Dolars And Sense: Exit, Part I: The Toll

By Owen D. Kurtin

In a two-part article in this space last year, "Private Equity: First the Good New/Now the Bad News," we examined the emergence of private equity buyers in the Fixed Satellite Service (FSS) sector, the defining event in satellite finance for 2004. In the series, we opined that one test of the new ownership’s ramifications would be when the private equity exit horizon approached, in three to five years, right before the massive capital expenditure required for several of those operators’ fleet replacement came due. It turns out we were overestimating the "buy and hold" duration strategies of the purchasers.

The defining theme in satellite finance in 2005 will be the private equity exit initial public offering. Panamsat Corp., purchased last year from the DirecTV Group by a consortium of private equity firms led by Kohlberg Kravis Roberts, The Carlyle Group and Providence Equity Partners, announced in December its intention to raise up to $1.1 billion in an IPO. New Skies Satellites Holdings, purchased by the Blackstone Group in August, filed in late January to raise up to $350 million in its own IPO. And Intelsat, whose purchase by a private equity consortium consisting of Apollo Management, Madison Dearborn Partners, Apax Partners and Permira Advisors was finalized in January. Finally Inmarsat, purchased by Apax and Permira, is now rumored to be considering and IPO. Eutelsat, which preceded the recent wave in private equity ownership, went through a series of changes late in 2004, but the new owners may not want to sit on the sidelines for much longer.

The rationales for any company to go public are well-known: to raise capital, to improve access to capital going forward, to "enhance image," management incentives, improve liquidity and acquisition currency. There are costs to going public as well. Public company reporting in the post-Sarbanes-Oxley world is more burdensome, costly and prone to litigation risk than ever.

Just as the satellite sector had little history of private equity ownership going into 2004, it has relatively little history in (direct) public ownership going into 2005. Few sector companies are publicly-owned and the largest operator, SES Global, is listed only on the Luxembourg and Euronext Paris exchanges, limiting its visibility outside of continental Europe. This limited visibility also impacts its flotation breadth, size and liquidity.

Other operators that were not public equity targets, such as Telesat Canada, as well as most of the large satellite manufacturers, such as Lockheed Martin Commercial Space Systems, Boeing Satellite Systems, Alcatel Space and Astrium, are divisions or subsidiaries, wholly or majority owned of large, public telecommunications and aerospace companies, shielded from the full force of market scrutiny by their relatively small size compared to their corporate parents. Other than these cases, Wall Street has a touchy history with the sector, having learned some bitter lessons while attending Mobile Satellite Service (MSS) Academy in the 1990s.

In this series of articles, we will examine the dynamics of the recent sales and what public flotation of these operators will mean to the satellite industry. Private equity firms bought into the FSS sector because of its cash flow and because they thought they could profit and exit before the next big wave of capital expenditure came due. The public markets may prefer a growth model, and the FSS sector, as opposed to DBS and DARS, is not a high growth business. Increasing growth rates will require new, advanced service rollout, development of new markets and encroachment on markets served by entrepreneurial satellite operators, such as the DBS and DARS operators, and terrestrial services. This in turn requires capital expenditure in research and development, technology rollout and new fleet procurement, which may crimp operator stock price accretion and limit stock value as acquisition currency.

It should be lost on no one that one route into new services may be through acquisitions of existing providers, such as the DBS and DARS operators. There would be antitrust/competition scrutiny of such acquisitions, but because the services offered by purchaser and target would be different, this column’s bet, however, is that such acquisitions would pass regulatory muster.

We warned in the prior columns that private equity owners might well have little appetite for the kinds of capital expenditure that would be necessary to transform their FSS acquisitions into growth businesses, both because such investment would eat into short-term profits and because the hoped-for returns on investment would come beyond the expected exit horizon. How to make the necessary investment to become growth businesses while supporting stock price is the key challenge facing FSS operators, their current private equity owners and the bankers that will be making markets for the planned IPOs.

Next issue: Making the Market.

Owen D. Kurtin is a partner in the New York office of law firm Brown Raysman Millstein Felder & Steiner LLP and a member of the firm’s Technology, Media & Communications and Corporate Departments. He may be reached at +1.212.895.2000 or by e-mail at [email protected].