Hawkeye Renewables has closed a $185 million B loan financing – the first public project financing for an ethanol facility. The deal, low rated and featuring relatively loose covenants, illustrates that lenders to such plants will need to be flexible. It also gives an indication of the priorities of the private equity firms currently circling the sector.

Hawkeye Renewables, formerly Midwest Renewables, features equity from Whitney & Co, a mid-tier private equity firm. Hawkeye is 100% owned by Hawkeye Holdings, which is in turn owned 58% by Whitney & Co, 17% by management and 25% by other investors. Midwest, originally owned by management, first planned a 40 million gallons per year ethanol plant in Great Falls, Iowa. Ethanol, a corn-based product, is beloved of corn producers since its price tracks that of gasoline, and provides them with a natural hedge.

Both federal government, and the Midwestern states, offer incentives for ethanol production, the most important of which is a 51 cents per gallon federal excise tax credit for the construction of additional capacity. Iowa, for instance, offers a small tax credit ($0.015 per gallon) for ethanol-based fuels sold in-state, and a number of grants and low-interest loans.

Hawkeye raised $45 million – $21 million in senior construction loans and $24 million in senior term loans – from Hudson United Capital in June 2004. These were converted to term loans in early February 2005, at which point the sponsor was close to completing a refinancing on a much larger scale.

The original deal was a small, though tightly structured financing, with roughly 60% gearing. With leverage at this level, Hudson could be comfortable with the prospects of recovery, and thus the fact that the facility is largely exposed to commodity risk. Ethanol producers often face a mismatch between revenues, indexed to gasoline prices, and costs, indexed to corn prices.

While hedging programmes are available, few go beyond 12 months, although some bankers claim that the futures can be found at the Chicago Board of Trade that go out 18 months. While the fundamentals look strong for ethanol (for more details, see US Agriculture feature, this issue), it is still a market in its infancy, and at the mercy of the legislative process.

Hawkeye wants to use the money from the refinancing to build a new 100 million-gallon plant at Fairbank, Iowa, and expand the Iowa Falls project to 80 million. This capacity would give it a meaningful slice of the ethanol market, although it would still keep it far behind the leaders such as Cargill, ADM and Aventine.

The new financing structure consists of a $185 million B loan at the operating company level, a $40 million subordinated loan provided to Hawkeye Holdings, and $17 million in equity. The opco is roughly 75% leveraged, since the ratings agencies consider the subdebt, which carries a 10% coupon and a 6% in-kind obligation, and equity together as equity. The $17 million also includes a note receivable from the contractor Fagen, an arrangement familiar to ethanol developers. Fagen is one of the main constructors of ethanol plants, and often takes a very proactive role in promoting projects.

With these fundamentals, Moody's assigned the debt a B2 rating, while S&P gave it a B rating, with a recovery rating of 3 (defined as a meaningful, or 50-80% recovery of principal potential). Credit Suisse, looking to make a reputation in the sector, structured the B loan as a single senior secured issue.

That decision looks more than justified, since the deal, initially carrying a 350bp over Libor margin, was so popular that CSFB flexed it downwards to 287.5bp. The deal features a cash sweep and one year's debt service reserve, although it does allow for a working capital facility, sufficient to allow the facilities to obtain supplies, that would have a first priority lien on inventory.

While the cash flow from the existing 40 million plant is enough to service the interest on the loan, the financing is dependent upon the ability of Fagen to bring the second plant online on time and within budget. It did so on Iowa Fallls, but the Fairbank plant will be larger, one of the largest plants yet attempted.

The two final considerations relate to the state of government support, and the effect of this support. Federal subsidies will be provided until at least 2010, and barring a massive political realignment would likely be extended again. Moreover, bans on MTBE, a rival fuel additive, are becoming more, rather than less, prevalent.

But the opportunities have not gone unnoticed, and a number of private equity firms have entered the space. All of them, as well as their lenders, want to see their money back before the 2010 deadline. The industry may well have too much capacity in the medium term, although that situation would likely squeeze smaller and less efficient producers.

The next test for developers will be to bring online plants closer to the key markets. At the moment, projects ship their ethanol and high-protein feed (a secondary, but valuable, output) from the Midwest corn-growing states further west to the southwest and California. Knowledgeable observers say that the savings in shipping from building a plant in California would be substantial.

CalGren, for instance, is planning two plants with 100 million gallons' capacity, and has received both approvals and a tax-exempt bond allowance, for one of them, a 40 million plant in Tulare County with a $65 million price tag. CalGren is believed to be working with Hudson on a financing package.

Hawkeye Renewables
Status: Closed February 2005
Size: $242 million
Location: Iowa
Description: Financing and refinancing of two plants, one as an extension, and one as a new project, with a total of 180 million gallons' capacity
Sponsor: Whitney & Co, management, private investors
Debt: $185 million
Arranger: CSFB
Construction finance: Hudson United Capital
Maturity: 2012
Margin: 287.5bp over Libor
Arranger legal: Skadden Arps
Borrower legal: Gibson Dunn & Crutcher
Hudson United legal: Baker & McKenzie