Tag Archives: equity funding

The Advantages of Equity Funding

A large majority of ISPs seeking BEAD grants will be financing matching funds using loans. Matching funds are the contributions expected from ISPs – a 75% grant means 25% in matching funds. Very few ISPs carry enough cash on hand to consider using equity to pay for broadband expansion. It’s possible that banks might require a small ISP to provide a small amount of equity, so the ISP has some skin in the game – but most matching funds will be borrowed.

This contrasts significantly with large telcos and cable companies that will be pursuing BEAD grants. It’s likely that most giant ISPs will be financing grants with equity. Using equity makes a gigantic difference in the approach to considering BEAD grants.

Below is a chart that is based on a real rural broadband market. The grant opportunity would bring fiber broadband to 2,700 locations for a total investment of $30.7 million. That’s a cost per passing of a little less than $11,400.

The following chart assumes that ISPs would seek a 75% grant and require a 25% match. The graph looks at the method of financing the matching funds – and ranges from 100% bank loan to 100% equity.

This graph demonstrates the huge benefit of using equity financing. The bottom blue line shows the expected accumulated cash for the small ISP that would use debt to cover the grant matching. For many years, the project just barely breaks even, but over twenty years, the project eventually accumulates over $2 million in cash.

An ISP that can finance with equity will generate far more cash. An ISP that could use 100% equity would accumulate over $16 million in cash over 20 years. The extra cash comes from the savings on debt payments over the life of the project.

This chart demonstrates a few things. First, it explains why ISPs that will be using equity can consider building in rural areas. In places where an ISP using debt financing can barely keep its head above water, an equity-funded ISP can generate significant cash.

The second benefit is that an ISP using equity can win the BEAD grant by accepting less than a 75% grant. In this example market, the ISP using debt financing cannot consider accepting less than a 75% grant. If they take a smaller grant the project will lose money every year. However, an ISP using equity could easily accept a 60% or 65% grant – which would almost certainly win the grant if competing against an ISP using debt.

I’ve said for years that the big ISPs are mostly going to go to the big ISPs, and funding is perhaps the major reason for this. But other grant rules also favor big companies over small ones.

But there is one more issue to consider that makes me wonder why the big ISPs are pursuing BEAD. An ISP that would use 100% equity for this particular project would see a return on Investment (ROI) over ten years of 19% and over 20 years of 88%. That is considerably lower than the returns the big ISP could earn by instead building fiber in larger communities. And those returns will drop significantly if the ISP accepts less than a 75% grant.

I’ve wondered since the day the BEAD grants were announced why big ISPs would pursue rural grants. It’s just as hard for them to service rural customers as it is for smaller ISPs. Rural BEAD projects will not earn the same kind of return that big ISPs get from investing elsewhere, and they are taking on serving areas that require a lot more work.

In many cases, the reasons for pursuing rural grants are likely strategic rather than economic. For example, Charter and Comcast seem to be panicking about the prospect of losing broadband customers, and pursuing rural markets can help to soften the losses. The big telcos like Frontier, Brightspeed, and Windstream already operate in rural areas and want to claim monopoly areas again. But in a decade, all of these companies will be complaining to the FCC about how expensive it is to operate in rural areas – and they’ll have their hands out asking for subsidies.

Why Aren’t There More Fiber Overbuilders?

Fiber CableThere are cities everywhere hoping for somebody to build fiber in their communities. I see cities surprised all the time when they can’t find anybody interested in building fiber. I think cities and people in general greatly overestimate the ability of private companies to fund and build fiber. So why aren’t there more fiber overbuilders?

First, there are hundreds of companies that are building fiber, but most are relatively tiny. There are independent telephone companies, cable companies and ISPs that are building fiber in their local markets. But every small company has a natural debt ceiling that restricts their ability to raise money, similar to a limit on how much money a family can borrow. As these small companies borrow money to build fiber they can quickly max out their ability to borrow more money. I have talked to dozens of small companies who have already built some fiber and that would like to build more – but once they get to a certain level of debt on their balance sheet lenders won’t extend them more credit.

Borrowing also requires cash equity. It is not unusual for a lender to want to see 10% to 20% of a project funded by equity before they will lend. Even a fairly modest fiber project can cost $30 million or more and that means that a builder would need $3 million to $6 million in cash equity to fund such a project. I don’t think most people realize that small companies rarely sit on that kind of cash. And even if they do, once they use their cash reserves for a project or two they are unable to finance additional projects.

Fiber business plans are also hard to finance because they lose money for the first few years before they generate any cash. That is a real challenge because during the first few years the builder has to not only cover operational losses, but they also normally have to begin making debt payments before they have generated enough cash to cover those payments. This then forces them borrow to cover debt payments – something that is hard to make work. I have seen numerous fiber business plans that cannot be funded because there is no easy way for the borrower to make it through the first three or four years. Many of these projects would eventually become great cash generators, but nobody is willing to take on a project that will run out of cash before getting to that better future.

Probably the biggest problem for small fiber builders is that there are not very many good sources of commercial debt for fiber builders. There was a time in this country when infrastructure construction was funded by the big banks. But those institutions – for a number of reasons – have largely bailed on funding almost all kinds of infrastructure. This affects not just fiber projects, but also roads, bridges, electric grids, water systems and infrastructure of all kinds.

There are a few sources for funding fiber projects, but the funding available represents only a small fraction of the demand that the public has for fiber projects. If every penny of funding that is available for fiber was to be borrowed the country would still largely be without fiber. There are not enough lenders willing to make the cash available to fund the national need. And this means that builders must be very selective and only put their money where they can make the best returns.

Interestingly, it’s now easier to fund rural fiber projects than it is to fund projects in larger towns (larger being towns over 20,000 population). There are a number of federal loan guarantee programs and other financing tools like new market tax credits that can help with rural projects that are not available to support fiber in larger communities. It’s certainly an interesting financial market that will fund fiber to farms before funding fiber to whole cities.

The best returns on fiber are made from what I call cherry picking. This is when a fiber builder only builds to business districts or to a few key parts of a city. Building very selectively where the returns are the best is probably the best use of the limited capital that a builder has available.

A lot of cities don’t understand the economics and want to impose a lot of restrictions on fiber builders. They want a builder to serve the whole city quickly; they want them to offer low-priced broadband to solve the digital divide and they even want them to finance a network and then open it up as an open access network for other carriers to use. The handful of fiber builders can be very selective and will shy away from markets that make these kinds of demands. Cities don’t seem to understand that in a world with very few fiber builders that those builders get to call all of the shots.