Finance principles and applications

IFC and Mozal

Alusaf/Gencor should invest in the deal if the IFC invests. Without IFC's co-investment and guarantees, This would be a risky proposition for the two companies, and they should not invest.

The particular reasons for Alusaf/Gencor to invest include the following:

The close geographic and cultural proximity for Alusaf and Gencor make it easier for those two companies to oversee their investments, and to help provide management if and when needed.

The investment's payback could be of benefit to both companies, but particularly to Gencor. For Gencor, a reasonable business plan achievement could double the size of the company's revenues and cash flow.

By creating a manufacturing entity with costs in the lowest 5% of the global industry, Mozal will have better staying power than many of its competitors, even in the event of an industry downturn in prices.

The pricing assumptions for aluminum product are quite conservative, given the previous history of aluminum prices. Although it can be viewed as a disadvantage that not all of Mozal's production is secured by long-term supply contracts, the opposite is also true: Mozal's participation on the world spot aluminum market could result in higher profits than projected. A probability analysis needs to be done to analyze the effects of these prices on Mozal's overall profitability, but it could be substantially higher than currently projected.

Pechiney's agreement with the consortium assures industry-standard construction and cost standards.

The French government's willingness to finance a major part of the project provides additional security to other investors and may lower the overall cost of capital.

This remains a risky operation, as the rating for Mozambique continues to be low (but rising fast, according the Economist Intelligence Unit). The commercial risks have certainly been identified, but there are several areas which need additional exploration. In particular:

It appears that Mozambique offers the potential of cheap hydroelectric power and cheap labor, but no specific advantages in terms of customers or bauxite supplies. As a result, Mozambique should be compared to other countries in the region which offer the same hydroelectric and labor cost advantages.

Although labor is not a large cost item, it is nevertheless an important component. Given the expectation that the project will hire 90% local citizens, it is important to know if there are capable, motivated people ready and willing to work with this new company.

The Mozambique government has yet to abandon its highly bureaucratic (and perhaps corruption-tinged) methods for approval. While the case mentions that a committee has been arranged to "take care" of the political dimension, the unstable nature of Mozambique's power structure and uncertain laws may require additional analysis.

An analysis of a new war needs to take into account the capital at risk for Alusaf/Gencor. Although a portion of this will be covered by insurance (assuming IFC participation), that may only pay back a portion of the capital costs. It will not cover business interruption, nor the sure legal action that buyers with long-term contracts may be able to take in case of a business interruption (note: it may be difficult to include "force majeure" terms in their long-term supply contracts (Miller).

There is no mention made of the future number of aluminum smelter lines being developed around the world. In a situation of overcapacity, and with high capital costs, some suppliers could be encouraged to sell their product to cover marginal cost (rather than total cost), which could wipe out Mozal's total cost advantage for a period of time. If the analysis demonstrates that worldwide smelting capacity is expected to be on a level with demand, or even below it that would increase confidence in the project.

Although spot aluminum prices are indicated for several years, it would be helpful to have an indication of the past (and expected) future spot buyers' volume. That would help to indicate where Mozal may have a shipping advantage or disadvantage. if, for example, China will account for a significant increase in aluminum demand, the shipping costs from Mozambique to China need to be taken into account to determine how competitive, FOB-wise, Mozal is with other smelters currently in existence or coming into existence in the next few years.

Will the sponsors be able to finance the deal?

The timing of this investment is important, and it is not covered in any depth in the case. That is because there is a significant increase in the number of countries where political risk is declining, but several countries (such as Argentina) provided negative surprises that made banks less willing to lend.

The case deals primarily with banks, but does not cover strategic investors, or banks aligned with strategic investors. This author believes that the economics of the deal can appeal to banks on a global basis, and the deal will therefore be financed.

In the managers' stead at Alusaf/Gencor, it would help to line up investors with more than a purely financial incentive to do the deal. These sources may include one or more of the following:

South African banks which are tied to Alusaf and Gencor, understand the management of those companies, and are personally invested in the success of the South African neighborhood (Simon).

French banks affiliated with Pechiney or the French government which have an interest in working with the project in order to secure the business for Pechiney (Vander Vennet).

Portuguese banks which would like to reestablish their relationships with their former colony. At this point, Portugal was one of the fastest-growing members of the EU, a participant in the Euro, and its banks were known to be reestablishing contacts with former colonial partners.

Countries and industries which would like to have an assured, long-term supply of aluminum. These countries (such as Japan and China) may regard secured supply (when political risk is covered) as more important than trying to meet their needs on the spot market. Given the high savings rates in Japan, Taiwan and China, there may be capital which is freely available and seeking the high potential returns that Mozal may provide.

IFC should invest in the deal for three reasons: (1) Mozambique represents a poster-child for the types of investments that fit IFC's charter. With a country risk ranking below "commercial grade" of 25, there are nevertheless encouraging signs that Mozambique will improve its business climate; the IFC can use this as a demonstration project which may trigger other investment, (2) the deal has most of the business risks reduced: as a low-cost producer in a global industry, Mozal has the ability to survive and continue operations even during a downturn in the global aluminum market, and (3) IFC's investment will leverage investments from at least three others: Pechiney, Alusaf and Gencor. Thus IFC has some assurance that management, industry knowledge and regional strength are assured.