose Amount of loan required Length on loan required Equipment Purchase $10 million Long term – 10 years System setup by TPC $2 million Short-term Annual maintenance $100,000 Short-term Current financing options and associated problems Lima Banks (LLBs) can provide $5 million loans while PPC has managed to arrange $5 million from US Banks (USBs). However, the LLBs are not sure of the guarantee that the uncle of one of the publishers of Diario Limeno is ready to provide. Similarly, the USBs want PPC to offer guarantees or collateral on its American properties. This is not acceptable to PPC. PPC also not sure whether the Diario Limeno’s uncle’s properties in US which are worth $10 million will be acceptable to the USBs as a guarantee. For the $2 million TPC billing, the Diario Limeno wants PPC to pay for it which it believes it can pay back to PPC in installments. However, PPC is not yet sure of the earning capabilities of the company. B. Financing Options There are a number of financing options available to companies depending on how mature the financial markets of a country are. For simplicity let us assume that the Latin American financial markets are mature enough to provide major financing products. We will look at what products can be used for the fixed capital costs and see what implications they will have on the parties concerned. One of the common sources of financing can be term loan from banks which can be secured or unsecured. In our case the banks are ready to give secured loans with a guarantee from the lender which is the uncle of the company’s publisher. Let us assume that the LLBs and USBs are charging an interest rate of 7% which is on the higher side on account of their uneasiness about the guarantor. We will also assume that they are ready to provide the loan for only 5 year term as they have estimated that the life of the equipment is not more than 5-6 years. The following table shows calculations for the monthly installments that need to be paid to the banks apportioned appropriately among them as per the amount contributed by each bank. Table 1 Interest calculation on $10 million loan @ 7% interest rate Month Loan Outstanding Interest payable Principle payable Monthly payment 1 1,00,00,000 58,333.33 1,66,666.67 2,25,000.00 2 98,33,333.33 57,361.11 1,66,666.67 2,24,027.78 3 96,66,666.67 56,388.89 1,66,666.67 2,23,055.56 4 95,00,000.00 55,416.67 1,66,666.67 2,22,083.33 5 93,33,333.33 54,444.44 1,66,666.67 2,21,111.11 6 91,66,666.67 53,472.22 1,66,666.67 2,20,138.89 7 90,00,000.00 52,500.00 1,66,666.67 2,19,166.67 8 88,33,333.33 51,527.78 1,66,666.67 2,18,194.44 9 86,66,666.67 50,555.56 1,66,666.67 2,17,222.22 10 85,00,000.00 49,583.33 1,66,666.67 2,16,250.00 11 83,33,333.33 48,611.11 1,66,666.67 2,15,277.78 12 81,66,666.67 47,638.89 1,66,666.67 2,14,305.56 . . . . . . . . . . . 55 10,00,000.00 5,833.33 1,66,666.67 1,72,500.00 56 8,33,333.33 4,861.11 1,66,666.67 1,71,527.78 57 6,66,666.67 3,888.89 1,66,666.67 1,70,555.56 58 5,00,000.00 2,916.67 1,66,666.67 1,69,583.33 59 3,33,333.33 1,944.44 1,66,666.67 1,68,611.11 60 1,66,666.67 972.22 1,66,666.67 1,67,638.89 The apprehensions of the banks can be mitigated by providing appropriate documents of the property papers of the guarantor. A signed legal document (called the demand guarantee) from the guarantor which has been registered with the relevant legal authorities will ensure that the guarantor is fully bound legally to the terms of the guarantee and cannot backtrack on his words. PPC can provide written counter guarantee but need not provide any collateral and instead use the US property of the uncle as collateral. The terms and conditions of the loan agreement should be such that the guarantor is fully bound to pay all debts if the borrower defaults. The banks have also been compensated for the risk they have taken by the giving higher interest rate. These steps will mitigate any fears on part of the banks. The $2million setup cost can be shared by PPC. With the above arrangement, the company will be able to recover the complete cost of the equipment. PPC can then afford to make a million dollar investment, which is half of the setup cost, recoverable over 5year period with some minimal interest say 5% taking time value of money into consideration. Similarly since the TPC would have received 50% of its cost it can agree to recover the remaining 50% over the next 5 years again at a 5% rate of interest for inflation effects. Both Columbia and Peru have low inflation rates hence an average of 5% has been estimated. Let see how we can convince the TPC as well as PPC management on the ability of the Diario Limeno to pay off the debts successfully over the proposed 5 year period. The calculations are based on following assumptions: Population of Peru and Columbia combined is 73,224,335. As the company is looking at both the countries we will base our projections on the entire population size of the two countries put together. The urbanization in both countries is on an average 73% and literacy is 90%. Assuming that on an average a household is made up of 5 members, the total daily sale of newspaper comes to 1,199,241 in the two countries. With the penetration rate of only 50%, profit margin of 5% after tax and operating expenses and selling price of each paper at $0.5, we are left with a monthly profit of $3,597,723. Here we are also assuming that only 50% of the households read newspapers daily and on that the penetration rate in 50% because of the competition from other newspapers. For PPC and TPC, the monthly outgo needs to be $20,833 each for the principal payment and interest of 5% p.a to be paid over 5 years (simple interest on $1,000,000 calculated on monthly basis). Revenue calculations are shown below: Penetration rate 50% Selling price ($) 0.5 Total daily sales 11,99,240.98 Margins(after admin & operating expenses) 5% Profit 59,962.05 Monthly profit 17,98,861.47 Less Loan payment (table 1) 2,25,000.00 PPC payment (calculation below) 20,833.00 TPC payment 20,833.00 Net Profit (monthly) 15,32,195.47 The calculations for PPC and TPC payouts are shown below Principal amount to be paid: $1000,000 Annual Interest (simple interest on the million dollars): $50,000 Principal to be paid annually: $200,000 Monthly outgo (Monthly principal plus interest): $20,833 Thus we can see that the company still has $1,532,195 as a monthly profit from which it can easily generate the annual maintenance amount of $1,000,000 for the TPC. Hence, with this financing arrangement and the forecasted sales on account of better efficiencies due to the machines, the company can easily pay off its loans over 5year period. This financing model can be used to boost sale of the printing press in other publishing houses also. Even if these projections fail, say after 2 years, PPC has already recovered its machinery cost in the starting of the deal itself. Only $600,000 of the $1,000,000 will be remaining which will be the loss. But it would have recovered $100,000 of the interest by then. So, net loss will be $500,000. FNM and PPC partnership analysis FNM and PPC can work in a Joint Venture partnership with a 30:70 partnership stake with PPC owning only 30% stake. As for PPC this is vertical integration, it will be beneficial in the long run but initially the risks are too high and returns too low from PPC point of view. Later when PPC feels that the sale of pulp is actually pulling more clients for them or they want to expand to other countries, they can put in more money to help in the expansion. Currently, putting in the entire money (which would be $250 million for a 50% partnership), would be too risky for PPC as growing farms was never their core business and they will be completely dependent of FNM for decisions regarding running the show. For FNM, there definitely is a very huge scope as they will get readymade clients. For them, this is their core business and hence they don’t have much to lose in higher stake. They are into this business of growing farms of this specific variety and hence are effectively getting financing for something which is not as risky for them as for PPC. The joint venture will help in smooth functioning of the business in Chile and distribute the profits, losses and risks proprtionately among the two parties. The joint venture should have previously agreed upon terms and conditions regarding the way of conducting business, suppliers and other working partners and terms of dissolution of the venture or changing stake in it. An important aspect of this partnership is the amount of technical knowhow involved. Both the parties are banking on each other for technical leverage. Hence, it is important that they keep them a secret even after the JV has dissolved (if it dissolves). Thus, they need to ensure that they are legally bound to observe this trade secret by signing such agreement and this agreement should also be enforceable in the court of law. Under the present circumstances, the best course of action will be to first start the farm with a partnership of a local biotech firm. As PPC already knows about an expert firm, ChileBio, they can start by hiring this firm as the first step towards the future long term partnership. ChileBio can start working on setting up initial infrastructure for the work to start. Arranging for finance is not a big problem and the project can start immediately. Simultaneously, FNM should keep importing small amounts of its product from Finland and start introducing it to the publishing houses and show them the advantages it has over the current products they are using. The major advantage that the newspapers will have is the cost advantage. The FNM paper is not only lower in cost but also has a much better quality that is required for the printing presses. ChileBio will be used for the marketing as they have the technical knowledge and are also local players. The payment style can be based on the number of orders they are able to generate and some basic monthly payout depending on their costs and margins that are currently running in the industry. So the market penetration strategy here can be to visit individual publishing houses and provide them with a free sample of the material for, say, one day’s production of newsprint. They can also be offered discounts for initial purchases for a certain quantity. Higher the order amount, higher the discount they can receive. The marketing firm, ChileBio, can be given incentives over a particular amount of sale of product. With this strategy, the publishers will get an opportunity to see the difference in the new product with reference to the one that they are actually using. This will result in trial orders for this product and also incentivize ChileBio to convert more presses into their purchasers. This was the initial marketing strategy for the paper. Once the publishers start gaining some confidence in the FNM, PPC can start showing the advantages of using their press for the paper they are using. This will not be an easy task as the amount of capital required for this investment is huge while switching to the FNM paper was actually saving them cost. However, with time as the publishers switch to the new product completely, they will slowly start realizing the significance of the PPC machine as the pulp would give maximum advantage with PPC press technology and would eventually result in sale. Thus, in our strategy, pulp sale is the route to the PPC press sale. In the meantime, an agri-based firm also needs to be involved in the care of the farm. Since the trees need special care and genetic modifications as they grow, the complete program needs to be shared with this agri-firm (ChileAgro). Some amount of knowledge transfer needs to be done under complete privacy agreements. Relevant patents also need to be filed and ChileAgro needs to agree to comply with all privacy statutes of the agreement. These agreements should be legally binding on both parties. For example, ChileAgro needs to ensure that its employees do not share any technological secrets with any other company. PPC and FNM need also to ensure that the experts responsible for upkeep of the farm and ensuring timely genetic interventions are competent enough to perform the specific roles. Hence, they also need to be involved in the hiring of personnel in ChileAgro. Let us have an overview of how many entities are involved and how are they will be tied to each other for a smooth functioning of the operation. There are currently 4 parties involved in the entire activity. PPC and FNM are the main partners in the deal. They are both tied and secured by the Joint Venture (JV) agreement between them. This agreement will be the guiding force for the future partnership. Then there are two more companies involved – ChileBio and ChileAgro. Both will have a vendor relationship with the JV company. They will be bound by the work agreement with the JV firm. All terms and conditions of payments will be written and signed by all the concerned parties in documents that have legal validity. ChileBio will be responsible for the infrastructure setup and marketing and sales distribution of both the pulp as well as the PPC press. For setting up the infrastructure there needs to be a separate contract which would require specifications as to the number of offices, staff and other resources required. The vendor will bill the JV company for sales and administrative staff and some pre-decided vendor fee which will be part of the work agreement. Likewise, the marketing and distribution profile of the firm would also need to be bound by a service contract where there would be some minimum payment guarantee to the agency while the incentive part can be left to the discretion of the management of the JV as per the product they want to incentivize. Any changes to personnel or other fees would need a consultation between all the three parties involved i.e. PPC, FNM and Vendor and fresh contracts or agreements need to be signed again. Similarly, ChileAgro also needs to be bound by a service contract and all terms and condition regarding payments need to be specified in it. The most important aspect of ChileAgro is that they will be providing experts for the maintenance of the farm. These individuals will have access to some patented information which if leaked to rival companies can lead to loss of business. Hence, they would be required to enter into secrecy agreements on a personal basis as well as at company level. ChileAgro also needs to be bound by such privacy agreements. As stated earlier, in order to ensure that only the personnel with the right caliber are being hired, the JV partners should have the right to be a party to the selection procedure or be able to hold out their own examination procedures. This is a very important aspect of the service agreement as the success of the entire project depends on the production of the right quality of product at the end of the whole project. If the right personnel are not hired, this will not be possible as the procedure is very complex. An important aspect of technology secrecy is to involve minimum number of working partners. This will ensure that the chances of information leaking out are minimal. The JV also needs to ensure that they have a right to conduct periodic checks or audits in the workings and accounts (only concerned with the working of the JV and the vendor) of the vendors. This should be clearly mentioned in the works agreements. Later on, as business grows, the vendors will keep adding up, but their contracts need to be prepared accordingly. Thus by following the above mentioned steps, we can ensure that all parties are equally and legally represented and hence their interests are secured. Read More