FINANCING THE TELSTRA´S PROJECT: SUBMARINE CABLE FROM AUSTRALIA TO JAPAN Doctorate of Finance...
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Transcript of FINANCING THE TELSTRA´S PROJECT: SUBMARINE CABLE FROM AUSTRALIA TO JAPAN Doctorate of Finance...
FINANCING THE TELSTRA´S PROJECT: SUBMARINE CABLE FROM AUSTRALIA TO
JAPAN
Doctorate of FinancePrepared for the Project Finance ClassOctober 2011Servio Fernando Lima ReinaBased on Harvard HBR 9-203-029 case
BACKGRO
UN
DBackgroundProject
To build a submarine cable between Australia and Japan (year: 1999)Partners
Telstra, Teleglobe, Japan Telecom
Investment$520Mn ($567Mn if major delay) , 12,500Km cable, 40 Gbps (up to x8 capacity) 256 STM-1 (up to 2048 STM-1)
PathAustralia-Guam-Japan-US
Useful life of cable15 years (contract term: IRU of 15 years)
RisksPrice decline of avg 25% per year. Volatility of submarine price capacityLenders base decision on sponsor´s background. Sponsors may change in time.
Competitors (as of 1999)Three competitors: SCC, Pac Rim, SEA-ME-WE3
PROJECT FIN
ANCIN
G FO
R EXPOSU
RE MITIG
ATION
PROJECT FINANCING AS A WAY TO LIMIT EXPOSURE FOR TELSTRA
Traditional ways of financing submarine cable projects
1. CLUBS (early 90´s)Comprised of as many as 90 sponsorsUse of equityTIME ESTIMATE TO COMPLETION: 5-7 yearslimited exposure : many carriers contributed small amounts of equity.
2. PRIVATE CARRIER DEAL STRUCTURE (mid 90´s)Carriers needed much larger blocks of capacity and quicker executionLimited partnership: 2-4 carriersUse of debt and equityTIME ESTIMATE TO COMPLETION: 2 yearsCarriers could not use all cable capacity. They began to sell capacity to other carriers (Wholesale market)
3. NON PRIVATE CARRIER STRUCTURENon carriers invest on submarine cable to sell capacity laterProfile of non carrier: Private investorsTIME ESTIMATE TO COMPLETION: 2 years
PROJECT´S M
AJOR O
PERATION
AL RISKSPROJECT MAJOR OPERATIONAL RISKS
Landing stationRight-of-way permitsHarbor clearanceLocal fishing permits
Permit delays
Fiber CableRepeatersDevices
Few electronicsuppliers
High installationTimes. Few ships(2 yrs)
Mitigation strategy: Implement a delay contingency fund (9% of total investment)
PORTER FIVE FO
RCESPROJECT OVERVIEW BASED ON PORTER FIVE FORCES
Competitive rivalry
MediumFew submarine
options between Australia-Japan
Threat of new entrants
SCC, other entrants attracted by excess demand
Bargaining power of customers
High (few carriers as buyers (6) @
Pacific)
Threat of substitute products
Low (satellite, low quality)
Bargaining power of suppliers
High @1999: High lead times for
electronics, submarine cable, landing stations
PROJECT´S SPO
NSO
RSSPONSORS
FINDINGS Initial sponsors were not so strongProject accounts for 28% of Telstra´s net income, 8% fo AT&T´s and 32% of NTT´s. These were
the strongestStrongest sponsors contribute with landing stations (i.e. it means less time to get permits)
Strongest but unconfirmed sponsors
Strongest sponsor
PROJECT´S PO
SSIBLE FINAN
CING
SCENARIO
SPROJECT´S POSSIBLE FINANCING SCENARIOS
Possible scenarios to finance AJC project
ScenarioGroup Ownership # sponsors Equity Tranche A
Tranche B Pros Cons
Corporate Finance Telstra 1
$567
$-
$-
Simple, 100% equity. Investment is 28% of
Telstra net income. Fast TTM
High risk, excess capacity and fast price
erosion
Corporate Finance
Telstra-Japan Telecom-Teleglobe 3
$567
$-
$- 100% equity. Fast TTM
High risk, excess capacity and fast price
erosion
Project Finance
Telstra-Japan Telecom-Teleglobe-AT&T-NTT-MCI 3
$85
$337
$145
15% equity. 85% of investment financed
by bank lends guaranteed by presold
capacity to sponsors and other carriers
Low risk, capacity sold in advance to any kind of sponsors (high, mid,
low)
Project Finance
Telstra-Japan Telecom-Teleglobe-AT&T-NTT-MCI 3
$85
$337
$145
Tranche B may be covered by issuing
bonus in stock markets. More
probability of finding investors. 59% presold to high rated sponsors
only
Low risk, but issuing bonus may delay more
the beginning of the project
PROJECT´S CAPITAL STRU
CTURE
TELSTRA CAPITAL STRUCTURE
Telstra´s financing:Tranche A:Presale commitment to purchase capacity as loan guarantee.Tranche B: Future sell of capacity to other parties as loan guarantee.No loans to bilateral or multilateral institutions, BUT loan to commercial banks(i.e. ABN AMRO)
Project susceptible to high leverage due to high demand of capacity in 1999and know how of over +150 years of building submarine cables.But, banks willing to lend if there are high rated sponsors of the project
PROJECT´S M
AIN CO
NSID
ERATION
SPROJECT´S MAIN CONSIDERATIONS
Main aspects AJC submarine system
Financing scheme 15% corporate finance, 85% project finance
assetscable system (submarine cable, electronic equipments, landing stations)
structure incorporated joint venture
leverage (D/capital) 85% debt
recourse limited-recourse debt
ownership 3 sponsors (up to 6 is possible)
Telstra exposure 50% of 85Mn
Organization complexity High if several sponsors
cash flow disposal limited (lenders priority)
monitoring external (by lenders)
PROJECT´S G
OVERN
ANCE
Project Governance
1. NEW COMPANY FOR PROJECT´S GOVERNANCEA new company has to be created out of the projectDifficult task to establish rules between sponsors: exit rules, valuing/selling
shares, board of directors composition, etc.Sponsors financed the project and were required to sign up purchase
agreements
2. TIMELINE
Demand forecasting (Oct
1999)
New entity: structure,
shareholderagreement
(March 2000)
MOU signedLand party
agreementsSupply
contracts(April 2000)
Financing definition
(June 2000)
Construction(1 year)
Ready for Service (June 30, 2001)
Decisions has to be taken before start of construction
1 year 8 months
FIND
ING
S IN TH
E CASEFINDINGS IN THE CASE
FINDINGS Before 2002, there is an excess supply of capacity in the zone. Forecasted supply after 2002 is in deficit. This is reflected in price erosion. Price erosion can be assumed to be deeper before 2002 and smoother after 2002.
AJC cableLaunch date
First year wheredemand exceedsSupply ( if no new Entrants)
Units (STM-1)
FORECASTED DEMAND IN STM-1 1999E 2000E 2001E 2002E 2003E 2004E 2005E
Existing capacity (STM-1) 174 174 174 174 174 174 174
Southern Cross Cable (STM-1) 0 774 774 774 774 774 774
SEA-ME-WE3 upgrade (STM-1) 0 129 129 129 129 129 129
AJC supply (STM-1) 60 0 196 0 256 0 256
Total existing & planned capacity 234 1077 1273 1077 1333 1077 1333
Forecast demand in STM-1 65 161 406 832 1348 2065 3032
Gap demand-supply in STM-1 -169 -916 -867 -245 15 987 1699
supply excess
supply excess
supply excess
supply excess
supply deficit
supply deficit
supply deficit
PRICE EROSIO
NPRICE EROSION
Observed price erosion is in average 30% since 1997.Will be kept constant for the becoming years (this is a worst case scenario), despiteSupply deficit after 2002. This will make the business case more realistic.
Market risk (price per STM-1, excess supply and excess demand) is the major concern of this project (source: ABN AMRO)
1999E 2000E 2001E 2002E 2003E 2004E 2005E 2006E 2007E 2008E0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00 8.00
5.60
3.92
2.74
1.921.34
0.94 0.66 0.46 0.32
Extrapolation price per STM-1 ($Mn)
First year wheredemand exceeds supplyBut we will assume constant price erosion
SENSITIVITY AN
ALYSISPresent value of revenues (absolute values)
Sensibility analysis based on price erosion and/or WACC
FORECASTED DEMAND IN STM-1 1999E 2000E 2001E 2002E 2003E 2004E 2005E 2006E 2007E 2008E
AJC supply (STM-1) 60 0 196 0 256 0 256 0 256 0
Price per STM-1 ($Mn) 8.00 5.60 3.92 2.74 1.92 1.34 0.94 0.66 0.46 0.32
Price erosion per year 30% 30% 30% 30% 30% 30% 30% 30% 30%
price erosion % 30%
Revenues ($Mn) 482 0 767 0 492 0 241 0 118 0
WACC 10%
NPV ($Mn) 10 years $1,494 $1,015 $1,320 $1,444 $1,494
% of NPV 32% 68% 88% 97% 100%
Upgrades to the system would cost approximately $25 million per 256 STM-1and would take approximately 12 to 15 months to implement.
SENSITIVITY AN
ALYSISImpact of declining STM-1 prices in Revenues
Impact of price per STM-1 decline in Net Present Value of Revenues
Keeping price erosion at 30% per year the expected revenues will be around $1.5Mn,Realized in less than five years.
These are good news considering that we have assumed a worst case scenario.The project will generate more revenues if no more entrants comes in to the marketor the SCC project fail to be executed (because the failure to get landing permits).
Price erosions % per year %NPV yr 1 %NPV yr3 %NPV yr5 %NPV yr7NPV Revenues
$Mn
0% 10% 34% 60% 82% $ 4,806
10% 15% 44% 70% 88% $ 3,158
20% 23% 56% 80% 93% $ 2,133
30% 32% 68% 88% 97% $ 1,494
40% 44% 79% 94% 99% $ 1,090
50% 58% 88% 98% 100% $ 832
SENSITIVITY AN
ALYSISWACC calculation
Is it right that the Discount rate should be 10%? Why?
Unlevered Beta Calculation
company symbolBeta L (S&P 500)
Debt/Equity ratio taxes
Unlevered beta
AT&T T 0.44 58.34% 3.25% 0.28
Verizon VZ 0.48 59.51% 3.25% 0.30
Sprint-nextel S 0.96 139% 3.25% 0.41
Average U Beta 0.33
Levered Beta for AJC cable Telstra
Project name CountrySector Avg U Beta Debt/equity ratio Taxes Au Levered BetaAJC cable project
Australia Telecom 0.33 567% 30% 1.65
k = Rf + β Δ + PRP
(Discount rate calculation)
Project name CountrySector Levered BetaΔ (market premium) PRP (Au) Discount rate (k)
AJC cable project
Australia Telecom 1.65 2.87% 84.16 10.8%
A discount rate of 10.8% has no significant impact in expected revenuesAustralia and Telstra are safe investments!
CON
CLUSIO
NS AN
D RECO
MM
ENDATIO
NS
CONCLUSIONS AND RECOMMENDATIONS
CONCLUSIONS AND RECOMMENDATIONS
• Go for it! : In the worst case scenario, the project is still attractive.• Time to market to deploy fiber is vital. Access on time to landing stations
is a must.• Mitigate risks before the project´s construction starts: This is an all or
nothing project that can not be stopped in the middle of the construction.
• Source of risk of this kind of projects are: Market risks, operational risks, governance risks.
• Market risks are mitigated selling capacity in advance and exploiting opportunities of deficit of supply
• Operational risks (delays due to suppliers, landing stations, etc) may be mitigated with the allocation of contingency CAPEX (10% was used in this case).
• Governance risks are mitigated choosing sponsors based on company´s debt rating.
•