Australian Japan Cable:

Structuring the Project Company

Project Appraisal & Finance

Kaushal A001 Anubhuti A003 Pooja A006

Nupur A008 Sarath A010 Udit A040

History

1850
Telegraph & Construction Maintenance Company

1980
FiberOptic Cables First Submarine fiber-optic cable (TAT-8)

1995
Dense Wavelength Division Multiplexing(DWDM)

1990s Demand

Explosive growth and rapid advances in cable

technology

Worldwide deregulation, growing international

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

Cost
Customers needed more transmission capacity

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

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 1990s 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) 2)

More efficient to surface and repower the signal than send it all the way to Japan It could connect with other cables running through Guam

Use of Collapsed Ring Configuration Findings of feasibility study :

1) 2)

There was more than sufficient capacity demand Expected cash flow could support highly leveraged capital structure

Japan telecom and Teleglobe agreed to sign MOU with Telstra

Funding

Clubs

Private deals with Non Carrier sponsors

Private deals with Carrier sponsors

System would use Telstras 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 cables 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 Systems

Clubs
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 AJC
First

feasibility study carried out by Telstra Australian telecommunication & information services co. in mid 1997 Several telecom companies expressed interest in the project and commissioned independent feasibility studies Choice 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 Home Country Net Income (in US $ mn) Landing Stations on AJC Route S & P Senior Debt Rating USA 6,398 Guam (2) AANTT Comm. Japan 1,625 Japan (3) 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?

Lack of Quantitative Data
Capacity utilization projections for AJC Future cash flows

Demand from Guam

Intra Asia cable capacity demand

Factors for Qualitative Analysis

Demand Supply

SCCN

Uniqueness of AJNs assts visa-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

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) 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 Risk
Not 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