The Fixed Satellite Service (FSS) sector, which has shown signs of settling into a period of operational growth after three years of financial engineering and consolidation, was thrown back into turmoil in April when reports surfaced that private equity firm The Blackstone Group has made a $6 billion bid for the largest operator, Intelsat.
Intelsat, owned since 2004 by a private equity consortium consisting of Apax Partners, Apollo Management, Madison Dearborn Partners and Permira Advisors, was immediately put up for sale. Since the consortium paid $515 million in cash for Intelsat in 2004, a sale to Blackstone would return more than 10 times the consortium’s cash investment — to say nothing of special dividends the company has paid.
But what does Blackstone have in mind?
The firm knows — and has profited from — the FSS sector. Blackstone acquired New Skies Satellites in 2004 for $956 million in cash and then flipped it in an initial public offering (IPO) and again in the 2006 sale to SES Global for $1.2 billion in cash and assumed debt, so it can be presumed to know what it is doing in bidding for Intelsat.
Nevertheless, how much more can be squeezed out of Intelsat? The operator is a completely transformed company since its 2001 privatization — after spending 37 years as a non-governmental organization. Intelsat now operates a 51-satellite fleet; reported revenues of nearly $1.7 billion in 2006, a nearly $500 million increase year-on-year (almost all contributed by the PanAmSat assets); operating income of about $400 million; and a net loss of $369 million.
Intelsat also is already the product of highly leveraged acquisitions. In the $5 billion acquisition in 2004, each of the four consortium partners took 25 percent of the deal and also refinanced $2 billion in Intelsat’s debt, valuing the equity at $3.1 billion, for which they paid $515 million. Immediately after the acquisition, the satellite operator paid its new owners a $350 million special dividend by issuing new debt.
The acquisition of PanAmSat in 2006 for $3.2 billion along with another $3.2 billion in assumed debt — partly financed by a $2.9 billion high-yield debt offering — has added to the debt burden.
Three years after the rounds of financial engineering began, Intelsat now has about $11 billion in long-term debt. The operator seemed recently to be preparing for its long-rumored and anticipated IPO, originally required by the ORBIT Act, but those layers of debt will have to be assumed by a buyer, and since they were structured during periods of historically low interest rates, there may not be much yield to be squeezed from further restructuring.
While several analysts have suggested that adding another debt layer might actually push Intelsat into bankruptcy, it is hard to imagine either the current owners or a prospective purchaser allowing that to happen, particularly to a business as sound as a going concern (apart from the debt burden) as is Intelsat. After all, the going concern value is the attraction; private equity firms love the FSS sector because of its healthy and predictable cash flows, which is key to servicing and retiring the debt levels incurred in leveraged acquisitions. However, Intelsat’s $11 billion in debt requires nearly $1 billion a year to service, and another debt layer would further limit the company’s strategic and operational options.
In addition to probing the limits of financial engineering, there are issues of management distraction and transaction costs. Intelsat’s executive team is highly regarded. Its integration of the PanAmSat assets has, by all accounts, been a success, and the company’s 2006 annual report affirmed its intention to “grow [Intelsat’s] business in the media, network services and telecom and government sectors.” A sale of the company will distract senior management from those goals.
Intelsat’s transaction costs have been substantial as well, and new transaction costs added to the debt service burden will further impact integration, satellite procurement, rollout of new services and research and development as well as put cost cutting at a premium.
Intelsat’s officers, private equity owners and prospective purchasers may have the smarts to operate and grow their business and achieve cost reductions while coping with a new change in ownership, new debt layers and a major transaction, but they are maneuvering perilously close to gimbal lock this time.