Question 4. Australia-Japan Cable: Structuring the Project Company Project summary In September 1999, representatives from Telstra, Japan Telecom, and Teleglobe met to discuss the next steps for the Australia-Japan Cable (AJC) project, a $520 million submarine cable system that would run between Australia and Japan. The sponsors, excited by the possibility of achieving large potential returns and obtaining incremental transmission capacity, needed to move quickly to capitalize on the projected shortfall in broadband capacity in the Australasian market. The size of the project and the need to move quickly in the face of significant demand, competitive, and technological uncertainty make this investment particularly risky. The case asks students to structure the project company. As part of this task, they must identify the factors that could prevent the 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 ones. Students must also determine the size and composition of the projects board of directors. Finally, they must structure a compensation package that encourages senior managers to maximize shareholder value. In addition to these equity-related concerns, students must assess the projects target debt-to-total capitalization ratio of 85% and the decision to pre-sell capacity as a way to transform market (i.e., price) risk into counter-party risk. (Culled from Davies 2003)

Questions a. Identify the asset characteristics and the capital providers. What are the problems that can prevent capital providers from getting a return? (10 Marks)

b. How does the project structure mitigate hold-up problems? Compare against a corporate finance (corporate governance solution). (5 Marks)

c. How does the project structure mitigate free cash flow problems? Would corporate finance (governance) mitigate the problems as effectively? (5 Marks)

d. What are your recommendations in terms of: Ownership structure (how many sponsors and which ones?) Capital structure (project vs. corporate finance, leverage, type of debt, etc.) Organizational structure Board structure (how many directors? should they be insiders or outsiders?) Management compensation (5 Marks)