Investing in Fiber

fios vanThere is a recent short article in Forbes titled, To Evade the Wheeler Tax, Capital is Fleeing Digital Infrastructure by Hal Singer. The premise of the article is that the FCC’s move to regulate broadband under Title II has somehow driven the large ISPs to stop investing in broadband. He cites the fact that Verizon has used their excess cash to buy content and software rather than invest it in infrastructure. Just in the last year Verizon has bought AOL for $4.4 billion, Fleetmatics (connector of smart devices) for $2.4 billion and recently announced the purchase of Yahoo for $4.8 billion.

But Singer couldn’t be more wrong. It’s obvious that Singer has a bias against broadband regulation by the title of his article, and certainly Forbes is in generally favor of the unregulated marketplace. But for his premise to be true, Verizon would have to be stopping its expenditures for broadband and instead be choosing these new paths. And that has not happened.

Verizon stopped building FiOS fiber well over a decade ago. It’s been clear for a long time now that Verizon doesn’t think their future is in landlines. For a very long time they have considered themselves as a wireless company. One only has to look at their annual report to understand that somebody who didn’t know the company might barely realize they are in the wireline business. Those reports talk almost entirely about cellular, which makes sense since the wireless business dwarfs the broadband business.

Singer is right that Verizon has been ditching landline properties. But these were mostly in areas away from Verizon’s northeast core and included both copper and fiber assets. But it’s also clear that Verizon hasn’t given up broadband in the northeast. They are currently in the process of buying XO for $1.5 billion, one of the larger fiber-based CLECs that’s centered in the northeast. Verizon also recently announced they were going to bring broadband to Boston, and it now looks like this will become a test bed for using millimeter wave radios as a fiber-to-the curb deployment, rather than building traditional FiOS networks. My guess is that Verizon sees wireless local loops for broadband as their next big use of their cellular spectrum and existing fiber assets, and if Boston proves the new technology then Verizon will probably begin making huge investments again in broadband.

The problem with articles like Singer’s is that rich people that make big investments read Forbes and might decide that investing in broadband is a bad idea. Before they do that I hope that they look at broadband investments with the right perspective. Investing in broadband is an investment in infrastructure. And that means that such the investment is going to earn infrastructure-like returns. Anybody that builds broadband networks is likely looking at long-term returns of 10% to 20%. The returns can be a little higher for cherry-picking only the best neighborhoods. And the returns will probably be higher if wireless local loops can save on capital expenditures.

But infrastructure returns are not venture capital returns. Investments today in software and content are seeking returns of at least 30%. But such investments are a lot riskier than investing in broadband – and thus the relative returns.

The fact is that for the last ten years almost nobody has invested in broadband in this country. Most of the new construction since Verizon stopped building FiOS has come from independent telephone companies, municipalities and cooperatives. Today we are seeing more activity with the two biggest players being Google and CenturyLink, along with a dozen or so smaller urban fiber builders. We also now see the cable companies making significant investments to move cable modems to the next generation DOCSIS 3.1.

So the decision by the FCC to regulate ISPs under Title II has changed almost nothing because big telcos like Verizon were not investing in landline broadband before that decision. Certainly that decision might eventually put a cap  on the returns of the largest ISPs like Comcast and Verizon. But mostly the FCC rules are going to stop the large ISPs from ripping off the public with data caps or by raising the rates through the backdoor by inventing imaginary fees. But the FCC rules are not going to change the fundamentals of the marketplace that understands that investment in broadband is infrastructure investing. Companies that make such investments will still make infrastructure-like returns, like has been true during all of my career. The much more fundamental question that Singer ignores is, why aren’t there more companies looking to make 10% to 20% infrastructure returns? Answering that question might require a book rather than a blog or a short article.

3 thoughts on “Investing in Fiber

  1. I’m intrigued by your figure of 10% – 20% returns. I haven’t found this to be true, at least not for small metro networks. Are there industry figures you are pulling to get that number or past experience (or both). Thanks!

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    • Fiber is not different than most infrastructure in that there is an economy of scale. You are right and a small fiber system might have trouble even breaking even. But put ten similar systems together under one management and you gain economy of scale and you can earn the expected infrastructure returns. I’ve modeled a lot of markets and by the time you get above 30,000 to 40,000 passings you start seeing the expected infrastructure-like returns.

      There is a flip side to this also. No matter how large you get there seems to be a natural cap on the earnings of fiber networks due to the fact that you still need technicians and trucks in the neighborhoods and similar costs that don’t get more efficient with size.

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  2. “The much more fundamental question that Singer ignores is, why aren’t there more companies looking to make 10% to 20% infrastructure returns?”

    Because the dominant legacy telephone and cable companies dictate the business model. It’s not based on providing telecommunications infrastructure. Rather, they’re in the bandwidth business, selling it opportunistically by the unit (speed or consumption-based) where it generates the shortest ROI. That short term investment horizon is incompatible with long term infrastructure investment.

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