Meridian Ports: Terminal Investment Under Demand Risk
Meridian Ports plc is evaluating a new container terminal. The project requires £150m of capital expenditure, depreciated straight-line to zero over 10 years. Expected throughput is 500,000 TEU a year, with an average tariff of £120 per TEU and variable operating costs of £40 per TEU. Fixed operating costs are £10m a year. Corporation tax is 25%, paid in the same year, and the project's nominal WACC is 9%. Working capital is negligible. The finance team has produced a base-case NPV of approximately £18.5m. The commercial director notes that a competitor is expanding its own terminal, which could reduce Meridian's volumes by up to 15%. The project can be built in two phases: phase one at £100m for 300,000 TEU capacity, with an option to spend a further £60m in year three for the remaining capacity. The board is risk-averse after a previous failed investment and wants to understand the downside.
1. Verify the base-case NPV and calculate the sensitivity of NPV to a 15% reduction in throughput. What does this reveal?
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Base case
Revenue = 500,000 × £120 = £60m. Variable costs = 500,000 × £40 = £20m. Contribution = £40m. Less fixed costs £10m = EBITDA £30m. Depreciation = £150m/10 = £15m. EBIT = £15m. Tax at 25% = £3.75m. Profit after tax = £11.25m. Add back depreciation = £15m. Annual operating cash flow = £26.25m. Annuity factor at 9% for 10 years = 6.4177. PV = £26.25m × 6.4177 = £168.5m. NPV = £168.5m − £150m = £18.5m, matching the finance team.
15% volume reduction
Volume = 425,000 TEU. Revenue = £51m; variable costs = £17m; contribution = £34m; EBITDA = £24m; EBIT = £9m; tax = £2.25m; profit after tax = £6.75m; add depreciation = £21.75m cash flow. PV = £21.75m × 6.4177 = £139.6m; NPV = −£10.4m.
Break-even volume
Required annual cash flow = £150m/6.4177 = £23.37m. Cash flow = 0.75 × (80V − £25m) + £15m = £60V − £3.75m, where V is volume in millions of TEU. Setting £60V − £3.75m = £23.37m gives V = 0.452m TEU, or 452,000 TEU. That is only 9.6% below the base case. The margin of safety is thin: a 15% volume shortfall destroys the NPV, and break-even occurs well before that.
2. Evaluate whether the phased approach reduces risk and how it might be valued. Recommend whether Meridian should proceed with the full project, the phased project, or neither.
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Phase one economics
Phase one costs £100m for 300,000 TEU. At the same unit economics, revenue = £36m, variable costs = £12m, contribution = £24m. If fixed costs can be held at £8m, EBITDA = £16m; depreciation over 10 years = £10m; EBIT = £6m; tax = £1.5m; profit after tax = £4.5m; add depreciation = £14.5m cash flow. NPV = £14.5m × 6.4177 − £100m = −£6.9m. If fixed costs remain £10m, it is worse. Phase one alone is therefore marginal or negative at the same tariff.
Option value
The option to spend £60m in year three for the remaining 200,000 TEU is a real call option. Its value depends on demand volatility and the expansion cost. A decision tree would show: if demand is high, expand and capture the full-project cash flows; if demand is low, do not expand and cap the loss at phase one. The phased approach limits downside but sacrifices scale economies and may leave the terminal sub-scale.
Recommendation
The board should not commit to the full £150m project when a 15% volume miss makes NPV negative and phase one is not viable on its own. It should negotiate a lower capex, a higher tariff, a volume guarantee or a contribution from the port authority. If none is available, defer. Proceeding with phase one alone is justified only if the option value and strategic positioning are sufficient to cover the negative NPV; that case has not been made.