conference & convention enabling the next generation of networks & services THE CHALLENGE OF MANAGING FINANCIAL RISK IN SUBMARINE CABLE PROJECTS SUBMARINE CABLE PROJECTS Nick Smith Alcatel-Lucent Submarine Networks
conference & convention enabling the next generation of networks & services 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
conference & convention enabling the next generation of networks & services Consortia Financing Model Financing Financing Financing Financing Operator A Operator B Operator C Operator D Construction and Maintenance Supply Contract Supply Contract Agreement Agreement System Supplier • Consortiums are an example of corporate finance , not project finance
conference & convention enabling the next generation of networks & services 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 operator • 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
conference & convention enabling the next generation of networks & services Project Financing Project Sponsors • Relies on project Equity revenues to Special Special Financial Financial repay debt repay debt Purpose Debt/Equity Institutions Vehicle Vendor • In the event of Financing failure, lenders’ only security is System the project assets Supplier
conference & convention enabling the next generation of networks & services 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
conference & convention enabling the next generation of networks & services 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
conference & convention enabling the next generation of networks & services 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, or 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
conference & convention enabling the next generation of networks & services 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
conference & convention enabling the next generation of networks & services Current industry position • Trend in recent years has been to sidestep the uncertainties of 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
conference & convention enabling the next generation of networks & services 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 original 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
conference & convention enabling the next generation of networks & services Conclusions • Financing submarine cable projects is very different from other 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 conference & convention enabling the next generation of networks & services The 7th International Conference & Convention on Undersea Telecommunications Pacifico Convention Plaza Yokohama & InterContinental The Grand Yokohama 11 ~ 14 May 2010 www.suboptic.org
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