Case No.: 200-039; Teaching Note: 5-200-050
Posted: 11 Oct 2000
Date Written: July 18, 2000
SUBJECT AREAS: project finance, financial strategy and execution, valuation analysis, corporate governance, global investment CASE SETTING: August 1999, telecommunications, $5.5 billion investment, $6 billion projected revenue
This case analyzes the demise of Iridium LLC, one of the largest private-sector projects in corporate history. The satellite communications company declared bankruptcy on August 13, 1999, and is now in the process of being liquidated under the auspices of the US Bankruptcy Court. Despite almost $6 billion of investment, the assets appear to be worth less than $50 million.
The first half of the case describes Iridium's creation, development, and commercial launch, and gives students an opportunity to critique the vision behind this project and estimate its value using discounted cash flow analysis. The second half of the case focuses on Iridium's financial strategy and execution. In particular, the case describes Iridium's target debt-to-total book capitalization ratio of 60%, the various kinds of capital Iridium used (secured bank debt, guaranteed bank debt, zero coupon bonds, cash pay notes, etc.), and the sequence in which it issue them. Although this post mortem analysis is intended to help students understand the relevant issues in financing large, greenfield projects, the lessons on financial strategy and execution readily extend beyond the realm of large projects.
The case has four pedagogical objectives. First, it illustrates the financial strategy and execution of a very large, greenfield project. The case helps students understand why project sponsors select highly-leveraged capital structures, why they use specific types of capital (bank debt vs. public notes), and why they raise capital in the sequence they do. This analysis forces students to confront the "capital structure puzzle" yet the setting differs from other attempts to differentiate among various capital structure theories because Iridium is a start-up venture that is less affected by prior financing decisions or past performance.
Second, the case illustrates not only the benefits of using project finance for high-risk projects, but also the dangers of using project finance for high-technology projects. With more than $43 billion of announced capital expenditure for satellite communications systems, it is critical to learn from Iridium's mistakes. One key lesson is that while financial structure can improve firm performance and increase the probability of success, it cannot save a project with fundamentally flawed economics.
Third, it illustrates how difficult it can be to value a large project with unproven technology. The case presents wide ranging revenue projections from some of the most informed investors (equity research analysts). The combination of large, relatively certain, upfront costs with large, relatively uncertain, distant revenues makes large-scale investment very risky.
And fourth, it provides an opportunity to discuss the governance of large projects. One of the key questions in this case is, "How could this have happened?" Part of the answer lies in Iridium's board structure (size, independence, and ownership).
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