Australian Japan Cable:Structuring the Project Company

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Project Appraisal & Finance

History 1990’s

Explosive growth and rapid advances in cable technology

DemandWorldwide deregulation, growing international

business , new voice and data applications, and the introduction of the internet reshaped the industry

CostCustomers needed more transmission capacity

quickly, and submarine cables offered the possibility of a low-cost solution

1850• Telegraph

& Construction Maintenance Company

1980• Fiber–

Optic Cables

• First Submarine fiber-optic cable (TAT-8)

1995• Dense

Wavelength Division Multiplexing(DWDM)

Demand for Submarine Cable Systems From 1990 to 1999, the global telecommunications

market grew at a compound annual rate of 10.2% from US$348 billion to US$835 billion

In the late 1990’s the demand grew & faster growth in capacity caused prices to fall at a rate of 20% to 40% per year

Ovum predicted that the cost of an STM had fallen from US$10 million in 1998 to US$5 million by the end of 1999, would be US$1 million by 2003 as a result, system owners faced front-loaded revenue & cash flow streams.

AJC Overview 12,500km cable from Sydney,

Australia to Japan via Guam (USA) at a cost of $520M

Key sponsors: Japan Telecom, Telstra and Teleglobe with asset life of 15 years

Potential Sponsors: AT&T, NTT, MCI WorldCom

Joint Feasibility study was carried out for the sponsors for Project Appraisal

“Sell shore to shore service on a wholesale basis and

AJC should be producer of basic capacity services with wholesale and retail sellers between AJC and the end

users”

Execution Process of AJC Telstra commissioned $6 million feasibility study

in mid-1997 for AJC through Guam Reasons to go through Guam:-1) More efficient to surface and repower the signal than send it all the

way to Japan

2) It could connect with other cables running through Guam

Use of Collapsed Ring Configuration Findings of feasibility study :-1) There was more than sufficient capacity demand

2) Expected cash flow could support highly leveraged capital structure

Japan telecom and Teleglobe agreed to sign MOU with Telstra

Clubs

Private deals with

Non – Carrier

sponsors

Private deals with

Carrier sponsors

Funding

System would use Telstra’s 2 landing stations

near Sydney In Guam, the project could contract with AT&T to

use landing stations Telstra envisioned private carrier deal using

project finance structure to fund construction Telstra engaged ABN AMRO to advise on

financing strategy

Key Issues:- Limited growth potential Market risk from fast changing telecom

market Risk from project delay Specialized use asset

Questions for Analysis

1- How would you characterize the project assets?

2- What makes the assets different or unique?

3- Who are the capital providers for the AJC project?

4- Are the capital providers likely to earn appropriate risk adjusted return on their investment?

How would you characterize the project

assets?

Assets

• Submarine Cable being its core asset• Repeaters • Transmission equipment

• Parameters• Life• Ownership • Depreciation charges

Transmission Cable• Core asset of the company• Fiber Optic cable of 12,500 kms long• Could carry both data and voice signals• Life of 25 years • Using DWDM technology, the cable could

transmit data at 40 Gbit/s • Suffer as few as one device failure during its

lifetime Transmission cable failure in shallow water Collapsed ring configuration reduces capital cost Not very expensive to upgrade traffic capacity

Repeaters• Required every 400 kms to reshape and boost

the signal

Transmission Equipment• Comprised the transmitter, router and reception

Hub• Determined the capacity of the system to

transfer signals • Could be upgraded at any point to handle

additional capacity at a fraction of original cost

Submarine Cable System

To build it one needs to • Choose the Equipment Suppliers• Sign supply contracts for cable and

repeaters• Hire Cable ships to install the cable and

repeaters• Sign “Landing Party agreements” to use

preexisting landing stations

What makes the assets different or unique?

Uniqueness of Asset Cables are durable and reliable and have very

low failure rate (1 failure on an average in the cable’s life)

Capacity up-gradation for fraction of original cost. However it takes 12-15 months to implement

Difficult to obtain permit to build new landing stations in new countries and the process is time consuming

Due to high growth in demand and carrying capacity, the prices had fallen dramatically, as a result, system owners faced front-loaded revenue and cash flow streams

Who are the capital providers for the AJC

Project?

Financing of Submarine Cable SystemsClubs

•Comprised of 90 odds sponsors•Committees to resolve issues concerning capacity, ownership percentages and governance•Multiple carrier involvement caused project completion time to stretch between 5-7 years

•Private deals with carrier sponsors•Small number of carriers(2-4) formed limited partnership to raise debt and equity•Fewer parties meant quicker decision making•Created a new wholesale market for capacity

Private deals with non carrier sponsors• Ownership of cable systems with private

investors• Eg. Pacific group , private investment firm,

raised equity to build Atlantic crossing

Sponsors of AJCFirst feasibility study carried out by Telstra – Australian telecommunication & information services co. in mid – 1997Several telecom companies expressed interest in the project and commissioned independent feasibility studiesChoice of strategic partners

•Compatibility both at company and personal level •Decrease project cost•Should be financially strong investors as well as capacity buyers•Quicker execution should be possible by avoiding government clearances

Strategic Partners

•Japan Telecom –owned landing station in Japan•Teleglobe – major carrier that could bring significant volumes to the project

Other Sponsors: Originally looking for 4 sponsors to simplify management of the project Effort to find partners whose presales contracts would support the project and give credibility with bankers

AT & T NTT Comm.

Home Country USA Japan

Net Income (in US $ mn) 6,398 1,625

Landing Stations on AJC Route

Guam (2) Japan (3)

S & P Senior Debt Rating AA- AA+

Benefits of having a high rated sponsor : Gave credibility to project for raising bank debt Least financial and operating covenants from banks

Decided to use bank debt but finer details needed to be worked out (optimal maturity and repayment schedule)

Wanted banks to be partners Help in tackling problems requiring waivers and

amendments Smaller lending group preferred for greater

flexibility

Are the capital providers likely to earn appropriate Risk Adjusted Return on

their Investment?

Why is Qualitative analysis done?

Capacity utilization projections for AJC

Future cash flows

Demand from Guam

Intra Asia cable capacity demand

Lack of Quantitative Data

Factors for Qualitative Analysis

Demand Supply

SCCNUniqueness of

AJN’s assts vis-a-vis that of SCCN

View from ABN Amro and

NTT Comm.

Potential Risk - AJC Market risk due to presence of number of

competitors. Completion delay due to environmental

approvals and other permissions Physical construction was not a big deal

Australian Demand and Supply for Capacity (Gigabits)

Existing Supply in Australia Australia’s Telecom carriers needed greater

access to:• Asia (Australia’s largest trading partner)• US (80% of all Internet hosts were located here)

In 1999, there were 3 cables for Australian Traffic:• SEA-ME-WE3 (Access to US from West Coast)• PacRim East (Access to US from East Coast)• PacRim West (Access to US from East Coast)

Southern Cross Cable Network

USD 1.2 Bn cable network, initially equipped with 40 Gbit/s of capacity upgradable to 120 Gbit/s

3 sponsors provided all 10 landing stations Debt-to-total-capitalization ratio of 85% Confirmed purchase agreements for USD 640 mn Merrill Lynch Analyst Reports:

○ 10-Year DCF model generated base case market value of equity of USD 1.12 bn (discount rate of 13%)

○ Book equity just USD 150 mn

Long term value driven by incremental sales of spare capacity which is expected to snowball as data traffic out of Australia to the US skyrockets

Views of ABN AMRO ABN AMRO had led SCCN financing Believed that AJC project could support a highly

leveraged capital structure due to sufficient expected cash flows

Recommended gearing ratio of 85% for AJC Raising 2 debt tranches:

○ Tranche A -Secured and repaid (probably within 5 yrs) with presale commitments

○ Tranche B -Repaid from future sales of capacity to other parties (within 5 yrs)

Identification and mitigation of major risks

Views of NTT Non existence of cable connecting Japan and

Australia Opportunity for AJC to offer the lowest cost if

the dividend to shareholders was taken into consideration

AJC would be an attractive addition to the business in their existing cable stations

Mitigation of Risks Market Risk

Mitigation: pre-sales capacity contracts from highly rated companies covering approx 2/3rds of total project cost

Construction RiskNot much of a concern due to enough experience of

cable suppliers Completion Risk

Mitigation: Incorporate procedures that would allow AJC to draw funds for construction even if there were delays

Thank You