conference & convention enabling the next generation of networks & services Turbulent Waters: Raising Capital for Subsea Systems …….or: What Lenders Really Want ����������������� ����������������������������������� ����������������������������������� ����� ���������!�"����#�������� "��$��%�����&���'���( )��'�'��*�+,��� %�������-.���������. ����.���������. ��������� Logo Here Option 1
conference & convention enabling the next generation of networks & services Glenn S. Gerstell is the managing partner of the Washington, D.C. office of Milbank, Tweed, Hadley & McCloy LLP, and heads the firm’s global communications practice. He represents sponsors, lenders and equipment suppliers in projects involving fixed-line and wireless telecom installations, submarine cable systems, satellites and the Internet, as well as telecom operators and financial investors in cross-border alliances, acquisitions and financial restructurings. A partner since 1985, he has served in the firm’s New GLENN S. GERSTELL York (1976-80), Washington (1980-88), Singapore (1988- Managing Partner 89) and Hong Kong (1989-96) offices. gerstell@milbank.com +1 202 835-7585 A frequent speaker at legal and business conferences, he is the general editor of Telecoms Project Documentation, published by Euromoney. He served as Adjunct Professor of Law for several years at Georgetown University in Washington, D.C. He is a graduate of Columbia University School of Law (Harlan Fiske Stone scholar).
conference & convention enabling the next generation of networks & services New Challenges in 2010 � Development and financing of subsea cable systems still faces traditional inherent challenges: � Complexity - multiple jurisdictions involved � Complexity - multiple jurisdictions involved � Uncertainty due to permitting schemes (environmental issues and landing sites) � General operational risk – both installation and cable breaks � All leads to uncertain revenue generation
conference & convention enabling the next generation of networks & services New Challenges in 2010 (continued) � And now, a new problem: the economic downturn of late 2008 and 2009 and continued financial markets volatility coincide precisely with the subsea industry needing more financing for capital expenditures and new submarine cable projects � Debt financing from banks and the capital markets dried up, resulting in tighter credit requirements and overall increased risk aversion � Problem is exacerbated because as subsea projects increasingly focus on the developing world, there are greater risks and uncertainty for procuring financing
conference & convention enabling the next generation of networks & services The Necessity of Debt Financing � Global and regional demand for bandwidth means upgrades or new construction of cable systems, but the cost is substantial and typically requires financing � Debt is preferred form of financing where available: it � Debt is preferred form of financing where available: it leverages equity, avoids shareholder dilution and interest is tax-deductible � Even top-tier operators (who may be able to fund such expenses out of cash flow) prefer to leverage their cap-ex and keep debt off their balance sheets through limited recourse financings � For lesser operators and all sponsors of investor-owned (as opposed to operator-owned) submarine cable systems, debt financing is crucial
conference & convention enabling the next generation of networks & services Why Do Lenders Worry? � Complexity: Subsea cables share differing characteristics from traditional infrastructure for a multitude of reasons: � Multiple jurisdictions involving differing of legal schemes (involving permits, acquisition of landing rights, revenue taxing and environmental regulation) � High degree of technical prowess to ensure a working system (e.g., � High degree of technical prowess to ensure a working system (e.g., demand surveys, desktop routings, actual laying of the cable) � Overall management of the system: including acts of nature, a reliable network ops center, careful negotiation of backhaul and interconnection rights, and intelligent marketing/selling of capacity � Great Reliance on Management: A power plant does not put a premium on management’s ability to market the project. By contrast, an owner of a subsea system must deal not only with a complex operation but also constantly shifting market forces
conference & convention enabling the next generation of networks & services Why Do Lenders Worry? (continued) � No Accepted Model: There is no one successful “blueprint” for a submarine cable system and each project is structured uniquely � The most common model, the consortium, is difficult to finance. � Consortium allows risk and costs to be shared among numerous operators (who can sell capacity to third parties or utilize it for their networks)
conference & convention enabling the next generation of networks & services Why Do Lenders Worry? (continued) � Each participating carrier invests an equity share in exchange for a proportional allocation of bandwidth, with the capital contribution covering construction costs and consortium members liable for future O&M costs � BUT…consortia are often not financed at the project level because: (i) lenders are hesitant to lend to a partnership, (ii) lenders are concerned about their ability to recover in an enforcement scenario from multiple parties and (iii) many operators/sponsor can fund out of cash flow
conference & convention enabling the next generation of networks & services Why Do Lenders Worry? (continued) � Many Legal Jurisdictions Involved. Sponsors also generally try to limit tax liabilities by placing the owner in a tax haven (however most nations now insist on granting landing rights and licenses only to their own granting landing rights and licenses only to their own domiciliaries) � This leads to a multitude of corporate entities as sponsors try to place different aspects of the submarine system in separate jurisdictions
conference & convention enabling the next generation of networks & services So, What Do Lenders Want? � Notable new or tougher requirements are being placed on new subsea cable systems as a result of the tightening of credit committee review and approval � 1. Strict scrutiny on the demand forecast, revenue projection and the � 1. Strict scrutiny on the demand forecast, revenue projection and the business case � 2. Minimization of permitting, construction, operation and management risk and the requirement that this burden be shouldered by the sponsors. Lenders will not accept risk of being stuck with an incomplete project. � 3. Significant equity component required to cover cost overruns or revenue shortfall � 4. Tighter transaction documents (more financial covenants, stricter general covenants, greater attention to collateral security)
conference & convention enabling the next generation of networks & services What Lenders Want: The “Base Case” � For lenders evaluating a project, the base case is the most crucial aspect; for the most part, it is easy to predict project cost, but revenue generation creates projection problems: � In areas not previously served by cable systems, the new project’s demand forecasts have no comparable precedent,as Internet take-up rates in developing countries are largely an unknowable factor � This problem for lenders is compounded by dropping prices (and the potential for consolidation in crowded telecom markets to further push down prices for capacity), unlit fiber on existing networks and alternate capacity solutions (e.g., satellite) � Result: Lenders will sharply discount or “haircut” the sponsor’s base case, resulting in diminished projected debt service coverage ratios and concomitant need for more equity
conference & convention enabling the next generation of networks & services What Lenders Want: Minimize Permitting and Delay Risks � Permitting and environmental risk are already established risks; however it becomes magnified in emerging markets as more time and effort must be utilized to understand inchoate legal and regulatory schemes � Result: lenders are becoming more intrusive in the permitting process, insisting permitting risks are adequately addressed in the conditions precedent or through other milestones. Sponsors need to actively manage the communications with lenders in this regard. � Lenders will require that the sponsor have sufficient funds to cover costs arising from permitting and compliance with environmental regulation and attendant delays � Lender concerns multiply when multiple sponsors/owners are involved due to: (i) questions of joint and several liability and (ii) varying creditworthiness among the group
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