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


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%


Cost of Initial Financing

Cost

Floating LIBOR +105 bps USD

Loan

Cost

Floating PBOC rate

Chinese RMB Loan


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


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


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


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??


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


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.


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


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


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??


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


ADDRESSING THE

SECONDARY

PROBLEM


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


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


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


Conclusion

LEARNINGS FROM THE CASE:

the refinancing of shanghai general motors

Documents

usd loans

usd export

usd lenders

usd libor rates

saic usd

rmbsample footer

expensesample footer

chinese lenders usd