Progress of the CAF II Program

If readers recall, the CAF II program is providing funds to the largest telcos to upgrade rural facilities in their incumbent operating territories to broadband speeds of at least 10 Mbps down and 1 Mbps up. The CAF II deployment began in the fall of 2015 and lasts for 6 years, so we are now almost 2.5 years into the deployment period. I was curious about how the bigger telcos are doing in meeting their CAF II build-out requirements. The FCC hasn’t published any progress reports on CAF II deployments, so I found the following from web searches:

AT&T. The company took $427 million annually for the six years ($2.56 billion) to bring broadband to 2.2 million rural customers. The company has said they are going to use a combination of improved DSL and fixed wireless broadband using their cellular frequencies to meet their build-out requirements. From their various press releases it seems like they are planning on more wireless than wireline connections (and they have plans in many rural places of tearing down the copper).

The only big public announcement of a wireless buildout for AT&T is a test in Georgia initiated last year. On their website the company says their goal at the end of 2018 is to offer improved broadband to 440,000 homes, which would mean a 17% CAF II coverage at just over the mid-point of their 6-year build-out commitment.

On a side note, AT&T had also promised the FCC, as a condition of the DirecTV merger that they would be pass 12.5 million homes and business with fiber by mid-2019. They report reaching only 4 million by the end of 2017.

CenturyLink. CenturyLink accepted $500 million annually ($3 billion) in CAF II funding to reach 1.2 million rural homes. In case you’re wondering why CenturyLink is covering only half of the homes as AT&T for roughly the same funding – the funding for CAF II varies by Census block according to density. The CenturyLink coverage area is obviously less densely populated than the areas being covered by AT&T.

FierceTelecom reported in January that CenturyLink has now upgraded 600,000 CAF II homes by the end of last year, or 37% of their CAF II commitment. The company says that their goal is to have 60% coverage by the end of this year. CenturyLink is primarily upgrading rural DSL, although they’ve said that they are considering using point-to-multipoint wireless for the most rural parts of the coverage areas. The company reports that in the upgrades so far that 70% of the homes passed so far can get 20 Mbps download or faster.

Frontier. The last major recipient of CAF II funding is Frontier. The company originally accepted $283 million per year to upgrade 650,000 passings. They subsequently acquired some Verizon properties that had accepted $49 million per year to upgrade 37,000 passings. That’s just under $2 billion in total funding.

FierceTelecom reported in January that Frontier reached 45% of the CAF II area with broadband speeds of at least 10/1 Mbps by the end of 2017. The company also notes that in making the upgrades for rural customers that they’ve also upgraded the broadband in the towns near the CAF II areas and have increased the broadband speeds of over 900,000 passings nationwide.

Frontier is also largely upgrading DSL, although they are also considering point-to-multipoint wireless for the more rural customers.

Other telcos also took major CAF II funding, but I couldn’t find any reliable progress reports on their deployments. This includes Windstream ($175 million per year), Verizon ($83 million per year), Consolidated ($51 million per year), and Hawaiian Telcom ($26 million per year).

The upcoming reverse auction this summer will provide up to another $2 billion in funding to reach nearly 1 million additional rural homes. In many cases these are the most remote customers, and many are found in many of the same areas where the CAF II upgrades are being made. It will be interesting to see if the same telcos will take the funding to finish the upgrades. There is a lot of speculation that the cellular carriers will pursue a lot of the reverse auction upgrades.

But the real question to be asked for these properties is what comes next. The CAF II funding lasts until 2021. The speeds being deployed with these upgrades are already significantly lower than the speeds available in urban America. A household today with a 10 Mbps download speed cannot use broadband in the ways that are enjoyed by urban homes. My guess is that there will be continued political pressure to continue to upgrade rural speeds and that we haven’t seen the end of the use of the Universal Service Fund to upgrade rural broadband.

Big Telcos and Rural Customers

Recently, Sunit Patel, the CFO of CenturyLink, told investors that the company would be focusing on expanding their broadband networks only to the most densely populated parts of its footprint. Further, the company will now focus on opportunities that maximize both their retail operations as well as their new wholesale business that comes from the purchase of Level3. This is not surprising, and this has undoubtedly been the Company’s philosophy for many years. However, this is something that you rarely hear said publicly by the large telcos. And that’s because saying it so plainly also means that the company is admitting that they are not spending capital for the less dense parts of the footprint.

The large telcos like CenturyLink, Verizon and AT&T have been ignoring the rural parts of their network for literally decades. And yet they rarely talk about this – no doubt due to a public relations edict inside the companies. It’s refreshing to hear one of them spell it out.

We’ve heard this same story from both AT&T and Verizon in the past, but couched in different language. They have tried to put a positive spin on their announcements about rural properties by framing them as upgrading customers to wireless instead of wireline. But this is just another way of saying that they want to tear down copper lines in rural areas and charge more to households that happen to live close enough to a cellular tower to serve them. What’s never said is that these rural transitions to wireless will leave a lot of homes that have poor cellular coverage with no broadband and no telephone coverage – a reversal of a hundred-year universal service effort to keep everybody in the country connected.

CenturyLink isn’t in the same position as the other two giant telcos in that they don’t have a cellular option for rural households. The company is in the process of making substantial upgrades to the rural copper network using money provided by the FCC as part of the CAF II program. This upgrade is intended to bring rural DSL speeds up to at least 10/1 Mbps. But this money isn’t covering everybody in rural areas and the company and the FCC excluded millions of the most rural homes from these upgrades. I’ve heard through the grapevine from technicians at some of the big companies that the telcos are using the FCC money to do their best effort and that not everybody will get the promised speeds. The telcos will do what they can with the FCC money until it is all spent.

What this means for rural customer of the big telcos is that good broadband is not coming. Many households are going to be offered somewhat faster DSL or else cellular broadband from the CAF II upgrades – but that’s a one-time upgrade and it’s unlikely that these companies are going to do any more upgrades beyond this one-time shot.

I find it unfortunate that rural households who don’t understand technology and don’t understand these big telcos probably think their broadband speeds will be improved. The press releases from these companies and even from the FCC make it sound like solutions are on the way.

I probably shouldn’t be so cynical, because for a home that doesn’t have any broadband today a 10/1 Mbps connection is going to be a welcome relief. But a connection at that speed is already inadequate today for any home that really wants to use broadband. That kind of speed is not going to easily let different family members use much broadband at the same time. And that speed will grow quickly obsolete as the amount of speed needed and the amount of total annual download for the average family continues to double every three years. Any connection that feels just barely adequate today is going to feel slow in five years and nearly non-functional in a decade.

I have to give credit to Mr. Patel for saying this so directly. There is no clearer signal to rural communities that they need to look for a broadband solution on their own. The big telcos will spend any money they get from the FCC on rural infrastructure, but otherwise the big companies are unlikely to devote any additional capital dollars towards improving rural networks. This is no change from the way it’s been for a long time, but finally we can point to somebody who said out loud what we’ve always known.

Operating on a Leased Network

One of the comments posted on a recent blog mentioned that CenturyLink recently had agreed to operate on somebody else’s fiber network to serve residential customers – the first time that one of the big telcos or cable companies had agreed to do so. One of the major reasons cited for lack of competition in the US is the unwillingness of the major ISPs to operate outside their own networks. This certainly sounded newsworthy and I looked into the example cited.

CenturyLink has agreed to use the fiber network provided by Lumiere Fiber, an affiliate company of Sterling Ranch, a new planned community outside of Denver. CenturyLink won the ability to serve the community through an RFP competition with Comcast, the cable company serving the area. As the winner, CenturyLink will be the exclusive ISP on the network – which only has a few homes now but has plans to grow to 12,000 residences.

So is this really newsworthy? I think the answer is both yes and no – but mostly no. It is true that CenturyLink will be using somebody else’s fiber network, and a large one at that, when the community is ultimately built. But there are a number of reasons why this is not as groundbreaking as it sounds.

First, this is not really unique. While this is a large new subdivision, in many ways this is similar to the thousands of arrangements that ISPs routinely have made to serve large apartment complexes. In the vast majority of apartments the wiring is owned by the landlord and not the ISPs. There are some large apartment units around the country numbering in the thousands of units and this opportunity is unique only from this perspective of being larger than most MDUS.

CenturyLink is already building a lot of fiber to residential neighborhoods, with nearly 1 million new units passed this year – so this isn’t going to present any technological challenges. I am sure that the company will use the identical electronics and provisioning software it uses everywhere else.

This also is not going to stretch the operational systems of CenturyLink. The only real difference between this and other CenturyLink fiber is that the company doesn’t own the fiber. But they are going to take orders and connect new customers using their normal processes. They will dispatch technicians for trouble calls in the usual manner. And if Lumiere hires CenturyLink to do the fiber maintenance then they would even make fiber repairs in almost the same manner (this detail was not specified in the press releases).

There seems to be two reasons why the big ISPs don’t generally use networks owned by others. In the case of the big cable companies there seems be a gentleman’s agreement to never cross those lines. I can’t find one example of a big cable company crossing the line to compete for residential customers.

But the hardest barrier for the big ISPs to use other networks is the fact that their systems are largely incapable of making operational exceptions. They have created operation systems and processes that work for them, on their own networks, with their own employees. These processes are often highly decentralized and it takes employees scattered across the country to accomplish normal daily tasks like adding a new customer or answering a trouble call. It’s extremely difficult for a decentralized company to make exceptions for customers that are treated different than everybody else – that always results in chaos.

An example of this is Verizon FiOS. When the company decided to build fiber they realized that they could not reshape their existing copper work processes and people to accommodate the new technology. They solved this by creating a totally new company and FiOS was new from top to bottom – from technology, to people, to processes.

The real headline I want to see is where one of the big ISPs gets on somebody else’s network in a competitive environment. For example, there are a number of open access fiber networks in Washington state that are significantly larger than the Sterling Ranch opportunity. There are numerous smaller open access networks around the country, and no big ISP has ever served residents on these networks. If the big companies would jump on competitive networks then a lot more of these networks would get built.

San Francisco is talking about building an open access fiber network and if it’s built will really challenge the big ISPs. If that network comes to fruition, will one of the other big cable companies decide to take on Comcast? That would be the big news we’ve always wanted to hear.

Big Telcos and Broadband

A recent article in Telecompetitor reports that analysts at Moffett Nathanson expect the big telcos to start making inroads into the near-monopoly for broadband currently enjoyed by the cable companies. The article focused specifically on AT&T, but some other big telcos like CenturyLink are also aggressively expanding fiber networks.

I would have to assume that the analysts got the following goals directly from AT&T because I can’t find any other references to these specific goals. But each of these is in line with statements made by AT&T executives over the last year. According to the article, AT&T broadband goals over the next few years are as follows:

  • Offer broadband speeds below 50 Mbps to 30 million passings using DSL;
  • Offer broadband speeds between 50 – 100 Mbps to 20 million passings using paired copper VDSL;
  • Offer ‘near gigabit’ speeds to 10 million passings using via 5G wireless;
  • Offer gigabit speeds using FTTH technology to 14 million residential passings and 8 million business passings.

The real news here is in the last two bullet points. AT&T accepted the goal from the FCC for passing 12.5 million customers with FTTH from the merger with DirecTV. It’s big news if they intend to extend that to 22 million passings. And the goal of using millimeter wave radios to reach another 10 million potential customers is something new.

If AT&T meets these goals they will be bringing serious competition to the cable companies. AT&T and the other telcos have been bleeding DSL customers for over a decade and handed the cable companies a near-monopoly on fast broadband in most urban and suburban markets. According to Moffett Nathanson the telco expansion will bring near-gigabit speeds on telco networks to 32% of the country.

It’s important to understand where the new AT&T broadband is being built. The majority of the new coverage is in three market niches – apartment buildings, new greenfield housing developments and business districts. AT&T’s expansion has largely focused on these specific market niches and is likely to continue to do so. AT&T is not proposing to duplicate what Verizon did with its FiOS network and bring broadband to older single family home neighborhoods. They are instead focusing on buildouts where the the cost of construction per customer is the lowest – the ultimate cherry-picking network.

This means that the AT&T coverage will bring the opportunity for gigabit broadband to a much larger footprint, but that’s not always going to bring customer choice. In the MDU market many landlords are still allowing only one ISP into their apartment complexes. As telcos like AT&T compete with the cable companies for this market the broadband speeds in apartments and condos will get much faster, but many customers will still only have the option to buy from whatever ISP that landlord has allowed.

I have to admit that this market shift to bring broadband to MDUs caught me a bit by surprise. Many years ago Verizon showed that there is a successful business plan for building fiber to older residential neighborhoods. In the northeast Verizon still carries significant market share in its FiOS neighborhoods, and customers consistently rate them as having better customer service than the cable companies. Other telcos like CenturyLink are copying the Verizon model and are building swaths of fiber in residential neighborhoods.

The traditional wisdom was that it is too costly to bring fast broadband to apartments. A decade ago bringing fiber to an apartment meant rewiring the whole building with fiber – and for many apartments that is prohibitively expensive. But there have been technology advances that have made this more feasible. For example, much of the ‘near-gigabit’ speeds can be achieved by using G.Fast technology over existing coaxial or telco cable in older apartments. There have also been big improvements for indoor fiber deployments that include small flexible fibers and techniques for installing fiber inconspicuously in hallways. Many buildings that seemed too costly to serve years ago now make economic sense. Finally, the potential to deliver backhaul to an MDU using millimeter wave radios is going to eliminate the need to build as much fiber.

The real big unknown is how successful any of these big companies will be with 5G. As I’ve been writing lately there are still a lot of barriers that might make it difficult for AT&T to use the wireless technology to cover 10 million passings. We’re going to have to wait to see some real deployments over the next few years to see if the technology works as promised and if the cost of deployment is as cheap as anticipated. But the one thing that these analysts have gotten right is that the big telcos are finally fighting back against the cable monopolies they helped to create by sticking with DSL too long. It’s going to be interesting to see how well they do in winning back customers that they lost over the last two decades.

G.Fast over Coax

There is yet another new technology available to carriers – G.Fast over coaxial cable. Early trials of the technology show it works better than G.Fast over telephone copper.

Calix recently did a test of the new coaxial technology and was able to deliver 500+ Mbps for up to 2,000 feet. This is far better than current G.Fast technology over copper which can handle similar data speeds up to about 800 feet. But telephone G.Fast is improving and Calix just demonstrated a telephone copper G.Fast that can deliver 1 Gbps for about 750 feet.

But achieving the kinds of speeds demonstrated by Calix requires a high-quality telephone copper network. We all know that the existing telephone and coaxial networks in existing buildings are usually anything but pristine. Many existing coaxial cables in places like apartment buildings have been cut and re-spliced numerous times over the years, which will significantly degrade G.Fast performance.

This new technology is definitely going to work best in niche applications – and there may be situations where it’s the clearly best technology for the price. There are a surprising number of coaxial networks in place in homes, apartment buildings, schools, factories and older office buildings that might be good candidates for the technology.

A number of telcos like CenturyLink and AT&T are starting to use G.Fast over telephone copper to distribute broadband to apartment buildings. Since as the incumbent telephone company they can make sure that these networks are available to them. But there might be many apartment buildings where the existing coaxial network could be used instead. The ability to go up to 2,000 feet could make a big difference in larger apartment buildings.

Another potential use would be in schools. However, with the expanding demand for broadband in classrooms one has to wonder if 500 Mbps is enough bandwidth to serve and share among a typical string of classrooms – each with their own heavy broadband demand.

There are also a lot of places that have coaxial networks that you might not think about. For example, coaxial wiring was the historic wiring of choice for the early versions of video surveillance cameras in factories and other large businesses. It would not be hard to add WiFi modems to this kind of network. There are tons of older hotels with end-to-end coaxial networks. Any older office buildings is likely to have coaxial wiring throughout.

But there is one drawback for the technology in that the coaxial network can’t be carrying a cable TV signal at the same time. The coaxial G.Fast operates at the same frequencies as a significant chunk of a traditional DOCSIS cable network. To use the technology in a place like an apartment would mean that the coaxial wiring can no longer be used for cable TV delivery. Or it means converting the cable TV signal to IPTV to travel over the G.Fast. (but that wouldn’t leave much bandwidth for broadband.) But still, there are probably many unused coaxial wiring networks and the technology could use them with very little required rewiring.

It’s more likely that the coaxial G.Fast could coexist with existing applications in places like factories. Those networks typically use MoCA to feed the video cameras, at frequencies that are higher than DOCSIS cable networks.

But my guess is that the interference issue will be a big one for many potential applications. Most apartments and schools are going to still be using their networks to deliver traditional video. And many other coaxial networks will have been so chopped up and re-spliced over time to present a real challenge for the technology.

But this is one more technology to put into the toolbox, particularly for companies that bring broadband to a lot of older buildings. There are probably many cases where this could be the most cost effective solution.

Our Aging Fiber Infrastructure

One thing that I rarely hear talked about is how many of our long-haul fiber networks are aging. The fiber routes that connect our largest cities were mostly built in the 1990s in a very different bandwidth environment. I have a number of clients that rely on long-haul fiber routes and the stories they tell me scare me about our future ability to move bandwidth where it’s needed.

In order to understand the problems of the long-haul networks it’s important to look back at how these fiber routes were built. Many were built by the big telcos. I can remember the ads from AT&T thirty years ago bragging how they had built the first coast-to-coast fiber network. A lot of other fiber networks were built by competitive fiber providers like MCI and Qwest, which saw an opportunity for competing against the pricing of the big telco monopolies.

A lot of the original fibers built on intercity routes were small by today’s standards. The original networks were built to carry voice and much smaller volumes of data than today and many of the fibers contain only 48 pairs of fiber.

To a large degree the big intercity fiber routes follow the same physical paths, either following interstate highways, but to an even greater extent following the railroad tracks that go between markets. Most companies that move big amounts of data want route diversity to protect against fiber cuts or disasters, yet a significant percentage of the routes between many cities are located next to fibers of rival carriers.

It’s also important to understand how the money works in these routes. The owners of the large fibers have found it to be lucrative to lease pairs of fiber to other carriers on long-term leases called IRUs (indefeasible rights to use). It’s not unusual to be able to shop for a broadband connection between primary and secondary markets, say Philadelphia and Harrisburg, and find a half-dozen different carriers. But deeper examination often shows they all share leased pairs in the same fiber sheath.

Our long-haul fiber network infrastructure is physically aging and I’ve seen a lot of evidence of network failures. There are a number of reasons for these failures. First, the quality of fiber glass today has improved by several magnitudes over glass that was made in the 1980s and 1990s. Some fiber routes are starting to show signs of cloudiness from age which kills a given fiber pair. Probably even more significant is the fact that fiber installation techniques have improved over the years. We’ve learned that if a fiber cable is stretched or stressed during installation that microscopic cracks can be formed that slowly spread over time until a fiber becomes unusable. And finally, we are seeing the expected wear and tear on networks. Poles get knocked down by weather or accidents. Contractors occasionally cut buried fibers. Every time a long-haul fiber is cut it loses a little efficiency, and over time splices can add up to become problems.

Probably the parts of the network that are in the worst shape are the electronics. It’s an expensive proposition to upgrade the bandwidth on a long-haul fiber network because that means not only changing lasers at the end points of a fiber, but at all of the repeater huts along a fiber route. Unless a fiber route is completely utilized the companies operating these routes don’t want to spend the capital dollars needed to improve bandwidth. And so they keep operating old electronics that are often many years past their expected functional lives.

Construction of new long-haul fiber networks is incredibly expensive and it’s rare to hear of any major initiative to build fiber on the big established intercity routes. Interestingly, the fiber to smaller markets is in much better shape than the fiber between NFL cities. These secondary fiber routes were often built by groups like consortiums of independent telephone companies. There were also some significant new fiber routes built using the stimulus funding in 2008.

Today a big percentage of the old intercity fiber network is owned by AT&T, Verizon and CenturyLink. They built a lot of the original network but over the years have also gobbled up many of the other companies that built fiber – and are still doing so, like with Verizon’s purchase last year of XO and CenturyLink’s purchase of Level3. I know a lot of my clients worry every time one of these mergers happens because it removes another of a small handful of actual fiber owners from the market. They are fearful that we are going to go back to the old days of monopoly pricing and poor response to service issues – the two issues that prompted most of the construction of competitive fiber routes in the first place.

A lot of the infrastructure of all types in this country is aging. Sadly, I think we need to put a lot of our long-haul fiber backbone network into the aging category.

A Year of Mergers

Bell_logo_1969Our industry has seen many mergers over the years between the biggest companies in the sector. But for the most part big mergers that change the face of the industry have been sporadic. We had AOL buying Time Warner in 2000, Alcatel buying Lucent in 2006 and CenturyLink buying Qwest in 2011.

But now it seems like I can’t read industry news without seeing discussions of a new merger. During the last year or so we saw AT&T gobble up DirecTV, saw Alcatel-Lucent grabbed by Nokia and saw Charter buy Time Warner Cable and Bright House Networks. And we are now watching the regulators sorting out mergers with Verizon trying to buy both XO Communications and Yahoo, with CenturyLink wanting to buy Level 3 Communications and AT&T wanting to acquire Time Warner.

From reading Wall Street speculation it seems like the current merger mania in our industry is not over. The rumors are strong that CBS and Viacom will soon announce a merger. There is rampant speculation that several companies might try to outbid CenturyLink for Level 3. There are rumors that Comcast, Charter and Altice are interested in buying T-Mobile or Sprint. There are continuing rumors that Verizon wants to buy Dish Networks to get permanent access to the huge swatch of spectrum they own. And there have been rumors for the last year that somebody ought to buy Netflix.

And these giant mergers aren’t just happening in telecom. We see Bayer buying Monsanto, Microsoft buying Linked-In, Marriott buying Starwood, Tyco buying Johnson Control, Protection 1 buying ADT, Sherwin-Williams buying Valspar and Fortis buying ITC Holdings.

It’s really hard in the telecom world to know if mergers are good or bad for the industry. Some mergers are clearly bad because they eliminate competition and create oligopolies at the top of the market. The rumored merger between CBS and Viacom is one such merger. Today there are only five major programmers in the country and this reduces that to four. A lot of the woes in the industry today are due to the greed of programmers and consolidation at the top of the industry can’t mean anything good.

But other mergers might be beneficial. Consider the impact of Comcast or Charter buying T-Mobile or Sprint. I just saw an article this week that showed that the wireless operations of AT&T and Verizon are still showing a gross margin of over 50%. It’s been clear to every consumer that cellular service is overpriced due to lack of meaningful competition. Perhaps one of the big cable companies could drive down cellular prices in an attempt to grab market share.

But on the flip side, letting these huge cable companies develop a quad play product is bad for anybody else that tries to compete with them for broadband. A new fiber overbuilder in a city would have an even bigger challenge if they try to displace a cable competitor that offers cellphone service bundled with their broadband. It’s been clear for a long time that lack of broadband competition is bad for consumers.

The underlying theme driving all of these mergers is that Wall Street has a never-ending appetite for increased earnings. That alone is often a good thing. Many times the companies being acquired are underperforming for some reason and mergers sometimes wake them up to do better. Many mergers promise improvement earnings due to the effects of consolidation and a reduction in the management and overhead drags.

But consider what mega-mergers in the telecom space more often mean. They mean that fewer and fewer companies control the vast majority of the market. And those giant companies are driven by Wall Street to increase earnings quarter after quarter forever – and at a pace and level that exceeds general inflation. You only have to do the math on that basic concept to realize that this means price increases for residential and business customers year after year to keep meeting higher earnings targets.

Years ago we had Ma Bell that controlled 95% of the phone business in the country. AT&T would have acted like any other commercial company except for the fact that their prices were heavily restricted by regulators. But stockholders of these big companies today do just the opposite and they pressure management to increase profits no matter the consequences. It is the chase for bigger earnings that has seen programming costs and cable TV rates climb much faster than inflation for the last decade to the point where the cable TV product costs more than many households are willing to pay.

I doubt we will see the end to these mergers, but if we don’t find a way to curb them the inevitable results will be a tiny number of companies controlling the whole sector, but with none of the restrictions in the past that were put on companies like Ma Bell. It scares me sometimes to think that broadband rates are going to increase in the same manner that cable rates increased in the past. But when you look at what the big ISPs have to sell it’s hard to not picture a scenario where earnings pressures are going to do the same thing to broadband that has been done to cable rates. That is going to do great harm the country to the benefit of the stockholders of a few big companies.

The CenturyLink – Level 3 Merger

CenturyLinkCenturyLink just confirmed their bid to buy Level 3 Communications for $34 billion in the latest round of what looks like major industry consolidation. After Verizon’s purchase of XO Communications it looks like large nationwide fiber networks are going to be gobbled by larger players.

But we can’t quite put this merger in the books yet. There have been rumors floating for the last year of others interested in the company. Just this summer there were strong rumors that Comcast wanted to buy Level 3. And now there is a lot of speculation that the big wireless companies are also interested in the company. So don’t be surprised by one or more counterbids.

Why is Level 3 wanted by so many large players? The easy answer is that they have a huge fiber network, but it’s more because they have a fiber network that goes to all of the right places. Big companies like Verizon and AT&T are already connected into all of the major fiber hubs around the country. But Level 3 is connected nearly everywhere else. Their network extends out to a huge number of tier two and three cities.

And more than that, Level 3 has a lot connections to the big fiber users in local markets – the ISPs, large businesses, governments, school systems and cellular sites. The company has been busy for many years building fiber to places asking for big broadband.

This makes Level 3 a huge player in the Internet backhaul business. They are the ones that carry a lot of the Internet backbone to the smaller competitors of the giant incumbents. Level 3 also serves the supply side of the Internet and is a prime supplier of bandwidth to companies like Netflix, as well as the many large data centers for the other big web companies. Level 3’s revenues have been booming with the explosion of video traffic on the web.

CenturyLink is already a significant player nationwide for large businesses and governments. Before Qwest bought the old US West company they had built a significant nationwide fiber network and had vigorously pursued nationwide customers. That business has been extended and grown under CenturyLink and this acquisition would push the company to the top of the heap in the fiber business. There are so many benefits of the acquisition that nobody is questioning the sense of the merger (unlike the AT&T and Time Warner merger that has analysts scratching their heads).

I have a lot of clients that are going to be concerned about this acquisition (and others who will be once they understand the implications). Level 3 is one of the primary providers of fiber backhaul to reach the Internet for a huge number of small communities, and in many cases they are the only alternative to buying overinflated backhaul directly from the incumbents.

There are a lot of small ISPs and other users of broadband that are going to be worried about losing affordable backhaul – particularly those that compete with CenturyLink. It’s unlikely that these places will be denied connectivity by the combined company, but rather that over time the fear is that if you compete directly with CenturyLink that prices for backhaul will be increased. It wouldn’t take long for smaller competitors to CenturyLink to be put at a competitive disadvantage.

There is another class of carriers that might not even know that the merger could harm them. It turns out Level 3 is the primary underlying carrier for most wholesale VoIP products sold to carriers. Level 3 has developed a product called local access that gives carriers connections into all of the right places to deliver VoIP traffic to the PSTN. When somebody today pays $6.50 to buy a wholesale VoIP line it’s likely that half of that money goes to Level 3. CenturyLink could gut the VoIP world and a lot of competitors by discontinuing or restricting that product.

So the concern with any merger like this is what it’s going to do to limit competition. Every big merger decreases competition significantly in some markets. This merger holds out the possibility of harming competition over the very large geographic footprint covered by CenturyLink. Big mergers like this almost always come with restrictions against bad behavior from the FCC or the Justice Department. But we’ve seen big telcos often ignore such restrictions within a few years after a big merger.

CenturyLink is not making this purchase to eliminate competition. There are numerous benefits directly to the company that are drivers of the transaction. But we know that over time companies act to limit competition when they have the ability to do so. We’ve seen this happen in huge ways with Comcast, Verizon and AT&T. We’ve not seen nearly as much anti-competitive behavior in the past from CenturyLink (and their predecessor Qwest) – but this merger puts them into the position to act like the other large companies if they so wish. And my cynical side says that the bigger a company gets, the more it benefits them to be anti-competitive.

What’s the Right Price for a Gigabit?

Speed_Street_SignI often get asked how to price gigabit service by clients that are rolling it out for the first time. For an ISP already in the broadband business, layering in a super-fast Internet product on top of an existing product line can be a real challenge.

Google certainly lowered the bar for the whole industry when they priced a gigabit at $70. And that is the real price since Google doesn’t charge extra for the modem. I think the Google announcement recalibrated the public’s expectations and anybody else that offers a gigabit product is going to be compared to that price.

There are a few other large companies marketing a gigabit product in multiple markets. CenturyLink has a gigabit connection for $79.95 per month. But it’s hard to know if that is really the price since it is bundled with CenturyLink’s Prism TV. The cheapest Prism TV product offered on the web costs $39.99 per month and includes 150 channels of programming and also comes with an additional settop box fee of $9.99 per month – the highest box fee I’ve seen. I don’t know exactly what kind of bundle discount is available, but on the web I’ve seen customers claiming that the cheapest price for the gigabit bundle is around $125 per month. That’s a far cry from Google’s straight $70. And for customers who want to use a gigabit to cut the cord a forced bundles feel a bit like blackmail.

Verizon FiOS has not yet given in to the pressure to offer a gigabit product. In looking at their web site their fastest product is still a symmetrical 500 Mbps connection at $270 per month plus an added fee for a modem, and with a required 2-year commitment. A 1-year commitment is $280 per month.

Comcast will soon offer a gigabit in more markets than anybody else. In Atlanta where Comcast is competing against Google Fiber a gigabit is $70 per month with a 3-year contract, including an early termination fee (meaning that if you leave you pay for the remaining months). This package also requires an additional modem charge. Without a contract the price for the gigabit is $140. It’s unclear if Comcast is offering the same lower-price deal in other markets with newly upgraded DOCSIS 3.1 like Chicago. The word on the Internet is that customers are unable to sign-up for the lower-price option in these markets, but the company says it’s available. I’m sure the availability  will soon become clear.

One thing that happens to any company that offers a gigabit is that the prices for slower speeds are slashed. If a gigabit is $70 – $80 then slower products must become correspondingly less expensive. Google offers a 100 Mbps product for $50 and each of the other companies listed above has a range of slower bandwidth products.

The first question I always ask an ISP is if they are offering gigabit speed for the public relations value or they really want to sell a lot of it. There are plenty of ISPs that have gone for the first option and have priced a gigabit north of $100 per month.  But for somebody that hopes to sell the product, the dilemma is that they know that the majority of their customers will buy the least expensive product that provides a comfortable speed. The rule of thumb in the industry is that, in most markets, at least 80% of customers will buy the low or moderate priced options. But if the choice is between a gigabit product and a 100 Mbps product, the percentage buying the slower product is likely to be a lot higher.

The issue that small ISPs face when recalibrating their speeds is that they end up increasing speeds for most existing customers. If they migrate from a scale today where 50 Mbps or 100 Mbps is the fastest product up to a new scale topped by a gigabit, then they have to increase speeds across the board to accommodate the new gigabit product.

This is a hard mental block to get over for many small ISPs. If a company offers a range today of products from 6 Mbps to 75 Mbps it’s mentally a challenge to reset their slowest speed to 50 Mbps or faster. They often tell me that in doing so they feels like they are giving away something for free. If a company has been an ISP since the dial-up days they often have a number of customers that have been grandfathered with slow, but inexpensive broadband. It’s a real dilemma when rebalancing speeds and rates to know what to do with households that are happy with a very cheap connection at 1 Mbps or 2 Mbps product.

For the last ten years I have advised clients to raise speeds. ISPs that have raised speeds tell me that they generally only see a tiny bump in extra traffic volume after doing so. And I’ve always seen that customers appreciate getting faster speeds for the same price. Since it doesn’t cost much to raise speeds it’s one of the cheapest forms of marketing you can do, and it’s something positive that customers will remember.

I think most ISPs realize that the kick-up to gigabit speeds is going to be a change that lasts for a long time. There are not many customers in a residential market that need or can use gigabit speeds. What Google did was to leap many times over the natural evolution of speeds in the market, and I think this is what makes my clients uneasy. They were on a path to have a structure more like Verizon with a dozen products between slow and fast. But the market push for gigabit speeds has reduced the number of options they are able to offer.

Again, Where is the AT&T Fiber?

u_verse_truckAT&T recently announced that they are expanding service of their GigaPower fiber to 35 more communities, bringing the total up to 56 communities. They say that they have plans to pass 14 million homes with fiber by the end of 2019, exceeding the commitment of 12.5 million homes that they promised to the FCC with the purchase of DirecTV.

AT&T says that they were serving 1.6 million homes and businesses with fiber at the end of 2015. The FCC agreement requires them to be offering fiber to 2.6 million customers by the end of this year. AT&T press releases and quotes made to the press claim that the company is already out building fiber like crazy. But are they?

I spent some time on the web looking for evidence that AT&T is building fiber. I started by seeing what I could find about CenturyLink’s fiber build since I know that they are building to pass about 900,000 new homes by the end of this year – about the same goal as AT&T. I skipped over corporate press releases and instead searched for local evidence that CenturyLink is building fiber. And I found plenty of evidence. There are postings by cities warning of coming traffic delays due to construction. There are people posting in local chat groups about CenturyLink fiber. There are newspaper articles taking about the fiber construction.

There was evidence of CenturyLink fiber construction in a lot of markets including: Mesa, Chandler, Phoenix, Scottsdale, Gilbert, Peoria and Anthem in Arizona; Portland in Oregon; Seattle, Tacoma, Vancouver and Spokane in Washington; Salt Lake City in Utah, and St. Paul and St. Louis Park in Minnesota. That’s the kind of aggressive fiber construction needed to pass 900,000 homes in a year.

I found a much smaller list of cities where AT&T seems to be building fiber that includes: Raleigh, Cary and Charlotte in North Carolina; Austin in Texas and Overland Park, Lenexa and Prairie Village in Kansas. These are all markets where Google is also building and where it’s been reported for a few years that AT&T is building fiber. I couldn’t find any evidence for new AT&T fiber construction of any magnitude outside of these Google markets. To give AT&T some benefit of the doubt, perhaps they will be able to meet their 2016 goal to add 1 million passings just in these markets.

I also investigated AT&T’s plans for capital spending. I looked at what AT&T told Wall Street about their capital budget. The company has a $22 billion capital budget for this year. $10 billion of that is aimed at overseas spending including $3 billion to build out from their new acquisition in Mexico. The rest of that spending is aimed expanding its Network on Demand and dedicated Internet of Things (IoT) networks in Europe and to roll out new features for its AT&T NetBond offering in Asia-Pacific, EMEA, and Canada.

Most of the rest of AT&T’s capital budget is aimed at improvements in its wireless networks. The company did tell investors in November 2015 that they planned to spend $2 billion per year for the next three years (2016 – 2018) on wireline networks. Further, AT&T told its investors that it expected overall capital spending to start dropping in future years.

But it’s the wireline capital budget that has me scratching my head. Certainly spending $2 billion in 2016 is enough to add the 1 million new passings they are claiming for this year. But AT&T’s overall goal by 2019 is to go from 1.6 million to 14 million passings. Conservatively that is going to cost at least $12.4 billion over four years just for the fiber. And assuming even a modest take rate for getting 20% of those passings as customers would add at least another $2 billion. Looking back at when Verizon was building FiOS we saw the same sort of big numbers for fiber construction.

It’s just hard to see that AT&T is serious about actually meeting the fiber targets it promised to the FCC. To meet their goals will cost something in the range of $14 billion, and yet they have told Wall Street they will only be spending $2 billion per year on wireline capital. Something isn’t adding up.