Dollars and Sense: Private Equity: First, The Good News….
by Owen D. Kurtin
August brought news of the purchase of Intelsat by a private equity consortium, which includes Apollo Management, Madison Dearborn Partners, Apax Partners and Permira Advisors. Also in August, the purchase price in the pending acquisition of Panamsat from DirecTV Group by another consortium of private equity firms led by Kohlberg Kravis Roberts, The Carlyle Group and Providence Equity Partners was renegotiated downward in light of the partial failure of the operator’s Galaxy 10R satellite.
These events provide a springboard to discuss one of the most interesting recent trends in the space business: this year’s entry of private equity firms. In addition to the Intelsat and Panamsat deals, since December 2003, New Skies Satellites NV has been purchased by the Blackstone Group, Inmarsat by Apax and Permira and Globalstar by Thermo Capital Partners. The emergence of these firms into the satellite sector has been abrupt and brings a new culture and mentality to the space business. What does it mean? First, the good news….
Financial investors are not likely to be, per se, less beneficial for a satellite sector company than strategic investors. True, private equity investors are more apt to be focused on an exit strategy for their investment–such as a sale or IPO–but that is not necessarily worse for the satellite company investment target than being the overlooked stepchild of an over-conglomerated larger corporation, especially if the parent uses the subsidiary as a cash cow to fund other ventures instead of growing its satellite business. Also, the fact that owners have an exit strategy is not necessarily negative. The investor may concentrate on improving profitability and growing market share to improve prospects for ultimate sale to another buyer or to the market.
The image of asset-stripping investors is probably not accurate for the satellite sector, particularly given the rapid depreciation of orbiting assets. Private equity firms are interested in the fixed satellite services (FSS) sector because of its cash flows; the revenue stream of FSS operators is secure and comes from blue chip clients for whom there is no alternative service. In a leveraged buyout paradigm (LBO), a relatively small equity investment is leveraged by debt secured by the revenue stream of the buyout target. The interest of private equity in the sector is easy to understand.
Also, private equity can supply business-side management and financial acumen, which satellite companies, awash in technical-side talent, often badly need. The principals of LBO funds in particular are expert at providing board-level guidance and strategy, and will bring to the table the ability to align executive motivations with company performance. They will not be constrained in their analysis of business models by legacy mindsets, bureaucratic imperatives, national or competitive pride or years of financial, technical and emotional investment in projects that may have once made sense, but which time and other developments have overtaken; or projects that are technologically innovative but economically unworkable. Private equity investors will also be far more experienced and adept at devising the kind of customized financing and partnering solutions we have been advocating in this space to take advantage of changing risk profiles on a company, mission or project basis.
They will, moreover, be highly motivated to find creative new ways to allocate investment in the satellite company among investors with different appetites for risk and return that a single security offering in the public market would not permit. For example, a leveraged buyout model could allocate to more conservative (bank) investors a low return debt instrument with modest warrant coverage tied to the middle years of a "proven" satellite’s in-orbit life, when costs have been substantially recouped, while leaving equity instruments based on early years of a satellite’s or project’s life as a more speculative, and potentially lucrative investment.
The recent Panamsat deal restructuring illustrates these points. The Galaxy 10R failure triggered a clause in the purchase agreement that would have allowed the private equity syndicate to terminate the deal.
Because of the other private equity deals in the sector, other buyers for Panamsat might not have been available, and Panamsat was reportedly anxious to close. Had the failure occurred prior to the pricing of a public offering, the effect would likely have been far more severe and deleterious to the operator, as underwriters and public investors scrambled to re-assess the company’s prospects.
By contrast, the private equity consortium was able to analyze the satellite’s reduced life span, the value of insurance claims and the effect of the whole on the revenue model on which the transaction was initially based, and quickly negotiated an approximate six percent purchase price reduction. This sort of practical, rational decisionmaking is the best feature of private equity investors, and to our mind (and probably Panamsat’s) the entry of such investors in the satellite sector could be very good news indeed.
Next month: the bad news.
Michael Flynn co-wrote this article. Kurtin and Flynn are partners in the New York office of law firm Sonnenschein Nath and Rosenthal LLP. They may be reached at 212/768-6700 or by e-mail at firstname.lastname@example.org and email@example.com, respectively.