the refinancing of shanghai general motors
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The Refinancing of Shanghai General MotorsBy:Bhavesh JainAdrija Chakraborty (F09063)Aman Gupta (F09067)Neeraj Jain (F09097)Sofia Saxena (F09115)
AGENDA
Introduction About SGM Capital Structure Why a Joint Venture?
Identification of the Problems of the Case Primary Problem Second Problem
Addressing the Primary Problem Problems of Existing Financing Terms
Possible solutions Refinancing Drawing on existing loans
Addressing the Second Problem Risks Faced Mitigating Risks
Conclusion Learning from the case
Introduction
ABOUT SHANGHAI GENERAL MOTORS
• June 12, 1997FOUNDED IN
• 50% with General Motors• 50% with Shanghai Automotive Industry
CorporationOWNERSHIP
• Chevrolet• Buick• Cadillac
PRODUCTS
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Capital Structure of SGM
• Source: General Motors
• Amount: USD 350 million
• Source: SAIC• USD 350
million equivalent
• Chinese Lenders
• USD 349million equivalent
• USD Lenders• Amount: USD
USD472million
Equity 23%
Equity 23%
Debt23%
Debt31%
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Cost of Initial Financing
Cost
Floating LIBOR +105 bps USD
Loan
Cost
Floating PBOC rate
Chinese RMB Loan
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Why a Joint Venture?
China was a promising market and GM had the means to do it all alone. Then why did it choose to go for a joint venture?
Reduces entry risks by using the local partner’s assets
Can gain access to local borrowing powers
There is access through local resources through
participation of national partner
Can access the foreign technology or expertise
7
Identification of the Problem
Primary problem of the case is:For its upcoming SAIL project, should SGM use
project-financing on existing terms or re-finance its existing debts altogether and start afresh?
Secondary Problem:How to hedge the foreign currency risk of SGM
given the restrictive nature of derivative trading in China
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ADDRESSING THE
PRIMARY PROBLEM
9
Problems of Existing Financing Terms
1. High cost of debt due to Asian Crisis. Situations have improved since then and loans are available at more favorable terms
2. Restrictive clauses of existing financial terms:▪ Any finance related decision needed a super-majority approval of the
existing bank committee▪ All existing and future assets of SGM were pledged▪ Equal use and pro-rata repayment of Cinese and American currency
loans
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Problems of existing financing terms
3. The super-majority clause was restricting decision making in areas such as expansion, capital expenditure etc
4. USD LIBOR rates at 6.2% were higher than the Chinese RMB rate of 5.85%, yet re-adjustment was not possible due to the proportionate borrowing clause between USD and RMB
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Problems of existing financing terms
5. Use of derivatives for hedging risks was also restricted except for forward contracts
6. Capital control by SAFE: The controlled supply of foreign
currency by SAFE made the repayment of USD loan uncertain
12
Possible Solutions
OPTION 1: REFINANCING
HOW TO GO ABOUT IT??
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Trend of 6mnth LIBOR & PBOC Rates
Jan/
99
Jan/
00
Jan/
01
Jan/
02
Jan/
0301234567
LIBOR
Interest rates in China has been lower than the 6 month LIBOR rates on which the USD loans were based
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Trend of CNY/USD exchange rate
Apr/9
9
May
/99
Jun/
99
Jul/9
9
Aug/
99
Sep/
99
Oct/9
9
Nov/9
9
Dec/9
9
Jan/
00
Feb/
00
Mar
/00
8.2768.2778.2788.2798.28
CNY/USD
CNY/USD
The chart below shows quite a stable exchange rate between USD and CNY during the period under discussion. Hence there is not much risk of loss in repatriation of profit due to currency appreciation in U.S.
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Comparison of Inflation between US and China
1999 2000 2001 2002 2003
-2
-1
0
1
2
3
4
Average Inflation in US
Average Inflation in China
Inflation rates in US have been historically higher than that of China
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Refinancing:
Based on the above three statistics, we feel that even if the interest rate parity and purchasing power parity holds loosely, it will be more profitable to borrow in Chinese currencies.
Hence the course of action available to SGM are:Borrow in Chinese currency and repay the old
loansReduce exposure to foreign exchange as
there are not many hedging options availableBecome self-sufficient, i.e. reduce
dependency on parent company
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Possible Solutions
Option 2: Take no action, i.e., continue to draw on the unused part of the USD and RMB loans to finance SAIL
HOW WILL IT AFFECT SGM??
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Continued dependency on the existing banking committee. Decision making will be slow and SGM will not be able to react quickly to the increased competition when China joins WTO
Cannot take advantage of the interest rate differentials
In the face of increased competition, SGM will not be able to reduce its interest expense
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ADDRESSING THE
SECONDARY
PROBLEM
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Risks Faced
Interest Rate Risk▪ Risk of an increase in 6mnth LIBOR or PBOC
rates
Currency Exchange Rate Risk▪ Risk of depreciation of Chinese currency and
thus dearer imports from US▪ Risk of SAFE not supplying enough USD to
make payments
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Mitigating Interest Rate Risk
1.Since there aren’t any derivatives available, interest rate risk can be mitigated only by an interest rate cap
2. Forward Rate Agreements3.Interest rate swap if possible:
BANK
Floating rate
Fixed rate
Floating rate
SGM
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Mitigating Exchange Rate Risks Localization: reducing dependency on US
imports and thus reducing USD liability
Refinancing: Change the borrowings from USD loans to Chinese RMB loans to avoid payment in USD
Export: Export products to US in order to balance out payables and receivables in the same currency
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Conclusion
LEARNINGS FROM THE CASE:
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