Financing the Mozal project:

Country Profile: Mozambique

It gained its freedom from Portuguese in 1974 after a civil war. The two sides signed a peace accord in
1992. After this Mozambique government made constant efforts to improve country’s macroeconomic
situation and encouraged the private sector investment. As a result, country’s GDP and FDI increased
constantly and its inflation decreased. But even after all those efforts, Mozambique remained a poor
and underdeveloped country in 1997.

Investment Opportunity in Mozambique:

The country was not very attractive for investors during the phase of 1997. Although improved, the
country’s investment risk rating was still 14 (up from 7.6 in 1989). Even ICRG had given it a high risk in
terms of financial and economic risk.

But the positive side was that country was growing at a much higher pace. Its GDP growth rate had
improved from 0.5% in 1980 to 6.5% in 1996.

Challenges Faced:

 No existing infrastructure to support the project

 Unskilled labor is available in abundance but scarcity of skilled labor
 Logistical challenges are there for importing raw materials and exporting finished goods
 Employee health issues
 Expectations of world standards was unlikely to be met due to above issues

About Mozal:

It began as consortium of three entities naming Eksom, Alusaf and Mozambican Government. The
project was mainly to build an Aluminum Smelter due to potential availability of hydraulic power. The
entire project was estimated to be around USD1.4 billion. It was supposed to be a low cost smelter due
to cheap electricity and low cost unskilled labor.

Essentials for the project:

 Alumina: They hedged the Alumina for 25 years from Billitons, Australia
 Electricity: The supply of electricity was also contracted for 25 years from Eksom and
Mozambican Government
 Labor: Mozambican government agreed to provide the project with a lot of low cost labor to
make the production of low cost Aluminum possible

Stakeholders:

 It was a joint venture of Government and IDC

  Genector became the world’s fourth largest player of Aluminum after acquiring Billiton from
Royal-Dutch Shell in 1994
 Alusaf (Subsidiary of Genector) and the IDC of South Africa both owned 25% of share in the
project
 IDC is a government owned bank in South Africa. Their goal was to promote entrepreneurship
and financing private sector enterprises
 In 1996 they created a USD1.8 Billion Hillside Smelter
 The Mozal project would appear along the Maputo Corridor, a major trading route between
Johannesburg and Maputo
 Estimated time was of 34+6 months to reach full capacity
 The average capital cost for any smelter was $4850 per ton but the Mozal project had an overall
capital cost of $4750 per ton at full capacity

Financing:

Sources of Fund Amount (in Million USD) Percentage

Cash during Start-Up 35 2.56%
Subordinate Debt 150 10.98%
Equity 500 36.63%
Senior Debt 680 49.81%
Total 1365 100%

Future of Project:

 Currency Denomination: USD

 Sponsors are potential buyers
 The plant was targeted for an industrial free zone exempting it from paying taxes
 Chase-Manhattan Corp – trustree responsible for collecting sales proceeds, paying debt holders,
remitting operational expenses and paying dividends

IFC’s role:

 A member of world bank group founded in year 1956, and owned by 172 member countries
 Invests in private sector for social cause for like reducing poverty, increasing the living standards
etc.
 Provides multilateral sources of debt and equity for private sector projects
 The loans provided by IFC aren’t backed by the sovereign funds
 They mainly focus on green field projects
 Financial ROR – projects IRR was based on constant price projections considering interest and
tax
 For the appraisal it took a time of 3 months

Anticipated outcomes:
  Increase in:
o GDP by $157 million (9% compared to 6.4%)
o Exports by $430 million
o Net foreign Exchange by $161 million
 It would generate 5000 construction jobs
 Provide critical infrastructure and investment along with Maputo corridor
 Assess social and environmental impact

Recommendations:

 IFC should immediately seize the opportunity presented in financing the financing of the Mozal
 Investment in Mozal Project on the part of the IFC would generate valuable social, financial and
economic benefits
 The use of South African power supply, the obtaining of Alumina from Billiton Australia, the
technology from France, and the holding of sales proceeds in a foreign bank account provide an
excellent structure that will alleviate sovereign, expropriation, and operating risks
 The Mozal project has qualified sponsors: at $78 billion and a conglomerate such as Mitsubishi
Corporation has signed in as a strong candidate with infinitesimal chance of default

The IFC should immediately seize the opportunity presented in the financing of Mozal. Investment in the
project on the part of the IFC would generate valuable social, financial, and economic benefits, not only
for the people and government of Mozambique but on a more global level as well, allowing the
international investors, suppliers, distributors, and sponsors involved in the deal to enjoy the catalytic
effects spurred by the project and the investment itself. The Mozal Project is the perfect trigger to boost
the economy of the emerging market, post-conflict Mozambique and improve the quality of life for its
people on every level.

While Mozal will require high leverage to mitigate sovereign and expropriation risks, the expertise of the
IFC will assist in quality financial and operational structuring. The use of the South African power supply,
the obtaining of alumina from Australia, the technology from France and the holding of sales proceeds
in a foreign bank account provide an excellent structure that will alleviate sovereign, expropriation, and
operating risks.

In June 1997, a project team from the International Finance Corporation (IFC) was recommending that
the board approve a $120 million investment in the Mozal project, a $1.4 billion aluminum smelter in
Mozambique. Four factors made this recommendation controversial. First, it would be the IFC's largest
investment in the world and by far its largest investment in Sub-Saharan Africa. Second, the project was
enormous by Mozambican standards--it was not much smaller than the country's 1996 gross domestic
project (GDP). Third, Mozambique was a very poor country at the time (per capita GDP of $90) and had
only recently emerged from 20 years of civil war. Fourth, many aspects of the deal remain undetermined
such as who was going to provide half the equity needed to finance the project.

Despite these concerns, the sponsors, Alusaf (the aluminum subsidiary of the South African minerals
company, Gencor) and Industrial Development Corporation of South Africa (IDC is a development bank),
want to structure a limited-recourse deal to finance the smelter; it will be non-recourse to the sponsors
after completion. Commercial bankers have refused to participate unless the International Finance
Corporation gets involved in the deal and so the sponsors have approached the IFC about participation.
After reviewing the project's commercial viability and development impact, the IFC team is recommending
the investment. The board must decide whether it is the right time and the right project to make such a
large investment.

The case has four pedagogical objectives. 1) It presents an extreme example of political risk in a
developing country setting and shows how organizations like Institutional Investor, the Economist
Intelligence Unit, and The PRS Group attempt to analyze it for prospective investors. 2) It illustrates the
modern form of political risk management through project selection, structuring, and insurance, and
contrasts this approach with the older, financial style of political risk management whereby sponsors
simply increased hurdle rates to ensure sufficient project returns. 3) It highlights the various roles
multilateral development institutions, in general, and the IFC, in particular, can play in financing major
projects. 4) It analyzes IFC's involvement in appraising, structuring, monitoring, and financing projects,
and shows how these activities create value by resolving costly market imperfections including
information, distress, agency, and transactions costs. It also explores the IFC's performance in these
various activities. Given these objectives, the case is appropriate for business/government, strategy,
international business, and finance courses.

“Financing the Mozal Project” Case Analysis: International Finance Corporation (IFC), along with other
investors, is faced with the critical decision- whether to invest or not in the Mozal project, a $1.4 billion
aluminum smelter in Mozambique. Apart from the magnitude of the investment involved, $120 million
for IFC - its largest investment in the world, the project is subject to high risk factors. Moreover
Mozambique is a very poor country with a GDP, only a little higher than the total project investment.
Under such adverse conditions, the sponsors along with the support of foreign investors, Industrial
Development Corporation (IDC) of South Africa, Multilateral Investment Guarantee Agency (MIGA) and
the analysis, expertise and resources of the IFC structure the project to create profitable returns for the
stakeholders as well as promote economic, social and industrial development in Mozambique. The
Mozal project, no doubt is a large project both in terms of investment as well as risk involved. The
principles of project finance have been effectively utilized to structure the project and mitigate political
as well as resource, technical, completion, operation and many similar risks. Since the end of the civil
war, establishment of a democratic government and movement towards a capitalist regime,
Mozambique is trying to rebuild its economy, infrastructure, human capital via privatization and creating
a beneficial environment for foreign investment. The Mozambican government is taking concrete steps
to strengthen its relations and develop an environment to attract investments. The Investment
Protection and Promotion Agreement, binds the government to honor and protect cross-border
investment. Especially in the case of the Mozal project a special liaison committee has been set up to
display government support. A highly leveraged capital structure financed by major development banks,
export credit agencies and multi-lateral agencies provide a sound foundation for the project. They act as
a deterrent to expropriation or any government interference. More over the MIGA support to provide
insurance and cover loan guarantee for the investment against the risks of expropriation, war and civil
disturbance. The project is set up as an independent entity; therefore the profits/losses of the entity are
not reflected on any single sponsors/investors balance sheet. Moreover the activities of the entity will
define and strengthen its position in Mozambique. The establishment of infrastructure, training of local
human resource, awareness camps for AID/HIV, school, hospitals or any such social/humanitarian
activities will be attached to the entity. Therefore making it difficult for the government to expropriate
it. The Mozal project will mirror, the Hillside Smelter recently established by Alusaf/Gencor in South
Africa, for project, resource, input and completion planning. It is beneficial for Alusaf/Gencor to invest in
the project, since they along with IDC were able to successfully establish the Hillside Smelter before time
and within budget. The Mozal project will employee the same project management team under similar
lump sum and turnkey agreements as the Hillside project to cover for any timing and completion risks.
The Mozal project offers future real options of doubling the capacity of aluminum production to 500,000
tons, under the same infrastructure. The project from a profitability perspective is very attractive. The
demand for aluminum is expected to grow at 2% - 3% per year. Mozal project with its strategic
partnerships with Eskom (South African power provider) and Electricidade de Mocambique will receive
competitively priced power. They will also benefit from the availability of low cost labor. The project is
also established in an Industrial Free Zone, exempted from custom duties and income taxes. Therefore
cashing on the competitive advantage of producing aluminum at lower prices. The inputs have been tied
in via long-term supply contracts. Billiton Australian operations will provide Alumina a major input-
under 25 years supply agreement for a price set as a function of LME aluminum prices. Electricity prices
will be negotiated prices. The cost of local unskilled labor from Mozambique will reduce the cost of labor
to one-fifth compared to similar western operations. The operation is not subjected to any such
currency exposure- all major inputs are prices in US Dollars. Both the price of aluminum and 75% of the
price of input are subjected to fluctuation with the LME prices, forming a natural hedge against market
risks. Despite the structural approach to risk management, the Mozal project will have to continuously
invest in Mozambique to develop favorable conditions for long-term sustainability such as training and
education for the workforce, health awareness programs, and infrastructure development like roads,
port etc. The low cost competitive advantage of placing the project in a poor country comes with long-
term development and social commitment to infrastructure and human capital over financial returns. To
ensure the long-term sustainability and feasibility of the project, both from the financial and economic
development point of view, the involvement of IFC is vital. IFC rightfully has a halo effect on the deal. As
a member of the World Bank, IFC provides a level of comfort to the investors to invest in a high-risk
project like Mozal. Its reputation as a honest broker also puts a check on over ambitious, profit minded
sponsors and ensures transfer benefits to the host government lessening the probability of
expropriation and developing a long- term sustainable project. Mozal will require high leverage to
mitigate sovereign and expropriation risks. IFC expertise and experience in appraising the projects,
structuring the legal and financial documents, providing long-term capital and deterring sovereign
interference especially in high risk countries uniquely positions it as an source of comfort for other
investors. The project appraisal for Mozal identified it as viable with acceptable financial and economic
rate of return. The IFC should seize the opportunity presented in the financing of Mozal project. IFC can
provide long term loan with longer maturities better suited for long-term projects. Moreover,
investment in the project on the part of the IFC would generate valuable social, financial, and economic
benefits, not only for the people and government of Mozambique but on a more global level as well,
generating a catalytic effect on international investors, suppliers, distributors, and sponsors involved to
invest in the project. The Mozal Project is the perfect trigger to boost the economy of the war ridden,
post-conflict Mozambique and improve the quality of life for its people on every level. While such an
investment, which would be the largest single FDI project for Mozambique, is projected to increase the
country’s exports by $ 430 million, GDP by 9% and net foreign exchange by $161 million per year. It will
also create employment, infrastructure and spur investment along the Maputo Corridor. IFC faces a
catch-22 situation in financing high-risk projects. Although its main goal and founding mission is to invest
in places no one else wants to go and finance projects no one else wants to finance, lower returns can
adversely affect its credit rating and the ability to attract low-cost funds for investment purposes. In the
Mozal project the involvement of IFC is critical in attracting/ensuring investment from other investors;
failure of the project would not only be devastating from a financial point of view but also deter
investments in Mozambique for years to come. The unique positioning of IFC as honest broker and its
affiliation to the World Bank reduces the political risks to the project. The use of the South African
power supply, the obtaining of alumina from Australia, the technology from France and the holding of
sales proceeds in a foreign bank account provide an excellent structure that can alleviate sovereign,
expropriation, and operating risks. The Mozal project provides an opportunity to invest in not only a
long-term financially profitable investment but also in the economic, social and industrial development
of one of the poorest countries in the world. The project will attract attention and create opportunities
for future investment in Mozambique, leading to better living standard for its people. The impact of IFCs
investment and success of the Mozal project, will pave the way for Mozambique to establish itself as
attractive, low-cost, low- risk destination for future foreign investment.