A devastating year for project finance in emerging markets since the currency crises in Asia has turned private investors' heads towards the more stable markets of Western Europe and the US. These markets however do not offer the opportunity for basic infrastructure project financings which were available in the emerging markets. Lenders have been made more cautious by the Asian crisis and this has forced project finance as a financial tool to change and become more flexible. This has brought about innovative hybrids between corporate finance, non-recourse finance and securitizations which have been developed through projects in the service industry.

Sponsors themselves are also looking elsewhere for deals and the market demand has led them towards leisure projects. Unlike power or sanitation, leisure projects rely on consumer choice and long-term guaranteed offtake agreements are not possible for these deals. But there is a lot of liquidity in the market at the moment which is being soaked up by the service industry. Leisure is big business in the Western world and project financiers are seemingly more than willing to find solutions to the risk problems to raise the capital needed. The higher perceived risk of leisure projects also means higher yields for financiers.

An example of the developments in financing for leisure projects is the £200 million ($312.12 million) financing, which closed on April 9, for the UK's ExCel exhibition centre which will be built in south east England. The Private Finance Initiative-type (PFI) deal was financed through the issue of £130 million of class A, secured bonds and £53.56 million class B, subordinated bonds. The Class A notes are secured on pre-agreed exhibitor contracts which are sufficient to cover debt-service payment requirements for the first 10 years of the project. The class B notes, although unsecured by written contracts, are informally secured by exhibitors who have negotiated dates, time and space to exhibit at the centre but have delayed signing binding contracts until sufficient progress has been made with construction to show that the project will get off the ground on time.

The UK government has lent its support to the ExCel centre through English Partnerships which will provide £16 million of on-site infrastructure as well as providing the use of the 85-acre site at the Royal Victoria Dock for a nominal rental charge for the full term of the 200-year lease. The government's relatively low-key role in the project has been replaced by the private sector and so the deal could not be called a true PFI transaction as it has not benefited from any government offtake. Says Robert Rees director of project finance at Barclays Capital in London and project manger for ExCel: ?The deal was a real mix. Effectively project bonds have been around in the UK for a while but this represented a fairly significant widening in the sector. The government was not as active in the deal as it would be in a PFI deal and this one was a step further toward a private deal. The role of the government in guaranteeing future revenues was taken up by Miller Freeman and Reed Exhibitions under a contractual take-or-pay agreement.?

The government will actually take 1.5% of the turnover in rent and holds a 7% equity stake in the project.

The contracts signed by Miller Freeman and Reed Exhibitions commit them to relocation of shows to ExCel, whether they use, or rent out the space to others. Both companies, which are subsidiaries of investment grade corporations, have also taken equity stakes in the project which they have agreed to hold for at least five years after the completion of construction.

The structure of the financing will be carried into other deals, says Jeremy Church of Duff & Phelp's: ?We are seeing more hybrid structures and securitizations with PFI. Bond issues are less costly to do than syndicated loans and it gave the sponsors the opportunity to do more work upfront and eliminate more risk early on. This structure is being looked at now to finance pubs and care homes.?

Says Barclays Capital's Rees: ?Bond issues provide longer maturities which allow longer pay-back times. This in turn means there is less to pay back each year making the break even point for the project lower. Looking at doing a shorter term it would be very difficult to justify the debt service covers?. The advantages of the ExCel structure make it attractive for other projects. Says Rees: ?The ideas incorporated have taken the use of capital markets a step further than has been seen before with a lower emphasis on the role of government and the slack taken by the private sector.?

The seemingly higher risks involved in investing in a project which does not provide a basic necessity, such as power or sanitation, have in the case of ExCel, been largely eliminated by the provision of signed contracts by large exhibitors.

This type of forward sale can be paralleled, to some extent, by the large sports stadia deals which are increasingly common in the US project finance market. For example, Enron paid $100 million for the right to put its name to the to the Houston Astros' baseball stadium which will be known as the Enron Field when it opens in April 2000. This is a significant investment towards the $250 million project cost which included $180 million in debt. The fact that Enron was prepared to make the investment is a reflection on its strategy to secure its place in the stadia business which it has identified as being a large and lucrative area of business. Says Lou Pai, chairman and chief executive officer of Enron Energy Services: ?Enron Energy Services' partnership with the Astros further validates our belief that entertainment facilities, especially sports stadia, represent a tremendous opportunity for our energy and facilities management services.?

Revenue streams for leisure projects tend to rely on numbers of visitors. A project which relies solely on day-to-day use without long-term contracts is the UK's £29.5 million Millennium Wheel project. Financing for the 135-metre Ferris wheel relies purely on the forecast number of users. Says project manager Layth Irani, a manager in project finance at Sumitomo: ?The size of the deal makes no difference you still do not take any more risks. Visitor numbers are considered a risk but we were confident that the forecasts used for our base case were very conservative and still gave us a large cushion so the risks were adequately covered. London Eye is a unique project in a fabulous location and is a very dramatic structure which is going to generate a lot of interest.? Construction of the wheel is already underway and it is expected to be erected by August 1999. Sumitomo and WestLB arranged a £20 million, five year, fixed rate credit facility to finance the project. Financing closed in October 1998.

ExCel's forecasters were equally as cautious as those for the Millennium Wheel. Says Rees: ?We were very conservative with our modeling assumptions and the UK exhibitions market is very positive as there is less space than demand, which has been growing for the past 20 years. We also looked at what happened in the last recession in 1990/91 and results were encouraging as the market did not suffer unduly. It is a stable market which is what bond holders like. It is not exciting or racy but it turns in decent profits year in year out.?

European leisure projects differ from those in the US which are characterized by large stadia deals. Says Irani: ?In the states they have big stadia with big corporate uptake for long term seats and with municipal support. Whereas here you have to battle through the planning stage and the sports institutions here rarely have the financial strength to justify it.?

The US sports industry is large and growing and benefits from a lucrative corporate entertainment sector. This provides long-term revenue for premium seats. US fans are also more likely to pay long-term for seats in stadia and the local governments are keen to offer their financial support.

It is true that leisure deals are perceived as being more risky than other types of infrastructure deal and investors have recently been put off by the high-profile disappointment of France's EuroDisney project. Says one financier with experience of the leisure market: ?Investors have been burned recently by a major leisure development in France which was a very bad experience. People piled in to EuroDisney and then found it did not perform which has made banks a lot less comfortable with the leisure sector. It has coloured perceptions and now even if it is quite a good project it has to overcome that hurdle.?

The perception of leisure projects as being risky is not entirely founded although there are elements which must be taken into account when structuring a deal. Says Rees: ?In general, terms of leases are much shorter than for other infrastructure projects where you can get 25 years from other companies, you cannot get them from leisure companies. Also, leisure companies are not as good credit as, for example, water companies or electricity distributors. In the past year or so there has been a lot of growth in the high-yield markets in Europe. We deal with companies at investment grade or good non-investment grade and the market is taking a lot more interest in this area as everyone needs yield and if you cannot get it out of emerging markets then a good way to find it is in the solid UK market where a lot of the political risk is removed.?

All leisure projects have in common that they rely on consumer choice which will always be risky and more fickle than long-term offtake agreements. However, leisure projects are here to stay and will increasingly provide fodder for project finance deals whatever form the financings take. Says Layth Irani of Sumitomo: ?All good leisure projects have to be looked at quite thoroughly and the risks understood in order to develop a structure that will deal with them.? Banks are finding these structures and those that do it best will find themselves a useful niche in this fast-growing sector.