THE CHALLENGE OF MANAGING FINANCIAL RISK IN SUBMARINE CABLE - - PowerPoint PPT Presentation

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THE CHALLENGE OF MANAGING FINANCIAL RISK IN SUBMARINE CABLE PROJECTS SUBMARINE CABLE PROJECTS

Nick Smith

Alcatel-Lucent Submarine Networks

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Presenter Profile

Nick Smith has been a Commercial Project Manager with Alcatel-Lucent Submarine Networks since 2000. Currently he is responsible for implementation of the Europe-India Gateway System. Prior to joining ASN he was with the submarine cable department of British cable department of British Telecommunications. Paper co-author: Leigh Frame, VP Projects and Customer Service, ASN Nick Smith Commercial Project Manager, ASN Email: nick.smith@alcatel- lucent.com Tel: +44 (0)20 8465 1516 Mobile Tel: +44 (0)7909 975842

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Consortia Financing Model

Operator A Operator B Operator C Operator D

Construction and Maintenance Agreement Supply Contract Financing Financing Financing Financing

• Consortiums are an example of

corporate finance, not project finance

Agreement

System Supplier

Supply Contract

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Consortia Financing

• Advantages of model

– Risk to each operator diminished by subscribing for only a small proportion of system capacity – Capacity is cost optimised because no intermediary between system supplier and intermediary between system supplier and

• perator
• Disadvantages

– Operators’ cashflow may be significantly ahead of capacity take up forecast – Initial system capacity must be fully subscribed at commencement of project – Changes to system configuration or capacity allocation must be agreed by all parties

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Project Financing

• Relies on project

revenues to repay debt

Project Sponsors Special Financial

Equity

repay debt

• In the event of

failure, lenders’

• nly security is

the project assets

Special Purpose Vehicle Financial Institutions

Debt/Equity

System Supplier

Vendor Financing

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Project Financing & Submarine cables – a troubled history

• Project financing of submarine cable projects became

fashionable in late 1990s

– Associated with “carriers’ carrier” business model

• Following market collapse systems failed to repay

construction costs and lenders unable to recover their construction costs and lenders unable to recover their investment because collateral assets traded for a fraction of their cost.

• But project finance has a successful track record in other

industries with volatile market characteristics. E.g. petrochemicals – why not submarine cables?

– Simple answer: poor market timing – More sophisticated answer: lack of risk management mechanisms

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Risk Management in Project Finance – Generalised Framework

General principle is that risks must be allocated to parties best able to control them, or able to absorb losses

• Completion risk

– Technical problems, delays, supplier failure – Mitigated by project planning and control, guarantees from system supplier system supplier

• Country and political risk

– E.g. Appropriation of assets, inability to repatriate revenues – Evaluation of legal and economic frameworks of relevant jurisdictions

• Financial risk

– Exchange rates, interest rate fluctuations

• Off-take risk

– Possibility that no purchaser may be found for output of project

• Pricing (market) risk

– Fluctuations in market price of product

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Offtake and Pricing Risk Management in Other Industries

• Debt financed petrochemicals projects normally include a

guaranteed purchaser for the product on a “take or pay” basis

– Equivalent mechanisms in submarine cables are pre-sales of capacity, either as IRUs or fibre pair sales

• Pricing risk is managed through forward sales contracts and

derivatives

– Parties who value certainty about future prices exchange risk,

• r offset with parties who will price the risk

– Example: oilfield developers may enter into derivatives contracts that produce a gain in the event of spot market oil price falls, thus compensating for reduced revenue from project

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Futures in telecommunications markets

• Telecommunication markets lack mechanisms for managing

capacity pricing on a forwards basis

– Bandwidth exchanges established in late 1990s, but not successful

• Obstacles to establishing futures markets in international

capacity include:

– Lack of price transparency – Lack of price transparency – Non transportable nature of product – Lack of standardisation on issues such as QoS – Perception that capacity prices will only ever decrease – Reluctance to enter into long term (IRU) contracts through anonymous exchange mechanism – Capacity increases come in large increments – Unwillingness of operators to commit on basis of long term forecasts

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Current industry position

• Trend in recent years has been to sidestep the uncertainties
• f the wholesale market by vertical integration into the retail

distribution market

– Resurgence of PTT type operators entering into consortium projects – Wholesale carriers diversifying into value added capacity products for enterprise markets products for enterprise markets

• This however only disguises risk of overbuild, rather than

eliminating it

– Current system promoters have no means of guaranteeing post construction capacity market prices – If post system completion market price of capacity drops below replacement cost, then investment decision is flawed

• When catastrophic revenue shortfalls occur, domino effect

develops as distressed assets sell capacity at close to incremental (ie upgrade) replacement cost

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Possible Hybrid Financing Vehicles

• Conceptually possible to combine concepts from consortium

systems with asset backed debt financing and risk mitigation concepts borrowed from other industries

• For instance, small group of operators could establish

project by contributing equity and management expertise. In return they receive

– Certain allocation of Day 1 capacity – Rights to future capacity increments at a fixed price

• Balance of project financed by debt secured against the

assets and guaranteed future purchases (“take or pay”) of capacity from operators (including but not limited to the

• riginal sponsors)
• For future take or pay capacity purchase customers, the

benefit of deferred cash outflow is balanced by non- proportional access to ultimate system capacity

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Conclusions

• Financing submarine cable projects is very different from
• ther infrastructure projects

– Risk management options are much more limited than in other industries

• Industry characteristics are slowly changing, which may
• Industry characteristics are slowly changing, which may

cause a re-evaluation of business practices

– Increasing trend for capacity to be traded on short term leases, as opposed to long term IRUs, the former are more amenable to be traded on anonymous exchanges – In some markets, capacity price is below replacement system cost, which raises prospect of price rises for first time in a generation

• But strong element of revenue certainty is an essential pre-

requisite to more flexible forms of financing

2010

enabling the next generation of networks & services

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Pacifico Convention Plaza Yokohama & InterContinental The Grand Yokohama 11 ~ 14 May 2010 www.suboptic.org The 7th International Conference & Convention

• n Undersea Telecommunications