Inflation and Grants

Diana Goovaerts wrote an article for Fierce Telecom with the headline that Inflation has doubled RDOF build costs. The article is based on interviews with three ISPs that won RDOF funding in the December 2020 reverse auction – TekWav, Nextlink, and Plains Internet. All three ISPs plan to satisfy the RDOF obligations with a combination of fixed wireless and fiber. Two of the three ISPs were quoted as saying that the cost to build the networks to satisfy the RDOF obligations has doubled since they won the award – the third said costs have risen materially. The three companies have significantly different obligations. Plains Internet is obligated to build broadband to 250 passings in Kansas, while Nextlink must build to pass 206,136 locations over twelve states.

There is a lot to unwrap in the assertion that costs have doubled. First, everybody in the industry will agree that the costs of both material and labor have increased over the last two years. But most of the ISPs I’ve been working with estimate the increase to be between 15% and 30%, differing by region and the planned technology. The article includes an interview with Jonathan Chambers of Conexon, who believes that the claims that a doubling of cost is highly unlikely.

But the interviews raised a few issues related to the cost of building broadband that aren’t talked about a lot. Clearly, materials and labor are more expensive. In the case of wireless ISPs that are obligated to deliver superfast speeds, the costs I’ve been seeing for newer radios like the ones from Tarana look to be triple or more the cost of other radios.

One issue that is not being widely discussed is the availability of loans. One of the things that always happens when interest rates increase is that banks drastically curtail making loans to new customers. They may still offer higher interest rate loans to existing customers, but an ISP looking for a new banking relationship is going to hit a stone wall. That is exactly what the Federal Reserve has in mind with interest rate increases – they want to cool off the economy by curtailing new lending. The trick for the Fed is threading the needle to cool the economy enough to slow inflation but not enough to cause a crash.

The difficulty in getting bank loans creates a dilemma for an ISP trying to fulfill an obligation to build a broadband solution with specified construction deadlines. And RDOF award winner has three years, starting with the year after the FCC finalizes the award to build 40% of the promised network. The rest must be built in the following three years. For the big RDOF winners, that probably means having to start on some of the construction right away to meet the first completion goal.

The RDOF awards suppose that recipients will fund the majority of a new network, with debt or equity – and except for the giant ISP winners like Charter, most ISPs rely on new debt. The current big grant programs like BEAD also assume an ISP will bring a significant matching fund to a project, most likely debt for most companies. It’s a huge problem for somebody trying to build a grant or subsidy project if they can’t find the loans.

The three RDOF winners didn’t cite the impact of higher interest rates. I’ve seen interest rates on infrastructure projects nearly double over the last year, and that means double the interest expense from the day of borrowing –  a huge financial hurdle to overcome for any kind of infrastructure project.

The other issue identified by Joseph McGrath of TekWav is the time lag between the cost of a new network and the revenues needed to pay for them. Most ISP have historically expanded organically in the past. They add new territory and customers each year that is partially funded by the cash flow from the existing business, supplemented with short-term loans. An ISP trying to grow fast must abandon the organic growth model. This means spending a lot of money before there is any new revenue. I’ve always referred to this as the cost of expansion, and it’s only a problem for an ISP that is trying to grow faster than what its existing financial structure can handle.

Unfortunately, anybody taking any sizable RDOF or grant projects will experience expansion costs. The ISP will be paying staff to work in the new areas and paying interest on the cost of the equipment for the new area, with far more costs to eat than would be experienced with organic growth. I have to wonder if the big RDOF winners built these costs into its plans. A company that has never tried to grow quickly before is likely to understand the cost of expansion.

The bottom line is that RDOF winners will either have to absorb these unexpected costs or default on the subsidy. There is a fairly minor penalty for defaulting on RDOF funding before any funding has flowed or construction begins. But I would suspect the FCC will level much bigger fines on somebody who has already taken funding, and the fine would likely include returning everything they’ve received. As Jonathan Chambers was quoted, there is a cost for taking federal funding – and it’s always more expensive than anticipated.

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