Intelsat's Triple-Flip Is Anchored on Debt

Washington's own Intelsat, the world's biggest and most respected satellite operator, is on the auction block again.

Only three years ago, Intelsat was scooped up by a quartet of private-equity firms that put a modest $515 million of their own money into the deal and borrowed the rest. Within a year, they'd taken all their cash out in the form of dividends and management fees. Last year they paid $3.2 billion, all of it borrowed, to buy rival PanAmSat from another group of private-equity firms, which in the space of a year had managed to turn an investment of about $500 million into a $3 billion gain.

You would have thought that at that point, with more than $11 billion of debt on Intelsat's balance sheet, revenue of about $2 billion, annual interest payments of $1 billion and a negative book value, the new owners would be focused on achieving the cost savings they envisioned from the consolidation.

But before most of those efficiencies have been realized, Intelsat is back in play. And if the price for the company's equity is anywhere near the rumored $5 billion, Intelsat/PanAmSat could go down as the greatest "triple-flip" in the history of private equity.

The obvious question is whether the $8 billion that private-equity firms will have realized from these companies can be justified on the basis of creating real economic value.

Or will they have loaded up solid companies with a mountain of debt, squeezed out every dollar of available cash and sold them to some sucker caught up in the takeover frenzy?

Or will they have simply been lucky enough, or smart enough, to have bought into an industry just as oversupply and low prices were giving way to tight capacity and rising prices?

The answer, it turns out, could be a combination of all three.

It's no coincidence that the amount of cash the private-equity firms have drained from these two companies is about equal to the increase in their total indebtedness and the amount of free cash they have generated during the past few years. As a result, the combined company now has so much debt, it's unclear how a new owner could leverage the assets of the company any further to finance the purchase.

Last year, for example, Intelsat managed to generate only $448 million in surplus cash after paying operating expenses and debt service. That's the money available to invest in its fleet of 51 satellites, each of which has to be replaced every 10 to 15 years at a cost of roughly $200 million each. That was enough for last year, but $448 million won't be enough for this year, when Intelsat projects it will have to make $615 million in capital expenditures, a more typical annual figure.

In short, unless Intelsat can cut expenses even more or increase its revenue, it's pretty much tapped out in terms of how much debt it can service.

Intelsat's recent owners deserve some credit for transforming the company from the fat and happy government-sponsored enterprise it was for nearly four decades into a leaner and more aggressive private enterprise. The company expects $92 million in annual operational savings once the PanAmSat and Intelsat operations are consolidated, plus another $100 million a year in capital expenditure savings. The prospect of a $200 million bump in annual cash flow is nothing to sneeze at. But it's hard to see how that justifies a $5 billion bonanza for the current crop of investors and managers.

(Speaking of the managers, chief executive David McGlade would have plenty to celebrate from a $5 billion sale. As I read the description of his employment contract, McGlade would get $70 million to $90 million of the proceeds.)

So why would anyone pay these kind of prices for a highly leveraged satellite company? You wouldn't unless you thought prices for satellite services were about to take off.

Remember that after the telecom bust of 2000, prices fell 25 percent or more, which in a business with mostly fixed costs pretty much wiped out any chance of making a profit. And for a time, the fear among public investors was that the industry was so overbuilt it would be years before profitability could be restored. Those fears gave clever private-equity investors the chance to pick up satellite companies at discount prices.

Now, however, the rapid growth of cellphone companies in Eastern Europe and Africa, and the added demand for bandwidth that has come with high-definition TV and cellphone video, has led to a noticeable pickup in demand for satellite capacity -- and with it, prices. If they were to double over the next five years, Intelsat could turn out to be a smart investment, even at $5 billion.

Maybe. Or maybe we're witnessing the manic final phase of a takeover bubble.

Steven Pearlstein can be reached atpearlsteins@washpost.com.