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ood Products. Fuqua School of Business Emerging Markets Corporate Finance. Contents. Industry Overview WTC Wood Project Country Overview Risk Analysis Project Appraisal. 1. Industry Overview. The Tropical Wood Industry. U$ 6.6 billion industry - PowerPoint PPT Presentation
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Fuqua School of Business Emerging Markets Corporate Finance
Contents
1. Industry Overview
2. WTC Wood Project
3. Country Overview
4. Risk Analysis
5. Project Appraisal
1. Industry Overview1. Industry Overview
The Tropical Wood Industry• U$ 6.6 billion industry• Vigorous growth in the past decade due to:
– a) lower trade barriers – b) increasing demand for wooden furniture– c) buoyant construction and renovation activity in
developed markets• Demand growth expected at 9-10% per
annum in the medium term (ITC)• Gradual tendency to substitute wood for non-
wood materials (bio-composite, plastic, aluminum)
World Exports of further processed wood products (ITTO)
0
1000
2000
3000
4000
5000
6000
7000
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
U$ M
Source: International Trade Center, 2002
The geography of the tropical wood industry
Africa: 1%Africa: 1%
LA-mkt share 12%16%
7%
As-mkt-share91%
87%
83%
Asia: 83%Asia: 83%
LA: 16%LA: 16%
Source: International Trade Center, 2002
Forestry Potential
1
IND IND PNG MYN MAL THA CAM PHI FIJ
0 100 200 300 400 500 600 700 800 900
1
BRA PER COL Bolivia VEN GUY SUR ECU HON PAN T&T
Area (M of hs.)
Asia
Latin
Am
erica
Saturation
Deforestation
Extinction of wood species
Larger potential
More sustainable forest practices
Source: International Trade Center, 2002
The Bolivian Tropical Forest
• 7th largest in the world (49 M hs.)• Over 360 wood species• Operating at less than 1% of its full
potential• 1,000,000 hs. recently certified for
sustainable exploitation• Currently low value-added
commercial timber only
2. TWC Wood Project2. TWC Wood Project
The Tropical Wood Consortium• Created in 2004 to explore investment
opportunities in the Bolivian forestry sector • Spearheaded by Tahuamanu
TAHUAMANU S.ATAHUAMANU S.A
SMEs (Bolivia)SMEs
(Bolivia)Large
(Brazil, Ecuador)Large
(Brazil, Ecuador)
Technology Suppliers
(Germany)
Technology Suppliers
(Germany)
Andean Development Corporation
Andean Development Corporation
Tahuamanu S.A.• The world’s largest producer of processed Brazil Nuts• Seeking diversification (nut production reaching saturation)• Extensive experience in sustainable forest management• High managerial and industrial capacity • Long-established international marketing channels
Tahuamanu's exports
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
200,000
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Volu
me
(20K
g-bo
xes)
Tahuamanu's market share
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%19
91
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
U$ 6M annual revenues
Source: Tahuamanu, 2004
Wood Processing Project
Private concessions
(50%)
Private concessions
(50%)
Community-based
suppliers(50%)
Community-based
suppliers(50%)
130,000 m3/y of raw material 130,000 m3/y of raw material
Subcontractors(70%)
Subcontractors(70%)
Own extraction
(30%)
Own extraction
(30%)Sawing (50%)
Sawing (50%)
Precious (4%)
Precious (4%)
Soft (46%)
Soft (46%)
Hard (50%)
Hard (50%)
Laminating(46%)
Laminating(46%)
Slicing(4%)
Slicing(4%)
PlywoodPlywood
VermeerVermeer
PanelsPanels
Para
nagu
a Sa
ntos
Para
nagu
a Sa
ntos
Bele
mBe
lem
Europe(30%)
Europe(30%)
US (40%)
US (40%)
RegionalBR-AR(30%)
RegionalBR-AR(30%)La
Paz
La P
az
Land-River-Sea Land-River-Sea
Land Land
58,000 m3/y of processed wood
MaintenanceMaintenance
Brokers Brokers
RAW MATERIAL
RAW MATERIAL
EXTRACTIONEXTRACTION TRANSP.PLANT
TRANSP.PLANT
PROCESSPROCESS PRODUCTPRODUCT TRANSP. MARKETS
TRANSP. MARKETS
EnergyEnergy
Internalized activityInternalized activity
OutsourcedOutsourced
Subc
ontra
ctor
s
187,000 he of forest land /20y
Marketing
Transportation Alternatives
Manaus (1,650Km)
Belem (3,015 Km)
Arquemes
Sao Paolo
Manaus (1,650Km)
Belem (3,015 Km)
Arquemes
Sao Paolo
Manaus (1,650Km)
Belem (3,015 Km)
Arquemes
Sao Paolo
Manaus (1,650Km)
Belem (3,015 Km)
Arquemes
Sao Paolo
North American markets
North American markets
European markets
European markets
Regional marketsRegional marketsFuture alternative
portsFuture alternative
ports
TT
Likely Financial StructureU$000 %
Total Investment 12,922 1.00
Debt 4,523 0.35 IIC-IADB 2,500 0.19 IFC-WB 1,500 0.12 Commercial 523 0.04
Equity 8,399 0.65 Tahuamanu 3,877 0.30 Brazil/Ecuador Partners 1,034 0.08 SMEs 775 0.06 International Furniture 646 0.05 Technology Supplier 646 0.05 USAID-GDA 646 0.05 PUMA Foundation 388 0.03 Andean Development Corporation* 388 0.03 *Subordinated loan (Quasi-equity)
Key Success Factors
Price Price AdvantageAdvantage
Price Price AdvantageAdvantage
-Wood-Nut synergy (extraction, storage, transportation, labor)-Economies of scale and scope-Tax-free industrial park (20% cost savings)-Low labor/production costs
-Bolivian Tropical Forest at 1% of full capacity
- One of the world's largest certified forest
-International demand expected to grow steadily -Market integration (FTAA + MERCOSUR)
- Modern regulatory and legal framework
SUCCESS
-Outsourcing -Strategic location
- Transportation alternatives through BR/PER- Access to the Brazilian wood cluster- Isolated from political conflict
FlexibilityFlexibility FlexibilityFlexibility
-Forestry management
-International marketing
-Industrial capacity (larger than most competitors)
-Continuous technological upgrading
-Knowledge of local suppliers
-Continuous learning through inter-firm cooperation
Internal Internal capabilitiecapabilitie
ss
Internal Internal capabilitiecapabilitie
ss
Growth Growth PotentialPotentialGrowth Growth
PotentialPotential
Major obstacles and mitigating factors
• Learning costs (new industry)
• Lack of infrastructure (roads, communications)
• Expensive energy
• Lack of supporting and related industries
• Long distance to ports
• Political instability
•Tahuamanu’s high managerial and industrial capabilities
•Inter-firm cooperation (consortium modality)
•Tahuamanu’s high managerial and industrial capabilities
•Inter-firm cooperation (consortium modality)
Strategic location (flexibility to use more reliable infrastructure in Brazil/Peru)Strategic location (flexibility to use more reliable infrastructure in Brazil/Peru)
Investment in a wood-based energy generating plantInvestment in a wood-based energy generating plant
Strategic Location (access to the Brazilian wood-processing cluster)Strategic Location (access to the Brazilian wood-processing cluster)
Value-added processed products with lower incidence of transportation costsValue-added processed products with lower incidence of transportation costs
Strategic location (isolated from the most conflictive regions)Strategic location (isolated from the most conflictive regions)
3. Country Overview3. Country Overview
Bolivia: Basics
Landlocked country located in the center of South American
Area: 1 million sq km (about three times the size of Montana)
Population: 8.7 million
Natural resources: tin, natural gas, petroleum, timber and others
Poorest country in South America - poverty rate - 60%
- GDP per capita - 900 USD
Source: CIA, 2003, World Bank, 2003
Bolivia: Economic Environment
GDP growth:1.5%/y (1990-2001)
23 years of democracy and 20 years of market reforms
Economic Reforms Package:
- liberalization of prices, exchange and interest rates
- privatizations
- trade and capital account liberalization
Results : macroeconomic stabilization (low inflation rates, stable ER, etc.)
However: stagnant growth
Source: World Bank, 2004
Bolivia: Key Comparative Indicators
Source: World Bank, 2004
Governance Indicators (2002)
Source: D. Kaufman, A. Kraay, and M. Mastruzzi (2003). World Bank Policy Research Working Paper
The major obstacles for doing business in Bolivia
How problematic are obstacles in the business environment in the following areas?
0
1F
ina
ncin
g
Infr
astr
uctu
re
Ta
xe
s a
nd
Re
gu
latio
ns
Po
licy
Ine
sta
bili
ty
Infla
tion
Exch
an
ge
Ra
te
Fu
nctio
nin
g
of Ju
dic
iary
Co
rru
ptio
n
Str
ee
t C
rim
e
Org
an
ize
d
Crim
e
An
ti
co
mp
etit
ive
1 2 3 4 5 6 7 8 9 10 11
% r
esp
on
da
nts
.
Source: World Bank, Doing business 2003
Political Environment Since 1980s – constant social tension driven by poor economic conditions, income and regional disparities, ethnic conflict and wide-spread drug production and trafficking.
Since the early 2003, conflicts have taken a violent tenor:
- in October 2003 President Gonzalo Sánchez de Lozada, an unconditional supporter of market reforms resigned after two months of rioting and strikes
- a separatist movement led by agricultural-rich elites in western Bolivia is gaining momentum
The current president has lost control over the congress and is seen as “weak” in dealing with social pressure. Recent attempts to modify the legal framework for the energy sector has increased legal uncertainty.
Comparative Historical Risk
Overall risk comprises:
a) Economic risk
b) Operational risk
c) Political risk
World Markets Research Center, September 2004
4. Risk Assessment4. Risk Assessment
Cost of Capital WorksheetRisk Premium Calculation
Inputs Output Category
4.00 U.S. risk free in %
3.50 U.S. risk premium in %
93.70 Current U.S. Credit Rating
24.40 Institutional Investor country credit rating (0-100)
31.32 Anchored Cost of Equity Capital for project of average risk in country (ICCRC)
23.82 Country Risk Premium
Industry Adjustment
1.05 Beta (Industry)
-3.50 Sector adjustment
Project Risk Mitigation
(-10 to 10; where 10=risk completely eliminated, 0=average for country)
Weights ScoreImpact on Country
Premium Risks
Sovereign0.35 6.00 -5.00 Currency (convertibility)0.05 3.00 -0.36 Expropriation-direct0.04 0.00 0.00 Expropriation-diversion0.04 6.00 -0.57 Expropriation-creeping0.04 3.00 -0.29 Commercial International partners0.04 5.00 -0.48 Involvement of Multilateral Agencies0.03 0.00 0.00 Sensitivity of Project to wars, strikes, terrorism0.03 -3.00 0.21 Sensitivity of Project to natural disasters
Operating-Precompletion (setting up the plant)0.02 -4.00 0.19 Resources available (quantity/quality) -part not in discount rate0.02 -6.00 0.29 Technology (proven technology) -part not in discount rate
Operating-Post-completion0.03 7.00 -0.50 Sensitivity of operations to blockades, riots and other disruptions associated with political instability0.02 3.00 -0.14 Market risks (prices of outputs and demand)0.02 8.00 -0.38 Supply/input risk (availability)0.01 8.00 -0.19 Throughput risk (material put through plus efficiency of systems operation)0.02 -5.00 0.24 Operating costs
Financial0.03 4.00 -0.29 Probability of Default0.02 0.00 0.00 Political Risk Insurance
Real Options (some handled through cash flows)0.02 7.00 -0.33 Input mix or process flexibility0.02 6.00 -0.29 Output mix or product flexibility0.01 0.00 Abandonment or termination0.02 6.00 -0.29 Temporary stop or shutdown0.02 4.00 -0.19 Intensity or operating scale0.02 7.00 -0.33 Expansion0.03 8.00 -0.57 Interproject/intraproject0.02 -3.00 0.14 Shadow costs0.03 8.00 -0.57 Financial Flexibility
1.00 Sum of weights
Project Cost of Capital 18.12
Risk Premium (Country)
Risk Premium CalculationInputs Output Category
4.00 U.S. risk free in % 10-year T-bond
3.50 U.S. risk premium in %93.70 Current U.S. Credit Rating Sep/04
24.40 Institutional Investor country credit rating (0-100)27.4 (Sep/04) - 3 to account for escalating social conflicts (Jan-Mar/04)
31.32 Anchored Cost of Equity Capital for project of average risk in country (ICCRC)
23.82 Country Risk Premium
Industry Adjustment
1.05 Beta (Industry) MSCI 12/99
-3.50 Sector adjustment
Weights Score
Impact on Country Premium Risks Mitigating factors Aggravating factors
Sovereign0.35 6.00 -5.00 Currency (convertibility) -Most of the production will be priced and sold
in international markets (90%).-The U$/Bs exchange rate has been stable in the last 20 years.-Diversified markets (US, Europe, South America, possibly Asia).
-Nearly 30% of production expected to be sold in regional markets that are more prone to exchange rate volatility (Argentina, Brazil).-Operational costs are to be incurred in two currencies (Brazil, Bolivia).-Growing fiscal deficit.
0.05 3.00 -0.36 Expropriation-direct -Bolivia has shown a strong commitment to market reforms and property rights.-The forestry sector in general is not considered strategic for the economy/government.-The project will own no land (supply of raw material through concessionaries)
0.04 0.00 0.00 Expropriation-diversion -Government with no stake in the project.
0.04 6.00 -0.57 Expropriation-creeping -Project located in a tax-free export processing zone.-The government has recently enacted a comprehensive forestry law.
-Increasing legal uncertainty; a) changes in the legal framework for the energy sector, b) A French utility company forced to terminate its contract.
0.04 3.00 -0.29 Commercial International partners -TWC will work closely with long-established supporting and related industries in Brazil.-TWC is reaching out to Brazilian and Ecuadorian wood processors to join the consortium.-USAID, Andean Development Corporation.
- No international partner directly involved in the initial phase of the project.
0.04 5.00 -0.48 Involvement of Multilateral Agencies -Financing likely to include loans from WB-IFC, IIC-IADB, KFW, CAF
0.03 0.00 0.00 Sensitivity of Project to wars, strikes, terrorism
0.03 -3.00 0.21 Sensitivity of Project to natural disasters -High levels of humidity in the Bolivian forest reduce the likelihood of wood fires.
-Vulnerability to wood fires and floods.
Operating-Precompletion (setting up the plant)
0.02 -4.00 0.19 Resources available (quantity/quality) -part not in discount rate
-No experience in setting up a wood processing plant.
0.02 -6.00 0.29 Technology (proven technology) -part not in discount rate
-TWC seeking local and international partners to acquire the necessary expertise in wood processing technology.
-Learning costs associated with adapting and mastering new technology.
Operating-Post-completion
0.03 7.00 -0.50 Sensitivity of operations to blockades, riots and other disruptions associated with political instability
-The project is located in a border city far from the regions more prone to social unrest.-Flexibility to use the transportation and communication systems of bordering Brazilian/Peruvian cities in case of domestic disruptions.
0.02 3.00 -0.14 Market risks (prices of outputs and demand) -Demand/price of processed tropical wood expected to increase steadily in the medium term (ITC).
-Some price volatility observed in low-value added products.-Increasing substitution of wood for non-wood products (bio-composite, plastic, aluminum etc.).-Central and Eastern European wood suppliers expected to capture part of the EU market.
0.02 8.00 -0.38 Supply/input risk (availability) -The seventh largest and most diverse forests in the world at 2% of full capacity. -Experience in forest management and working with indigenous communities.-The nut-wood synergy guarantees a year-round availability of labor with no reallocation costs.
0.01 8.00 -0.19 Throughput risk (material put through plus efficiency of systems operation)
-The plant is designed to process 35 species of hard, soft and precious wood in order to maximize throughput and reap economies of scale.-Nut-wood synergy expected to reduce extraction and transportation costs.
0.02 -5.00 0.24 Operating costs -Learning through inter-firm cooperation.-Outsourcing to Brazilian supporting industries (transportation, extraction, maintenance).-Flexibility to use Brazilian/Peruvian road networks.-Plant located far from the regions more prone to social conflict.
-Learning costs (no experience in wood production).-Expensive and unreliable transportation through Bolivia.-Operational risk due to political instability (road blockades, strikes, riots).
Financial
0.03 4.00 -0.29 Probability of Default -Tahuamanu has a high credit record (it has never defaulted on its debt).
-No experience/expertise in wood-processing
0.02 0.00 0.00 Political Risk Insurance
Real Options
0.02 7.00 -0.33 Input mix or process flexibility - Only 35 out of 360 wood species will be initially exploited.
0.02 6.00 -0.29 Output mix or product flexibility -Technology can be easily adapted to manufacture other types of products in the future.
0.01 0.00 Abandonment or termination -Since TWC will own no land and outsource many activities, the cost of termination is relatively low.-Marketable technology/infrastructure (easy to be resold).
0.02 6.00 -0.29 Temporary stop or shutdown -Since TWC will own no land and some of the processes are outsourced, the cost of temporary shutdown is relatively low.-Labor-intensive processes to be outsourced (extraction, transportation).
0.02 4.00 -0.19 Intensity or operating scale -Plant designed with overcapacity to allow production flexibility
-Full capacity reached in year 6 according to projections.
0.02 7.00 -0.33 Expansion -Availability of inputs (wood forest)-Relatively simple infrastructure/technology.-Technology supplier likely to be part of the consortium (easy access to technology for expansion/upgrading).
0.03 8.00 -0.57 Interproject/intraproject -The synergy between nut and wood processing will make both industries more competitive and allow for future expansion projects to take place.
0.02 -3.00 0.14 Shadow costs -Project design and implementation requires Tahuamanu's management and engineering time.
-Brazil nut production reaching saturation (not many expansion opportunities).
0.03 8.00 -0.57 Financial Flexibility -Low initial leverage (0.35 debt/equity ratio)
5. Project Appraisal5. Project Appraisal
Cost of DebtU$000 %
Total Investment 12,922 1.00
Debt 4,523 0.35 Cost Weight Weight * Cost
IIC-IADB 2,500 0.19 0.080 0.55 0.044
IFC-WB 1,500 0.12 0.082 0.33 0.027
Commercial 523 0.04 0.093 0.12 0.011
Equity 8,399 0.65 Cost of Debt (Kd) 0.082
Tahuamanu 3,877 0.30 Brazil/Ecuador Partners 1,034 0.08 SMEs 775 0.06 International Furniture 646 0.05 Technology Supplier 646 0.05 USAID-GDA 646 0.05 PUMA Foundation 388 0.03 Andean Development Corporation* 388 0.03 *Subordinated loan (Quasi-equity)
Valuation
Scenario 1with real options
Scenario 2no real options
Ke 18.12 20.31 Kd 8.19 8.19 t - - D 0.35 0.35 E 0.65 0.65
WACC 14.65 16.07
NPV $6,248.43 $4,947.86IRR 25% 25%Pay-Back 6.1 6.1
Net Present Value of real options $1,300.57
Different ScenariosU$ 000
Scenario 1with real options
Scenario 2no real options
Scenario 3different leverage
Scenario 4effective tax of 20%
imposedTWC valuation
Ke 18.12 20.31 19.60 18.12 Kd 8.2 8.2 11.5 7.2 t - - - 0.20 D 0.35 0.35 0.60 0.35 E 0.65 0.65 0.40 0.65 WACC 14.65 16.07 14.74 13.80 11.20
- - - - NPV $6,248.43 $4,947.86 $6,156.27 $4,372.78 $8,658.29IRR 25% 25% 25% 22% 24%Pay-Back 6.10 6.10 6.10 6.10 $6.10
TWC is unable to find equity partners and has to leverage more. Implies higher financial distress and reduces future growth options
Tax is imposed (export processing zone ceases)
Some risk accounted for in cash flow projections
Thank you