Australia Japan Cable: Structuring the Project Company
Posted: 26 Oct 2004
SUBJECT AREAS: project finance, corporate (and project) governance, organizational structure, capital investment, telecommunications industry
In late September 1999, representatives from Telstra, Japan Telecom, and Teleglobe met to discuss the structure of the Australia-Japan Cable (AJC) project, a $520 million submarine cable system that would run from Australia to Japan. The sponsors, excited by the possibility of large returns, needed to move quickly to capitalize on the projected shortfall in Australia's broadband capacity. As telecommunications carriers, the sponsors needed additional capacity to serve their retail and wholesale customers. As cable system owners, they wanted to earn an appropriate return on their invested capital while mitigating ownership risks. The need to move quickly in the face of significant demand, competitive, and technological uncertainty made it particularly risky to invest at this time.
The case asks students to create an optimal governance structure for the AJC project. As part of this task, they must identify the factors that could prevent capital providers from earning an appropriate risk-adjusted return on their investment. They must then design an optimal governance structure to mitigate these risks to the extent possible. For example, they must decide whether to include additional equity investors (sponsors) and if so, which firms. Students must then determine the size and composition of the project's board of directors. Finally, they must design a compensation package that encourages senior managers to maximize shareholder value. In addition to these equity concerns, they must assess the project's target debt-to-total capitalization ratio of 85% and the decision to pre-sell a large amount of system capacity.
This case was written for a course on project finance, but is appropriate for courses on competitive strategy, corporate governance, international finance, and general management. It illustrates one of the primary reasons to use project finance: it allows firms to create a governance structure that mitigates costly agency conflicts inherent in particular greenfield assets with dedicated uses. One of the major conflicts is over the use of "free cash flow" (Jensen, 1986) - the project structure is explicitly designed to prevent inefficient re-investment and expropriation of quasi-rents. The case offers an effective way to teach corporate governance by contrasting the unique structural features of project companies with the features found in most corporations. Second, it prevents a framework to help identify which assets are the most appropriate for project finance. And third, it documents a set of stylized facts - institutional details such as leverage ratios, equity and debt ownership structures, board structures, and management compensation - about project companies. For this reason, the case serves as a very good introduction to the field of project finance. Finally, there is a technical note entitled, "An Overview of Project Finance - 2002 Update," that accompanies this case which provides additional institutional details.
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