Australia-Japan Cable: Structuring The Project Company

Australia-Japan Cable: Structuring The Project Company

Australia-Japan Cable: Structuring The Project Company Group 1: Section 1 Bharat Agarwal 01 Sumit Bhatia08 Saravanan C 09 Manuja Chaudhary 10 Sharad Chopra 11 Varun D 12 Agenda

What the case is all about? Project Assets- Characteristics Capital Providers Return on Investment Current Status of AJC Project The Case

Australia Japan Cable (AJC) project Project finance to be used Feasibility study to be done Various strategic partners Analyze the risks The Industry Cable technology Changes in the market conditions Customer needs The Technology Evolution of the Cable Systems DWDM

Fiber-Optic Cables Coaxial Cables Submarine Fiber-Optic Cables The System Physical Cable Repeaters

Transmissio n Equipment Submarine Cable System The Process The Precautions Deep water and Shallow water Durable and Reliable cables Loops

The Demand The Financing Clubs Up to 90 Sponsors Projects took longer time to complete Why the model was followed? Private Deals with Carrier Sponsors Large blocks of capacity needed

Competition increased Small number of carriers Using as well as selling capacity Co-opetition Private Deals with Non-Carrier Sponsors The Pacific Group Built the cable and sold the capacity Atlantic Crossing-1 (AC-1)

Building the System Choose equipment suppliers Hire Cable Ships Access to landing station, right-of-way permits and harbor clearance The Australian Submarine Cable Industry Access to Asia and United States SEA-ME-WE3 The Australia Japan Cable (AJC) Telstra commissioned $6 million feasibility study

Cable system via Guam How AJC came to life Philosophy for AJC The Process 12,500 Kilometer cable system, with initial 40 Gbit/s capacity Use Telstras 2 landing stations near Sydney AT&T in Guam, to use landing stations Obtaining access to landing stations in Japan The Estimates Primary estimate = $520 million, or $567 million if there were delays

The Estimates contd.. Two 40 Gbit/s upgrades during first 5 years Ability to increase capacity to 320 Gbit/s Cost of upgrading Money = $25 million per 40 Gbit/s Time = 12-15 months Estimated useful life = 15 years The Strategy Private carrier deal using a project finance structure to fund construction Why project finance? Limit the amount of equity to invest in the project Significant role in running the company (holding

40% equity) Something for the partners too Reduce the investment size to $30-$40 million The Strategic Partners Need for long-term relationship Feasibility showed there was demand and the expected cash flows could support a highly leveraged capital structure Japan Telecom and Teleglobe signed MOU with Telstra The Structuring Timetable: June 30, 2001 Ready for Service

June 2000 Financing to be in place April 2000 Release Information memorandum, sign agreements and sign supply contract March 2000 Structure the Project company (a separate legal entity under the project finance structure) The Issues to be Resolved Show there was demand for a new cable A realistic business case AJCs advantage relative to existing cables Compared to SEA-ME-WE3

Need to attract high quality sponsors Q1. How would you characterize the project assets? What makes them different or unique? Project Assets Company Owned Assets Leased Assets Optical

Fibers Landing Station Repeaters Cable Laying Ships Connectors Routers Asset Characteristics

Financial Structure Asset financed through 85% debt and 15% equity Sufficient demand ensured cash flow to support such a financial structure Total Debt ($mn) 482 Asset Coverage Ratio = 1.0788 ACR supports the financial structure Existing capacity of 40 Gbit/sec can be raised to 320 Gbit/sec Asset characteristics Salvage value High Cost of Recovery Zero Salvage Value

Utility Assets are Project specific Assets are in public domain No reusability Operational Risk Cable Failure due to shipping, dredging and fishing activities Landing Station Difficult to get approval to build new one Contract with existing Landing station owners Asset Uniqueness Security Flow of Confidential Information During wars nations have cut the cables of the other

sides in order to stop or shape the information flow Threat of Theft by Pirates Mar 07 Pirates stole an 11 kilometres Submarine cable connecting Thailand, Vietnam, and Hong Kong Accountability for Damage Protection zones has been identified Guided by United Nations Law of the Sea Convention Asset Uniqueness Contd Impact due to Failure Nations get affected due to Communication disruption 2008 disruption in Persian gulf caused problems in India and Middle east

Reason for failure is difficult to identify Q2. Who are the capital providers for AJC project? Are they likely to earn an appropriate risk adjusted return on their investment? Risks Associated with Project Market Risk Price (25% decline per year) and Demand Risk Completion / Delay Risk - Risk Of Delay in execution Strategy Risk Existing Competitors Threat of New Entry Technology Risk Alternatives to existing technology Construction Risk Late equipment supply / delivery

Operating Risk Equipment Failures, difficulty to get permission for new landing stations Financing Risk Due to covenants (CP) , refinancing required Mitigation of Risks Risk Market Risk Hedging Strategy 1.Pre-sales capacity contracts from highly rated companies covering approx 2/3rd of total project cost & 2.Collapsed ring configuration (lower cost) Price Risk

3.Low cost capacity across North Pacific Completion (delay) or Counter party risk 1.Incorporate procedures to allow AJC to draw funds for construction even if there were delays 2. Existence of delay contingency in funding 3. Environmental approvals & other permits Strategy Risk & Competitor Risk 4. Right of way permits Co-opetition & collaboration

Mitigation of Risks Risk Hedging Strategy Technology Risk & Threat of New Entry Faster launch so that technology does not become obsolete Operating Risk 1.High Expertise Level of cable suppliers

2. Shared Ownership with companies having Landing-Stations 3. Provisions & Insurance Construction Risk Supply contracts signed in advanced, existence of construction contingency Environment Risk Insurance Qualitative factors Considered while considering Risk Adjusted Return

Projected Demand on this route Existing Supply-Demand Position in Australia Other projects (SCCN) ABN Amro Financial Strategy Advisers Views of NTT Communication Shareholder agreements with high rated sponsor users Project Finance Structure Management / Governance Structure

Projected Demand Growth North America to Asia Projected Demand 1600 1400 1200 1000 Capacity (Gigabits) 800 600 400 200 0 ...

... ... ... ... ... Existing Demand Supply & Shortfall 600 500 400

300 200 100 0 1999E 2000E 2001E 2002E 2003E 2004E 2005E -100 -200 Forecast Demand Total Existing Supply Shortfall Existing Supply in Australia Australias Telecom carriers needed greater access to : Asia (Australias 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) Excess capacity Prone to cable failures due to extensive shipping, dredging, and fishing activities PacRim East (Access to US from East Coast) Full Capacity PacRim West (Access to US from East Coast) Full Capacity SCCN AJC

29,600 km linking East Coast of Australia, New Zealand and the US 12500 km linking East Coast of Australia, Japan & US 40 Gbit/s capacity upgradable to 120 Gbit/s Capacity - 40Gbit/s upgradable

to 320 Gbit/s Debt-to-total-capitalization ratio of 85% Gearing ratio 85% AJC had to be bigger, safer & cheaper than SEA-MA-WE3 for traffic to US & it would be roughly the same cost as SCCN ABN Amro Financial Strategy Advisers ABN had successfully led SCCN financing Believed that AJC could support high gearing Ratio (as high as

85%) as they had identified and mitigated most of the risks Views of VP, NTTs international network Potential Sponsor No previous cable connecting Japan and Australia AJC would 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 Keating, Project Finance Manager, Telstra AJC needs high rated sponsor for bankers to lend Hibbard, Managing Director, Telstra Greater harmony in decision making by linking

ownership & cable use by requiring sponsors to sign purchase agreements Requirement of good Project Management & Governance Structure Sponsor Selection Japan Telecom Teleglobe NTT Comm AT & T Landing Stations

Buyers -

- Investors AA BBB+ AA+

AA- Sales (millions) $3,117 $1,701 $71,591 $53,223 Net Profit Margin

1.9% -2.5% 2.2% 12% Operating Margin 16.7% 19.1%

42.9% 23% Asset Turn Over 73% 28% 54% 89%

RoA 1.4% -0.7% 1.2% 10% Int Coverage 14.94 10.18

17.23 28.37 Debt Equity Ratio 1.12 0.42 2.17 1.33

S & P Senior Debt Rating Capital Providers Equity 15% of Total Capital Telstra 40% Mn $ 85 34

Japan Telecom, Teleglobe & NTT Telecom 60% 51 70% 30% Mn $ 482 337 145

Debt 85% of Total Capital Tranche A (5 yrs) Tranche B (5 yrs) Repaid with Pre-sale commitments Future Sales Issues with Project Finance Decision to use high leverage - 85% capitalization ratio Optimal maturity Short / Medium Repayment Schedule Bullet / Amortizing Covenants package

Reporting Requirements Loan Syndication ( Lead arranger & no. of banks) Keating smaller the lending group, better issue resolution Information memorandum to raise debt In a nut shell Facts and Qualitative data suggest AJC is a viable project Single Asset Company

Limited, well defined expansion opportunities Execution on the core asset important Debt and Equity ownership to be concentrated Highly leveraged capital structure to leave minimum free cash flows with managers Mitigation of Agency problems Management Compensation aligned to execution Current Status of AJC Partners Telstra WorldCom Global Networks Concert Softbank Telecom NTT Communications

ACMA Submarine Cable Regulation Upgraded to 1000Gbit/s capacity Purchase Options Indefeasible Rights of Use Annual Lease Growth Lease Lease to Buy Short Term Lease Ad hoc Capacity Latest trends In 2009 Partnership between AJC and Pacific Crossing

Bharti Airtel and AJC Australia, Singapore and US Lower Indian Ocean Network 37 million Euros Orange Madagascar, Mauritius Telecom, France Telecom 1070 Km with 1.3TB capacity Thank You

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