Skynet 5: Safe launch

The £1.343 billion refinancing of the Skynet 5 secure military satellite project shows what canny sponsors can do with the government guarantees associated with more exotic PFI assets.

The sponsor, defence contractor EADS, had to contend with unresolved issues of launch insurance. And the final financing structure incorporates both government support and a solution to the insurance issues.

Skynet 5 is a contract to provide secure space communications using two satellites to the UK's Ministry of Defence (MoD). The PPP contract had been in the works since 1997, although Paradigm, the concession-holder, was appointed preferred bidder in 2003. It needed to find funding to put two satellites into orbit, and provide the UK's armed forces with global communications capability.

The result was a bank financing from HSBC, BNP Paribas and CIBC, which closed in October 2003. That deal broke down into an £880 million loan with a tenor of 13 years and four months, and a second tranche of £83 million. This second tranche had pricing of 140bp over Libor, and reflected the sales of communications services to parties other than the MoD. The larger tranche priced at 90-100bp over Libor.

But the issue of launch insurance was not satisfactorily settled in 2003 – the sponsors were meant to go out and find commercial launch insurance, and if this was unavailable then the MoD would provide a backstop. Since close, however, the commercial insurance market has not become any more forgiving of launch risk, and premiums are still prohibitive.

The sponsors decided to move from a policy of external insurance, to one of self assurance, whereby the project builds an additional satellite to compensate for the possibility of losing one of the existing assets. The concept appears at first sight to be extravagant, but the savings in insurance costs, coupled with the gain from the refinancing, as well as a crucial extension in the concession by two years from 2018 to 2020, allows Paradigm to build a third satellite.

The new concession structure also involved a shift in the way that both sponsor and government presented the credit of the transaction. The initial project finance bank solution looked principally at the cash available from the MOD under the concession contract, and then at the revenues from sales of capacity to (strictly vetted and approved) third party users.

The refinancing, however, had an audience of public sector banks in mind, and wanted to aim for a much higher rating equivalent, as well as a slightly different way of viewing the credit. It drew upon the Tubelines PFI refinancing, which featured payments paid by the UK government and other state agencies in the event of termination.

The termination payments are available as soon as the project reaches pre-agreed milestones, as it gets the relevant equipment into space and operational. They are paid in most instances when the contract terminates, and are backed by the MoD's, and thus the UK government's, credit. This is, if anything, a less equivocal commitment than the Tubelines comfort letter.

The other main difference with Tubelines is that the bonds are not all drawn down at the same time. This serves two purposes – it avoids the negative arbitrage associated with carrying cash from bond proceeds, paying interest on it, but not using it, and it also makes sure that the project does not have obligations to bond holders that available termination payments would not cover.

The intervening funding requirements are met through sponsor loans from EADS, the shareholder and principal contractor. When the bonds are drawn down the matching sponsor loans are with paid off. The institutions taking the bonds provide a financing commitment equal to the total financing requirement for three satellites in exchange for a fee.

Paradigm, through Satellite Financing Plc, has used a master trust structure to issue a first tranche of £186 million in notes, which corresponds to the drawn amount under the bank facility, as well as some funds provided from EADS. The next tranche of £979.5 million will draw when the first satellite is operational. This satellite will be launched in December 2006, and is set to be operational in March 2007, at which point the second tranche will fund. At this time, the concessionaire would be able to carry out the MoD's base operational requirements and would thus be subject to the full termination schedule.

The final tranche is £178.4 million in forward floating purchase enhancement notes, due in 2021. These will only be drawn if one of the satellites suffers a launch failure and the spare satellite is required. These notes therefore represent an option rather than a commitment to buy.

The notes achieved a zero risk rating, although they were not publicly rated. The buyers are a small number of public finance banks. Dexia, a co-manager, is one of them. The buyers are more interested in floating rate than fixed rate debt, and thus the bookrunners provided a swap to Paradigm back into fixed rate. The notes priced at 6bp over the one-month Libor.

The structure provides extremely cheap funding, and is largely able to do so on the back of commitments from the sponsors and government. But these commitments are the necessary result of a very complex communications project. And they still provide, through an innovative financing route, cost effective services.

Any future projects with a large, lumpy capital component could look to the refinancing for inspiration. Indeed, EADS, which has been named the preferred bidder on the Galileo satellite, a joint venture between the European Union and European Space Agency, will find inspiration in the Skynet deal. Its applicability will depend, however, on the contract that the client and sponsor work out.

Satellite Financing Plc
Status: Closed 16 December 2005
Size: £1.343 billion
Description: Restructuring of a PFI contract for secure military satellite communications
Sponsor: EADS
Concession awarder: The UK Ministry of Defence
Debt: £186 million initial issue, £979 million second tranche, £178 million tranche to be used if an accident requires it
Bookrunners: Citigroup, Goldman Sachs
Co-manager: Dexia Credit Local
Financial adviser to MoD: Deloitte & Touche
Financial adviser to sponsor: Citigroup
Technical adviser to lenders: Mott MacDonald
Insurance adviser to the lenders: Marsh
Insurance adviser to the sponsor: Willis
Lawyers to the project company: Freshfields
Lawyers to the sponsor: Lovells
Lawyers to the lenders: Allen & Overy
Lawyers to the concession awarder: Burges Salmon