Sovereign Funds And The Space Business

The private equity investment of capital into the satellite sector since 2003 has fuelled industry growth, consolidation, and rationalization. The subprime mortgage crisis and resulting credit crunch across investment and commercial banking groups threatens to undermine the source of leveraged finance key to private equity investment.

Several leading banking groups have taken multibillion-dollar capital infusions from sovereign funds to offset their subprime write-offs and restore their balance sheets and are entering a new cycle of conservatism in lending practices. In the current environment, sovereign wealth funds may become the critical source of investment into the satellite sector, both directly and indirectly, through investment in private equity firms.

Sovereign wealth funds are investment funds owned by the governments of sovereign states. Most of the significant funds started as reserve currency holdings — generally for holding dollars when the dollar was pegged to the price of gold — and in many cases for currency reserves generated from oil revenues.

Today, sovereign funds have morphed and hold assets denominated in all major reserve currencies and in a mix of financial instruments. In addition, the basis of wealth is diversifying: Several projections estimate that by 2015, non-oil revenue-based funds with holdings in industry, pension funds, currency and commodity reserves will be as significant as oil revenue-based funds, which currently account for about two-thirds of sovereign wealth assets.

Projections also estimate that the total size of the sector may be as much as $12 trillion, up from a current estimate of $2.5 trillion. (By way of comparison, the gross domestic product of the United States in 2006 was a little more than $13 trillion.) China alone has more than $1.2 trillion in foreign exchange reserves. China’s 2007 investment of $3 billion in Blackstone Group — the private equity firm that invested in New Skies Satellites — prior to its public offering and subsequent acquisition by SES Global should serve to engage the industry’s attention.

Because they do not have limited partner owners with a short- to mid-term investment horizon, sovereign funds do not come with the same set of assumptions about return on investment and exit strategy that private equity firms do, and their investment capital may therefore promote a longer return or exit horizon and longer-term, more strategic thinking.

Nevertheless, sovereign fund investment comes with its own set of risks and represents shoals that require careful navigation. The funds necessarily are tied to individual countries or regions, some of which are politically sensitive in the prospective investment target jurisdiction. The Committee on Foreign Investment in the United States (CFIUS) regulatory regime — significantly amended by legislation last summer — may play a role in sovereign wealth fund investments in sectors considered to have national security implications in the United States. The CFIUS regime applies even to minority investments when effective control of the target is gained.

In addition, sovereign fund investments in the U.S. space sector, either directly or through private equity investment vehicles, may face scrutiny under the U.S. International Traffic in Arms Regulations (ITAR) technology export regulatory regime if there is an issue of backflow of the investment target’s technology to the investor country. The effective blocking by CFIUS in 2005 of China National Offshore Oil Corp.’s bid for U.S. oil company Unocal and the U.S. State Department’s ITAR-based blocking in 2007 of regional satellite operator Asiasat’s bid to increase the stakes of its principal shareholders, GE Capital Equity Investments and the Citic Group of China, demonstrate the continuing political sensitivity and need for sovereign funds to approach U.S. investments carefully and with political astuteness.

Even where the sovereign fund country of origin is not particularly politically sensitive, the fund’s national status may run into considerations of dilution of “national champion” status, making targets and their governments hesitant to accept the sovereign fund as an investor. On the other hand, sovereign funds might be ideal investors when national champion status is to be maintained and the specific fund would not dilute it.

Given the longer-term return horizon and political sensitivities, sovereign funds may be ideal for the satellite manufacturing sector, which unlike the satellite operator sector,  have not yet been the target of private equity investment.