Intelsat’s Buyers Eye Cash Flow

Intelsat Ltd. is destined for internal change after a group of four private equity firms agreed to purchase it last week in what is the latest of a continuing series of moves toward consolidation among satellite operators worldwide.

The deal’s value of $5 billion includes the assumption of $2 million in debt by the proposed new owners and likely will lead Intelsat’s management in the future to emphasize free cash flow, to limit capital expenditures for risky projects and to maintain the company’s operational and engineering strengths.

Management change often is a byproduct of such transactions but Intelsat CEO Conny Kullman offered no hint that he was planning to do anything but carry out his existing strategy for the company that involves maximizing the revenues of North American satellites recently acquired from Loral Skynet, building up the company’s data services and transition away from its past focus on telecommunications.

Intelsat shareholders, led by 24 percent owner Lockheed Martin [LMT], would receive $18.75 for each Intelsat share issued and outstanding immediately prior to closing from a subsidiary of Zeus Holdings Ltd., the investment vehicle created by the investment firms to consummate the deal. The transaction has been approved unanimously by the Intelsat board of directors but still requires regulatory approvals that may not be gained until late 2004 or early 2005.

The transaction would allow Intelsat’s current shareholders to fully “monetize” their shares, said Diane VanBeber, Intelsat’s vice president of investor relations. An initial public stock offering (IPO) proposed by Intelsat earlier this year before it was withdrawn may not have been large enough to accommodate all the selling interest among the shareholders, she added.

London-based Apax Partners and Permira, two of Intelsat’s four would-be new owners, also control Inmarsat, the world’s largest mobile satellite operator. However, no plans currently exist to combine Inmarsat and Intelsat, which both began their existence as intergovernmental satellite organizations.

New Owners

Apax Partners and Permira opted to pool their interests with New York-based Apollo and Chicago-based Madison Dearborn Partners in the deal announced last week to buy Intelsat, the third global satellite operator to be sold to financial buyers this year.

PanAmSat was purchased by for $4.3 billion by Kohlberg Kravis Roberts & Co. L.P. (KKR), The Carlyle Group and Providence Equity Partners Inc. (KKR). Much smaller global operator New Skies Satellites N.V. [NSK] was sold for $956 million to affiliates of the Blackstone Group.

Blackstone’s offer values New Skies at 6.9 times the company’s estimated 2004 Enterprise Value (EV)/Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA), according to Patrick Fuhrmann, an independent satellite analyst based in Berkeley Heights, N.J. In comparison, KKR’s purchase of PanAmSat in a similar bidding process resulted in a valuation of 7.2 times estimated 2004 EV/EBITDA.

“Intelsat’s valuation is roughly in line with the PanAmSat and New Skies deals,” Fuhrmann said Thursday. “I think the valuation for Intelsat appears to be very good and a better valuation than what some observers on Wall Street had expected from an IPO. The valuation partially is a reflection of the low interest rates that allow the buyers to use relatively inexpensive financing to raise capital to make the acquisition.”

Private equity firms now control three of the world’s global satellite operators and could end up carrying out transactions that might have been unheard of in the past, such as swapping satellites or combining large operations with each other. The next targets for the financial investors could be the regional satellite operators around the world that are too small to compete head-to-head with global behemoths.

SatMex is one of the regional operators that could be “rolled up” by one of the private equity firms that already has purchased a satellite company or may be looking for an ownership role in the industry.

Intelsat positioned itself with prospective buyers as a “great consolidation platform,” VanBeber said. The company earlier this year proved it could digest an acquisition by paying roughly $1.1 billion to buy the North American satellite assets of Loral Skynet, she added.

Intelsat recently terminated several dozen employees and is planning to take further actions to cut its costs and its 850-employee workforce. The goal is for the company to be “running on all cylinders” when its sale closes to ensure its new owners are rewarded with a peak performance, VanBeber said.

Future Plans

Intelsat is looking for ways to build its share of the North American video and data businesses. The company’s acquisition of Loral Skynet’s satellite fleet in that region provides an opportunity to carry out that goal.

“On the data side, we believe that the North American presence will enable us to win government services contracts that we could not compete for in the past,” Kullman said. The company’s sale should have not impact on its data business, the fastest growing segment in the fixed satellite services (FSS) industry, Kullman said.

“Corporate data network applications have been a large driver of demand for satellite capacity,” Kullman said. “I don’t see that changing.”

Intelsat should be aided in its consolidation efforts by a centralized operations center in Washington that is “one of the key reasons “why it has been able to generate synergy by adding incremental satellites to its fleet, Kullman said.

The Open-Market Reorganization for the Betterment of International Telecommunications (ORBIT) Act, enacted on March 17, 2000, called for Intelsat to go public but the company has received three different extensions on its deadline since then from Congress. The new deadline is Dec. 31, 2005, but Intelsat may try to obtain elimination of that requirement in light of its sale to financial buyers that completely would change its ownership.

“We contend this transition satisfies the objective of the ORBIT Act that is to substantially dilute the ownership of the signatories,” VanBeber said. “Through this deal, the signatories will no longer have any ownership.”

For the new owners, the key attraction appears to be Intelsat’s cash flow generated from long-term contracts with financially stable customers that include large media companies and the U.S. government, said Jim Perry, managing director of Madison Dearborn Partners.

Harvesting Cash

“Point-to-point telecommunications service are in the harvesting mode,” Perry said. In addition, the satellites Intelsat acquired from Loral “show promise” and a substantial amount of free cash flow will be produced in the years ahead, he added.

Tom Watts, a satellite analyst with SG Cowen, said, “Intelsat has done a very good job of cutting costs and becoming more competitive with its industry rivals. That process just is not done yet.”

D.K. Sachdev, president of the SpaceTel Consultancy, said the sale of Intelsat would be a bigger transition than its privatization in 2001. Sachdev, who worked at Intelsat 18 years between 1978 and 1996, was responsible for planning and acquiring new satellites, as well as managing the organization’s technology in a career that ultimately led him to become its director of system engineering and planning.

Since the private equity firms buying global satellite operators by their nature are focusing on generating a return on their investments, they almost assuredly will cash out their holdings in the companies “at the appropriate time,” after enhancing the value of the acquired assets, Sachdev said. Such changes could include “efficiency improvements” and a more profitable mix of services in tune with fast emerging direct-to-user applications, he added.

“Since such services are by their nature more regional and national rather than global, the future may well bring emergence of new regional operators after re-grouping the assets of the erstwhile international operators,” Sachdev predicted. “Regardless of what kind of changes follow, it would be too pessimistic a perspective toview such acquisitions as necessarily a negative judgment on satellite systems per se. Rather it is more likely to be the turning point for the industry to place itself in stronger and more cohesive postures to demonstrate and exploit its fast maturing unique intrinsic strengths of ubiquity and instant access.”

Peter Nesgos, a partner with the New York-based law firm Milbank, Tweed, Hadley & McCloy LLP, worked with the acquirers involved in buying Intelsat and said the company now is in the unique position of having operated for decades without its stock trading in any significant way.

“Both the IPO and private equity initiatives resulted in the company becoming much more responsive to the business challenges confronting the fixed satellite services industry,” Nesgos said.

In the view of Nesgos, the sale is the “next step” in the commercial evolution of Intelsat as a former inter-governmental organization. He expects Intelsat’s financial buyers to contribute much time and effort to further develop the company once the pending sale is closed.

Important Step

Scott Blake Harris, managing director of the Washington-based Harris Wiltshire law firm and former chief of the FCC’s International Bureau, said the announced sale of Intelsat is an “important step” on the road to a fully mature and competitive satellite industry. That path should be good for both the industry and consumers of satellite services, he added.

Jorn Christensen, principal with the Ontario, Canada-based telecommunications consulting firm J. Christensen Consultants Ltd., said when the process of privatizing Intelsat was begun, one of the first steps was to continue the public service obligations of the old Intelsat under the name of International Telecommunications Satellite Organization (ITSO). That move freed the new Intelsat from its inter-governmental obligations and made it more lean and responsive to a commercial environment, he added.

“The sale of Intelsat to financial buyers is a continuation of this process and will likely make the organization even more bottom-line oriented and this may cause some reduction in staff.” Intelsat cut 55 jobs in July and plans further reductions soon.

The consolidation that is taking place is a sign of the industry’s maturation, Christensen said. A mature industry typically is dominated by three to four companies that have 70 percent to 80 percent market share, he added.

Andy Lipman, partner and chair of the telecom practice at the Washington-based law firm Swidler Berlin, said Intelsat’s new owners are sophisticated private equity investors in the telecommunications arena. Any further efficiencies achieved under the new ownership just as likely could come from “intelligent growth” as cost cutting, he added.

(Diane VanBeber, Intelsat, 202/944-7406; Jim Perry, Madison Dearborn Partners, 312/895-1220; Patrick Fuhrmann, 908/490-1391; D.K. Sachdev, SpaceTel Consultancy, 703/757- 5880; Peter Nesgos, Milbank, Tweed, Hadley & McCloy LLP, 212/530-5075; Scott Blake Harris, Harris, Wiltshire, 202/730.1300; Jorn Christensen, 519/534-3345; Andy Lipman, Swindler Berlin, 202/424-7833)