Private Equity in a Post-ECA World: Where Does it Stand?
Private equity firms have long been a source of funding for ambitious satellite companies. However, with testing economic times as well as new modes of financing being used, their role in the sector going forward is open to debate.
Private equity firms have a good reason to avoid competing with Export Credit Agency (ECA) loan rates in the satellite industry. Approximately one-third of all satellite-related finance deals signed in the past three years have involved ECAs. Since 2009, more than $6 billion in loans and loan guarantees were made to satellite firms at below-market rates, with better-than-market repayment terms, according to a satellite financing report issued by the Milbank, Tweed, Hadley & McCloy law firm earlier this year. Between France’s Coface, the U.S. Export-Import Bank and the Chinese government, export-credit agencies have been active in securing the domestic and international satellite and launch industries.
While private equity firms also are looking to put their investment capital to work in the face of strong headwinds for the satellite industry, uncertainties in the economic outlook could make it difficult for buyers and sellers to agree on price. While private equity firms may or may not want to shop alongside ECA rates and propel satellite deal-making, the real question for the financing market in 2012 exists for the smaller satellite companies that traditionally do not have access to significant loans. Are private equity firms willing to take on new investments? Or, can financial problems be solved more efficiently through mergers and acquisitions in a market saturated with struggling start-ups?
Feeling Pressure
Hugh MacArthur, head of private equity industry consultant firm Bain and Co., sees debt-market conditions as less favorable in 2012 than in 2011. His primary concern is whether the available supply of debt will be able to keep pace with demand.
“Even if deal-making picks up, it’s likely that credit markets will remain accommodating as long as the hunt for yield in a low interest rate environment continues to attract investors,” he says. “Private equity firms will feel pressure to unload assets in 2012. They have been slow to return capital to investors since the downturn and the exit overhang has grown to nearly $2 trillion globally, due to the fact that 48 percent of the private equity sector’s total funds that have been earmarked for buyouts is being held in funds raised during 2007 and 2008.”
MacArthur warns that unless that capital is invested by the end of 2013, general partners may need to release limited partners from their commitments and forego the management fees and potential carry it could generate.
That said, one may ask — how does the state of the private equity environment affect satellite companies coping with credit constraints and market uncertainty and looking to get new satellite ventures and projects off the ground? The answer may be that despite 2012 looking like another year that will pass in an uncertain economy, demand for mobile, broadband and fixed satellite services continues to surge ahead.
Nic Volpi, principal of private equity firm Permira, however, says that the satellite sector’s health and ability to generate opportunities has attracted private equity firms like Permira to satellite investments. Volpi, who joined Permira in 2008, is a member of the firm’s financing group and has worked on numerous transactions including Aearo Technologies, Arysta LifeScience, Asia Broadcast Satellite (ABS), Freescale Semiconductor and Intelsat.
“The satellite industry has always presented Permira with good investment opportunities,” says Volpi. “This is a natural fit, due to the long-term contract structure and strong cash flow generation that are prevalent in the satellite market. These factors are clearly attractive to financial buyers. Permira, for example, has a long history in this sector and have worked to foster the investment relationship between the public equity world and the satellite industry. Our early deals with Inmarsat and Intelsat generated very strong returns for our funds investors. Our agreement to purchase ABS gave us a nearly 100 percent interest in a fast growing, Asia-Pacific operator that is developing in one of the most dynamic markets in the world. This shows that the private equity model can work.”
James Murray, a managing director at Morgan Stanley, believes that the combination of unpredictable financial conditions and the need for more space and related terrestrial infrastructure has necessitated creative and resourceful financing solutions. He says that, in the satellite sector, the prevalence of ECA support, access to a choppy high-yield marketplace, strategic partnerships and joint procurements may serve as better alternative for financing.
“Private equity finds it difficult to compete with ECA rates, which are unmatched and feature loan covenants that are flexible,” says Murray. “At this point, the question of whether ECA involvement distorts the market is almost beside the point because ECA financing is popping up everywhere. This could have a chilling effect on the equity markets’ view of startup satellite operators, and in some cases, established operators.”
Some analysts say that with so many telecommunications satellite systems in orbit receiving export-credit assistance, the likelihood of loan defaults could increase and cause a general pullback by the agencies. The track record of ECAs in the satellite sector has been solid so far and some analysts say that track record has stimulated more ECA transactions among established, profitable satellite operators.
Chris Quilty, senior vice president of financial analysis firm Raymond James, agrees with Volpi that the endurance of the satellite sector has proven its worth as a safe investment for all types of financiers. “I believe that the way the satellite industry has performed during the recession, combined with the fact that it has acquired the capital it needs to launch projects that will generate long-term growth, should make satellite attractive to the private investment world,” he says.
Essential Elements
That isn’t to say the satellite industry doesn’t have its share of challenges. Quilty admits that private equity firms are just as aware of the risks involved with the satellite business model as satellite companies themselves. The typical new satellite business case, according to Quilty, is often comprised of three main elements: access to orbital slots and frequencies; availability of a satellite; and the basis of a relationship with a client or customer base. “The satellite industry has increasingly become more competitive, which makes it more and more challenging to pull together these three elements in a timely manner and open up avenues for growth for individual operators.”
Osvaldo Ramos, a managing director at Barclays Capital, says that investment bankers have a unique perspective on how satellite projects are getting financed from established and non-traditional sources. “The key satellite industry issues that the public capital markets have been looking at are realistic growth expectations, the health of related manufacturing partners and, especially, the evolving merger and acquisition landscape in the satellite services realm,” he says.
Ramos refers to Quilty’s three elements of the satellite industry as an example of how mergers and acquisitions can be valuable selling points for investors. “Coopertition can benefit two partners in a deal if the synergies created by the combination allow both companies to bring together all three elements and thereby successfully launch a new satellite,” says Ramos. “Individually, they may have lacked one or more of the critical pieces of the business plan.”
The satellite sector enjoyed a financial rebound of strength two years ago, however, Ramos says that progress has stalled since the summer of 2011 and may not show significant signs of acceleration any time soon. “Despite the resilience of the satellite business, the current environment may impact potential merger and acquisitions transactions and fundraising for new systems,” he says. “Top players in the financial and banking community have different views on strategic issues and financing options to support capex. Each of those views takes satellite acquisition activity and credit ratings into account.”
Deceleration has been a trend through the private equity environment in a variety of sectors. According to MacArthur, the progress that was made with the 2010 financial rebound may not be seen again for at least another year, as fund-raising is not poised for a recovery in 2012. “The slower pace of exit activity is leaving liquidity-strapped private equity firms strained to meet capital calls for past commitments and volatile equity markets are pressing them against their allocation ceilings. Meanwhile, an oversupply of funds seeking capital could force general partners to scale back lofty expectations or face being disappointed,” he says. “Despite a huge backlog of capital that private equity firms are already struggling to put to work, combined with deteriorating fund-raising conditions going in to 2012, general private equity partners are looking to raise 2.8 times as much capital globally this year as they were able to raise in all of 2011.”
MacArthur breaks this trend down by geographical cases, highlighting the differences between private equity funding scenarios in different regions. “Private equity firms are well endowed in Singapore, Malaysia and to a lesser extent, Indonesia. Unlike China and India, where private equity funds have typically been able to take minority stakes in smaller companies or limit themselves to private investments in public equities, Southeast Asia has traditionally been a buyout market, offering general partners more opportunities to create value,” he says. “In Europe, general private equity partners are also playing the business cycle, looking broadly within the industrial sector at everything from automotive to chemicals that they might be able to buy at low valuations relative to recent highs.”
Thomas Watts, chairman of the investment management firm Watts Capital Partners, is one of many financial experts that predicted that 2010 and 2011 would mark an increased presence of private equity investors in the satellite merger and acquisition scene. He says that the ongoing credit crisis and global recession has pressured satellite industry balance sheets around the world. “At the beginning of the recession, many analysts were wondering when satellite companies would run out of cash, which is remarkable, considering that, just months earlier, those same analysts looked forward to seemingly bright futures,” says Watts. “While the public equity markets and many sources of debt financing have closed to satellite companies, the market for private investments in public equity offers a potential solution. In fact, the private equity market already has been the financial savior of at least one high-profile satellite operator.”
The most common example of a private equity firm’s role in an acquisition can be found in East Asia — one of the most active markets for consolidation. The Permira-owned ABS took over in-orbit capacity owned by Korea’s KT Corp. and the Philippines’ Mabuhay Satellite Corp. as part of a soft consolidation strategy for assets in the region.
“Many satellite operators in Asia, as in other regions, are viewed as strategic assets by their governments,” says Watts. “That has slowed what should be a natural reduction in the number of satellite players given the economies of scale of operating spacecraft.”
Accessing Capital
In North America, the satellite industry is led by large FSS operators and service providers that have a variety of opportunities to access debt capital with the most attractive absolute rates available in the world. Murray says it is difficult to tell how long this environment will endure, but predicts that loan issuers and underwriters will remain optimistic as company backlogs of increase. “The FSS sector is still ripe with strong businesses, predictable revenues and visible backlog — all of which makes them very likable in the credit markets,” he says. “North American FSS players were so highly levered over the last three years. Even though operators such as Telesat and Intelsat were once levered at eight times EBITDA, the businesses performed just fine with very high levels of leverage. Now that their markets are better, debt investors feel even better about these businesses.”
This is not the same case for smaller satellite companies, according to Watts, who notes that credit markets have improved for investment grade issuers, but lower quality companies still face significant challenges in finding capital.
Quilty adds that larger satellite firms and service providers also face challenges — not in obtaining financial support, but with maintaining access to favorable loans and ‘just-in-case’ reserves if something goes wrong.
“I think you can look at Inmarsat’s relationship with Harbinger Capital as an example,” says Quilty. “Inmarsat was making constellation upgrades that were set to define the competitive mobile satellite service environment for the next 20 years and there were clearly new growth applications to leverage. Philip Falcone [director of Harbinger Capital] sold half of its stake in Inmarsat and restructured the hedge fund’s investment in [4G-LTE operator] LightSquared to facilitate direct investments by existing and prospective investors. Harbinger now has $3 billion invested in a satellite-hybrid broadband network that will probably never see the light of day, thanks to the FCC.”
At the time, Harbinger’s current investor consortium voiced concerns to Falcone regarding the fact that his LightSquared stake accounts for nearly half of the hedge fund’s $6 billion in total assets. “Some investors were not happy with LightSquared’s long-term revenue-generating plan. Harbinger’s heavy stake in LightSquared made it a struggle for the fund to honor investors’ redemption requests. In 2010, the Harbinger flagship fund ended with a 12 percent decline during a year when other hedge funds were growing by an average of 10 percent. In such a strong market like telecoms, that makes investors nervous.”