Description

1. FINANCING THE TELSTRA´S PROJECT:
SUBMARINE CABLE FROM AUSTRALIA TO
JAPAN
Doctorate of Finance
Prepared for the Project Finance Class
October 2011
Servio Fernando Lima Reina
Based on Harvard HBR 9-203-029 case

2. BACKGROUND
Background
Project
To build a submarine cable between Australia and Japan (year: 1999)
Partners
Telstra, Teleglobe, Japan Telecom
Investment
$520Mn ($567Mn if major delay) ,
12,500Km cable, 40 Gbps (up to x8 capacity) 256 STM-1 (up to 2048 STM-1)
Path
Australia-Guam-Japan-US
Useful life of cable
15 years (contract term: IRU of 15 years)
Risks
Price decline of avg 25% per year. Volatility of submarine price capacity
Lenders base decision on sponsor´s background. Sponsors may change in time.
Competitors (as of 1999)
Three competitors: SCC, Pac Rim, SEA-ME-WE3

3. PROJECT FINANCING FOR EXPOSURE MITIGATION
PROJECT FINANCING AS A WAY TO LIMIT EXPOSURE FOR TELSTRA
Traditional ways of financing submarine cable projects
1. CLUBS (early 90´s)
Comprised of as many as 90 sponsors
Use of equity
TIME ESTIMATE TO COMPLETION: 5-7 years
limited exposure : many carriers contributed small amounts of equity.
2. PRIVATE CARRIER DEAL STRUCTURE (mid 90´s)
Carriers needed much larger blocks of capacity and quicker execution
Limited partnership: 2-4 carriers
Use of debt and equity
TIME ESTIMATE TO COMPLETION: 2 years
Carriers could not use all cable capacity. They began to sell capacity to other carriers (Wholesale market)
3. NON PRIVATE CARRIER STRUCTURE
Non carriers invest on submarine cable to sell capacity later
Profile of non carrier: Private investors
TIME ESTIMATE TO COMPLETION: 2 years

4. PROJECT´S MAJOR OPERATIONAL RISKS
PROJECT MAJOR OPERATIONAL RISKS
Permit delays
Landing station
Right-of-way permits
Harbor clearance
Local fishing permits
Few electronic
suppliers
Fiber Cable
Repeaters
Devices
High installation
Times. Few ships
(2 yrs)
Mitigation strategy:
Implement a delay contingency fund (9% of total investment)

5. PORTER FIVE FORCES
PROJECT OVERVIEW BASED ON PORTER FIVE FORCES
Threat of new
entrants
SCC, other
entrants attracted
by excess demand
Bargaining power
of suppliers Competitive
rivalry Bargaining power
High @1999: High of customers
lead times for Medium
High (few carriers
electronics, subm Few submarine as buyers (6) @
arine options between Pacific)
cable, landing Australia-Japan
stations
Threat of
substitute
products
Low (satellite, low
quality)

6. PROJECT´S SPONSORS
SPONSORS
FINDINGS
Initial sponsors were not so strong
Project accounts for 28% of Telstra´s net income, 8% fo AT&T´s and 32% of NTT´s. These were
the strongest
Strongest sponsors contribute with landing stations (i.e. it means less time to get permits)
Strongest sponsor Strongest but
unconfirmed
sponsors

7. PROJECT´S POSSIBLE FINANCING SCENARIOS
PROJECT´S POSSIBLE FINANCING SCENARIOS
Possible scenarios to finance AJC project
Group Tranche
Scenario Ownership # sponsors Equity Tranche A B Pros Cons
Simple, 100% equity.
Investment is 28% of High risk, excess
Corporate Telstra net income. capacity and fast price
Finance Telstra 1 $567 $- $- Fast TTM erosion
Telstra-
Japan High risk, excess
Corporate Telecom- capacity and fast price
Finance Teleglobe 3 $567 $- $- 100% equity. Fast TTM erosion
Telstra- 15% equity. 85% of
Japan investment financed
Telecom- by bank lends Low risk, capacity sold
Teleglobe- guaranteed by presold in advance to any kind
Project AT&T-NTT- capacity to sponsors of sponsors (high, mid,
Finance MCI 3 $85 $337 $145 and other carriers low)
Tranche B may be
covered by issuing
Telstra- bonus in stock
Japan markets. More
Telecom- probability of finding Low risk, but issuing
Teleglobe- investors. 59% presold bonus may delay more
Project AT&T-NTT- to high rated sponsors the beginning of the
Finance MCI 3 $85 $337 $145 only project

8. PROJECT´S CAPITAL STRUCTURE
TELSTRA CAPITAL STRUCTURE
Telstra´s financing:
Tranche A:Presale commitment to purchase capacity as loan guarantee.
Tranche B: Future sell of capacity to other parties as loan guarantee.
No loans to bilateral or multilateral institutions, BUT loan to commercial banks
(i.e. ABN AMRO)
Project susceptible to high leverage due to high demand of capacity in 1999
and know how of over +150 years of building submarine cables.
But, banks willing to lend if there are high rated sponsors of the project

9. PROJECT´S MAIN CONSIDERATIONS
PROJECT´S MAIN CONSIDERATIONS
Main aspects AJC submarine system
Financing scheme 15% corporate finance, 85% project finance
cable system (submarine cable, electronic
assets equipments, landing stations)
structure incorporated joint venture
leverage (D/capital) 85% debt
recourse limited-recourse debt
ownership 3 sponsors (up to 6 is possible)
Telstra exposure 50% of 85Mn
Organization complexity High if several sponsors
cash flow disposal limited (lenders priority)
monitoring external (by lenders)

10. PROJECT´S GOVERNANCE
Project Governance
1. NEW COMPANY FOR PROJECT´S GOVERNANCE
A new company has to be created out of the project
Difficult task to establish rules between sponsors: exit rules, valuing/selling
shares, board of directors composition, etc.
Sponsors financed the project and were required to sign up purchase
agreements
2. TIMELINE 1 year 8 months
New entity: MOU signed
structure, sh Land party
Demand Financing
areholderag agreements Construction Ready for Service
forecasting (Oct definition
reement Supply (1 year) (June 30, 2001)
1999) (June 2000)
(March contracts
2000) (April 2000)
Decisions has to be taken before start of construction

11. FINDINGS IN THE CASE
FINDINGS IN THE CASE
FINDINGS
Before 2002, there is an excess supply of capacity in the zone. Forecasted supply after 2002 is in
deficit. This is reflected in price erosion. Price erosion can be assumed to be deeper before 2002
and smoother after 2002.
FORECASTED DEMAND IN STM-1 1999E 2000E 2001E 2002E 2003E 2004E 2005E
Existing capacity (STM-1) 174 174 174 174 174 174 174
Southern Cross Cable (STM-1) 0 774 774 774 774 774 774
SEA-ME-WE3 upgrade (STM-1) 0 129 129 129 129 129 129
AJC supply (STM-1) 60 0 196 0 256 0 256
Total existing & planned capacity 234 1077 1273 1077 1333 1077 1333
Forecast demand in STM-1 65 161 406 832 1348 2065 3032
Gap demand-supply in STM-1 -169 -916 -867 -245 15 987 1699
supply supply supply supply supply supply supply
excess excess excess excess deficit deficit deficit
Units (STM-1)
AJC cable First year where
Launch date demand exceeds
Supply ( if no new
Entrants)

12. PRICE EROSION
PRICE EROSION
Extrapolation price per STM-1 ($Mn)
8.00 8.00
7.50
7.00
6.50
6.00
5.50 5.60
5.00
4.50
4.00 3.92
3.50
3.00
2.50 2.74
2.00 1.92
1.50 1.34
1.00 0.94
0.50 0.66 0.46 0.32
0.00
1999E 2000E 2001E 2002E 2003E 2004E 2005E 2006E 2007E 2008E
First year where
demand exceeds supply
But we will assume constant price erosion
Observed price erosion is in average 30% since 1997.
Will be kept constant for the becoming years (this is a worst case scenario), despite
Supply deficit after 2002. This will make the business case more realistic.
Market risk (price per STM-1, excess supply and excess demand) is the major concern
of this project (source: ABN AMRO)

13. SENSITIVITY ANALYSIS
Present value of revenues (absolute values)
Sensibility analysis based on price erosion and/or WACC
FORECASTED DEMAND
IN STM-1 1999E 2000E 2001E 2002E 2003E 2004E 2005E 2006E 2007E 2008E
AJC supply (STM-1) 60 0 196 0 256 0 256 0 256 0
Price per STM-1 ($Mn) 8.00 5.60 3.92 2.74 1.92 1.34 0.94 0.66 0.46 0.32
Price erosion per year 30% 30% 30% 30% 30% 30% 30% 30% 30%
price erosion % 30%
Revenues ($Mn) 482 0 767 0 492 0 241 0 118 0
WACC 10%
NPV ($Mn) 10 years $1,494 $1,015 $1,320 $1,444 $1,494
% of NPV 32% 68% 88% 97% 100%

14. SENSITIVITY ANALYSIS
Impact of declining STM-1 prices in Revenues
Impact of price per STM-1 decline in Net Present Value of Revenues
NPV Revenues
Price erosions % per year %NPV yr 1 %NPV yr3 %NPV yr5 %NPV yr7 $Mn
0% 10% 34% 60% 82% $ 4,806
10% 15% 44% 70% 88% $ 3,158
20% 23% 56% 80% 93% $ 2,133
30% 32% 68% 88% 97% $ 1,494
40% 44% 79% 94% 99% $ 1,090
50% 58% 88% 98% 100% $ 832
Keeping price erosion at 30% per year the expected revenues will be around $1.5Mn,
Realized in less than five years.
These are good news considering that we have assumed a worst case scenario.
The project will generate more revenues if no more entrants comes in to the market
or the SCC project fail to be executed (because the failure to get landing permits).

15. SENSITIVITY ANALYSIS
WACC calculation
Is it right that the Discount rate should be 10%? Why?
Unlevered Beta
Calculation
Beta L (S&P Debt/Equity Unlevered
company symbol 500) ratio taxes beta
AT&T T 0.44 58.34% 3.25% 0.28
Verizon VZ 0.48 59.51% 3.25% 0.30
Sprint-nextel S 0.96 139% 3.25% 0.41
Average U Beta 0.33
Levered Beta for AJC cable Telstra
Project name Country Sector Avg U Beta Debt/equity ratio Taxes Au Levered Beta
AJC cable Australi
project a Telecom 0.33 567% 30% 1.65
k = Rf + β Δ + (Discount rate
PRP calculation)
Δ (market
Project name Country Sector Levered Beta premium) PRP (Au) Discount rate (k)
AJC cable Australi
project a Telecom 1.65 2.87% 84.16 10.8%
A discount rate of 10.8% has no significant impact in expected revenues
Australia and Telstra are safe investments!

16. CONCLUSIONS AND RECOMMENDATIONS
CONCLUSIONS AND RECOMMENDATIONS
CONCLUSIONS AND RECOMMENDATIONS
• Go for it! : In the worst case scenario, the project is still attractive.
• Time to market to deploy fiber is vital. Access on time to landing
stations is a must.
• Mitigate risks before the project´s construction starts: This is an all
or nothing project that can not be stopped in the middle of the
construction.
• Source of risk of this kind of projects are: Market risks, operational
risks, governance risks.
• Market risks are mitigated selling capacity in advance and
exploiting opportunities of deficit of supply
• Operational risks (delays due to suppliers, landing
stations, etc) may be mitigated with the allocation of
contingency CAPEX (10% was used in this case).
• Governance risks are mitigated choosing sponsors based on
company´s debt rating.
•