Will Banks Invest in Infrastructure Again?

Six local banks in Kentucky banded together to create a $150 million investment fund to support public private partnerships. The fund is called the Commonwealth Infrastructure Fund and is intended to provide debt financing to state and local PPP initiatives in the state.

You might not think this is newsworthy, but it is for several reasons. It’s one of only a handful of examples of bank debt being clearly earmarked for infrastructure investing. In this country virtually all debt for projects that involve the government is financed with municipal bonds. But this wasn’t always the case. While municipal bonds, or their equivalent, have been around for centuries, as recently as fifty years ago banks also played a big role in lending to municipal projects.

But for various reasons banks backed out of infrastructure investing. First, banks have backed away over the years from lending into long-term projects. Municipal projects are often of long duration and it’s not unusual to see infrastructure projects financed over 20 – 30 years. That’s a long time for a bank to tie up money and it also carries the risk of lending into future higher interest rates.

There have also been some spectacular failures with municipal bond defaults in places like New York City and Detroit. While the risk of lending to commercial businesses is a lot higher, the municipal defaults have added risk to lending to municipal-based projects. However, to offset this, the collateral on municipal loans can be extremely safe, particularly if default on a loan is backed by tax revenues.

It’s important to note that this particular fund is looking specifically at public private partnerships. That is a venture that that benefits the government but is backed to some degree by private capital. PPPs come in many flavors. At one end of the spectrum are projects that are all private money, such as some recent projects where a commercial company built new schools and then leased them back to the government. At the other end of the spectrum are PPP projects where the government mostly finances but a private firm largely operates the venture. A good example of this is the fiber network in Huntsville, AL where the city built the project and Google Fiber operates the business.

This fund is something that the country really needs. I’ve seen estimates that there are somewhere between $4 – $6 trillion of needed infrastructure improvements in the country. This ranges from deteriorating roads, crumbling overpasses and bridges, old government buildings, outdated schools, old dams and water projects, etc. But currently there is already over $3.7 trillion in outstanding municipal bond debt. The cities and states can’t begin to take on all of the additional debt needed to bring our infrastructure up to snuff. So we need private money to enter the picture and to help pay for projects where that makes sense.

Anybody lending into PPPs understands the relatively low returns from infrastructure investing. Municipal bonds today generally pay interest rates of 2% to 5%. A lot of private money has been chasing the higher returns of technology investing, but there are still plenty of sources of money like pension funds that are happy with long-term stable and predictable returns. All of the financiers I know say that they are seeing a renewed interest in long-term safe returns.

This Kentucky fund would be a perfect place to look for help with fiber projects. Kentucky is one of the states that still has huge amounts of its geography with poor or non-existing broadband. I would be surprised if the telcos in the state don’t show interest in the fund, assuming the fund would be interested in them.

Raising $150 million for infrastructure lending is only a drop in the bucket when looking at the big picture. But it’s a start and hopefully this will lure other banks and sources of debt and equity to give more consideration to infrastructure funding.

Politics and Municipal Partnerships

ppp_logoOne of the hot topics around the industry today is the creation of Public Private Partnerships (PPPs) with municipalities to provide fiber-based broadband. Today I want to talk a bit about the difference in partnering with a municipality compared to other commercial carriers.

Commercial carriers are often very used to partnering with each other. They will build fiber routes together and routinely share facilities. And many ISPs will outsource functions to another carrier when it makes economic sense. I see ISPs everywhere engaging in some very creative partnerships with other carriers.

But partnering with a municipality is different, mainly due to the very nature of how municipalities work. Any carrier that does not understand the differences and that doesn’t account for those differences in their plans is likely to get very frustrated over time with a municipal partner. Today I look at some political issues that arise in PPPs and I will look at financial and legal issues in subsequent blogs.

Municipalities are (by definition) political entities. The people at the top of the political pyramid are elected officials and that has to be considered when partnering with a municipality. The city you partner with today might not be the same city you find yourself working with in five years after a few elections. Change can happen with a commercial partner as well, but it’s rarely as abrupt or as expected.

I know one company that partnered with a city to build fiber and the city was an enthusiastic partner. But the next administration of the city came in with a bias against the city working to ‘enrich’ private businesses, and that partnership then became a lot more difficult to maintain. So the one thing that a good PPP needs is to be insulated from politics as much as possible. You don’t want to have the PPP structured in such a way that future decisions like raising rates or building new facilities must be approved by a city council.

It’s also important for a business to understand how slow municipalities are in making decisions. The whole municipal deliberative process is slow on purpose to give the public a chance to weigh in on things a city does. But it can drive a commercial entity crazy waiting for a municipal partner to make a decision when you are running a commercial business venture.

Another shock that those involved in PPPs are often surprised about is how everything they decide or do as part of the PPP is suddenly in the press. Local ISPs can often go for decades without making the paper for anything bigger than making a donation to a local charity. It’s very disturbing to see your business decisions discussed in the press, and often incorrectly.

Engaging in a PPP also can subject an ISP to an unusual kind of attack from the larger incumbent providers. They will make the argument that anything that a municipality provides as part of partnering with an ISP ought to be extended to all carriers. These arguments are labeled as ‘level playing field’ issues and incumbents can sound incredibly persuasive when talking about the unfair advantages given to one of their competitors (while ignoring the monopoly power they probably held over the city for decades before).

All of these issues can be managed as long as a carrier walks into a PPP arrangement fully aware of each of them and with a strategy for dealing with each one. Once a carrier has joined with a municipal partner they can never be free of these sorts of political issues – but they can structure the business arrangement in such a way as to minimalize the practical impact of them.

PPPs – Issues to Consider

ppp_logoOne of the hottest topic in the broadband industry today is Public Private Partnerships (PPPs) where a commercial ISP partners in some manner with a city or county to provide broadband. The trend is probably being nudged forward by the many communities that are becoming desperate to find better broadband and which are waking up to the fact that they are going to have to put some skin in the game if they want somebody to build broadband.

Many carriers are used to creating partnerships or joint ventures with other carriers. But many carriers have never considered working with a government entity – be that a city, a county, or perhaps a school district. Working with government entities is definitely different than working with commercial companies and below I highlight some of the differences to be prepared for.

This list might sound negative and drive a carrier away from thinking about a PPP. But there are strategies for dealing with each of these issues. And generally, the smaller the government entity, the fewer of these issues probably apply. Working with small towns can be fairly easy while big cities might have every issue listed below, and even more. There are some great PPPs in the country, and today there are more communities willing to commit some funding towards paying for a broadband network. So the rewards for working with a PPP can well be worth the extra effort needed to create a successful partnership. I use the word ‘city’ below very generically, and these same things can be true for any municipal entity.

Politics. Government entities, by definition, are political. The main issue with politics is not that you can’t negotiate a good deal with a willing city, but rather the fear that the city can change over time and in the future the city might turn into a partner very different than the one you partnered with.

Decision Making. Cities cannot make decisions very quickly. The process of making municipal decisions involves a very specific process that often requires public meetings and allowing time for public comment. This is not that much of a hurdle in getting a new partnership started, but after it is up and running, a city will not be a nimble partner that can make a quick decision when needed.

Public Disclosure. In most places there are public disclosure laws that mean that almost everything you do with a city will be subject to disclosure to the public should somebody want to see it. There are states where ‘commercially sensitive information’ can be protected to a degree, but in some states everything can be made public. Generally even any records of negotiating a PPP might be publicly discoverable.

Purchasing Process. Even when you negotiate a PPP with a city, some of them will feel obligated to then send the whole deal out to the public on an RFP or an RFI to make sure there isn’t a better deal available. Cities are often cautious about agreeing to sole-source deals without having gone through the process to see if they could have negotiated a better arrangement with somebody else. This is often a case of CYA in case the deal ever goes sour later.

Different Goals. It’s always important to remember that a city partner will not have to same goals as a commercial partner. They might care, for example, about making sure that there is broadband brought to the poorest parts of a city while the commercial partner cares most about profits and cash flows.

Ownership. Most cities cannot own a share of a corporation or a for-profit partnership. This means that if the city is to be a true partner that some alternate mechanism must be found to compensate them for their contribution to the partnership.

The “Anti-Voices”. Since the process is usually at least somewhat public, you must expect that there will be some citizens who will be loudly vocal against whatever the PPP is doing. This is inevitable because there are some citizens that are against almost everything. This is something that governments are all used to but which might be an eye-opener for an ISP.

You need to keep all of these things in mind when negotiating or working with a municipal partner. At the end of a day a city can be a great partner and there is at least anecdotal evidence that a broadband venture with a city partner will get more customers than a pure commercial venture – due probably to the fact that many people like their city governments and trust them to do the right thing.

Highlights from the NTCA PPP Panel

ppp_logoI was just on a panel at the NTCA Spring Convention looking at the topic of Public Private Partnerships (PPPs). The audience was mostly independent telephone companies and cooperatives. I was one the panel with Curtis Dean of Smart Source Consulting, and Dan Olsen and Ben Humphrey of Finley Engineering. Together this particular group has a lot of day-to-day operational experience working with or for municipal telecom companies.  Following are a few of the major points made during the presentation and the follow-up questions:

Cities are Different. Cities don’t think the same way as commercial companies. They have different goals. They have a number of issues that make working with them a challenge such as slow decision making, open records laws, public purchasing practice, and of course, politics. They even have a different idea of what a successful venture looks like and any business that can cover costs and not need a subsidy is considered successful.

A Good Partnership Can be Harder to Maintain than a Good Marriage. In general, it’s hard to find a good partner, commercial or municipal, that you will feel comfortable with working over a long period of time. The recommendation was to take the time up front to ask the right questions to make sure that you understand the differences in working with a city, and to figure out an operating structure that will let both sides be comfortable with the differences over many years.

Don’t be Afraid of PPPs. There is no reason to be afraid of PPPs. There are numerous examples of successful PPPs already in existence and the parties in those ventures found ways to make it work. While cities and commercial companies are very different, if you do the hard work up front in creating a sustainable partnership it can work.

Shield a PPP from Politics. Probably one of the most harmful things that can happen in a PPP is for politics to influence decision-making after it’s up and running. You need to find a governance structure that isolates the business to some extent from direct political interference. A PPP should not require government approval to raise rates or to make operational changes needed in the business.

Have an Exit Plan. One thing that is often missing in the creation of a PPP (and in the creation of commercial partnerships as well) is for both sides to have an exit strategy. When negotiating a new partnership the two sides should always talk about what happens if things go south, and the contractual arrangement should allow both partners a way out of the partnership if it isn’t working for them.

Rural America is Growing Desperate for Broadband. Towns that don’t have great broadband today are seeing a huge gulf opening between them and neighboring towns that have good broadband. Cities are growing fearful that without broadband they will lose jobs, lose population as kids move elsewhere for work and will not attract new housing or businesses. Broadband has grown from something that is nice to have to an economic necessity and places without broadband are fearful that their towns will become irrelevant and disappear.

Municipalities Need to Put Skin in the Game. Cities are waking up to the fact that in order to get the broadband they want that they are are going to have to help pay for it. The numerous RFPs that are asking somebody to show up and build broadband are falling on deaf ears and they are realizing that they are competing against tens of thousands of other cities in the same situation and with the same need. Cities and citizens are getting more willing to put taxpayer money into the pot to find a good broadband solution. And municipal money can make it easier for a commercial partner to make the desired returns.

Seek Help. If you are considering a PPP, then seek advice from those that have already done this right. There are many things that can wrong, and no partnership is assured of long-term success or harmony. It’s worth the extra time and cost up front to make sure that you are not making one of the fatal mistakes that will be a problem five years down the line.

Connecticut’s Call for a Fiber PPP

Fiber CableA large number of municipalities in Connecticut have banded together and let it be known that they would love gigabit fiber. They’ve recently made numerous announcements about the initiative as well as assembled a list of the things that each municipality is prepared to contribute to somebody who will build fiber for them. This list includes the typical sort of things that cities offer to potential commercial partners – expedited permitting, real estate and building access, access to existing conduits or other sorts of existing telecom infrastructure, etc.

What these cities are doing is not unusual, but it’s by far the biggest such initiative I have seen. I have no doubt that these cities would love gigabit fiber, and they clearly understand the benefits and implications of getting it. But unfortunately, I see very little chance of their approach working. The Connecticut group is calling this a PPP (public private partnership). I love the ideas of PPPs and I have worked with some successful ones. In addition to being a telecom consultant I also am on the Board of Directors for a PPP financial consultancy firm that works across a wide range of infrastructure projects.

Numerous cities have taken this same approach to try to find a private partner. The first one I recall was the city of Seattle nearly a decade ago, a project that I helped with. The city made the same sort of appeal to investors to build fiber in their city and they had no takers. Since then I have regularly seen similar appeals made from cities all over the country. And except maybe for a few small cities that might have found a small local ISP or telco to partner with, I am not aware of any of these attempts that has ever been successful in attracting a partner. There are a number of reasons for this:

  • I saw several quotes from Connecticut officials that said that they are hoping that some venture capitalist will see this offer and become interested. That is not the way that venture capital works. Venture capitalists don’t invest in ideas for good projects; they invest in management teams that they trust. And they expect those management teams to have a strong track record and to bring them shovel-ready projects. Venture capitalists never go and seek opportunities, but instead wait for fully fleshed-out opportunities to be brought to them. For the Connecticut opportunity to be shovel-ready someone will have to expend significant millions up front to perform the engineering to determine the cost of the build, undertake market research to understand the potential for customer interest, and then create financial business plans to demonstrate that the project can make the kind of returns that venture capitalists or other financial sources will find acceptable. For just one decent sized city, that development work can easily cost half a million dollars or more, and for the 40+ towns in this consortium this would be a huge outlay. There are probably not many companies around willing to take a multi-million dollar risk on doing this upfront development work without knowing for sure that they can get it financed.
  • I have done several recent financial analyses of large fiber PPPs. These studies show that the kind of contributions that these cities (and most cities) are willing to make to a fiber project are not worth very much to a potential builder. One of the few benefits that might get somebody’s attention would be if a city already has a significant network of empty conduit through which fiber could be pulled. The other things these cities are offering don’t change the potential IRR (internal rate of return) of a project by much at all. Sadly, cities are overvaluing the benefits they can bring to a commercial fiber partner as part of a PPP. If a city really wants to attract a private builder they ought to be thinking about providing an economic development bond to pay for some significant portion of the fiber – a bond that they would repay out of tax dollars. That would be real skin in the game that would create a real partnership opportunity which might attract investors.
  • There are not many companies building fiber that would be large enough and have the ability to respond to the Connecticut group. To build to the fifty plus communities in this group must be a billion dollar venture and there are not many companies that have the wherewithal to raise that kind of money to build fiber. Only a company with deep pockets and a proven track record of building and operating telecom networks would have any chance of raising this kind of money. Even for companies with deep pockets this kind of construction is going to require at least 30% to 40% equity and there are not many firms sitting on the cash and equity needed to pay for this.
  • The various announcements said that since fiber is profitable that they ought to able to attract the needed money, But is it that profitable? Venture capital investors normally seek risk-adjusted returns of 30% or better and since fiber is a capital intensive undertaking it’s hard to achieve returns that high. It’s not impossible, but if building fiber was really that lucrative there would be fiber projects everywhere.

I hope these communities prove me wrong, because I think what they want is terrific. I really don’t want to be throwing a wet blanket on this because I am a huge believer in the benefits of fiber networks. But this sounds to me like wishful thinking on the part of economic development people who do not understand the market reality of how large amounts of money are raised in this country today. These cities are basically wanting somebody else to bring the money to build fiber in their communities, and you can count the firms who are capable of doing this on one hand – and most of those are the giant telcos who are no longer building fiber at all.

If They Can Do It

ppp_logoI think everybody agrees that we don’t have enough last mile fiber infrastructure in this country to bring high-speed internet to the homes and businesses that want it. For various reasons the large telecom companies have decided to not invest in rural America, or even in any town or neighborhood where it costs more than average to build fiber.

Meanwhile we have a lot of municipalities that are interested in getting fiber to their communities but don’t know how to get it financed. Lastly, from what I read, we have tens and maybe hundreds of billions of dollars of potential investment money on the sidelines looking for solid investment opportunities. It seems like there ought to be an easier way to pull these things together because all of the components are there to make this work – the customer demand, the community desire and the money needed to get it done.

One has to look north to Canada to see an economic model that offers an answer – public private partnerships (P3s). For an example of a working investment model, consider  Partnerships British Columbia. The venture was launched in 2002 and is wholly owned by the province. It’s operated by a Board comprised of both government and private sector members.

The primary function of Partnerships BC is to analyze potential infrastructure projects and then attract private capital to get them constructed. The benefits to the province are tremendous. First, Partnerships BC stops the government from undertaking projects that don’t make financial sense. After all, governments often like to build ‘bridges to nowhere’. Partnerships BC will analyze a project and make certain that it will cash flow. They then attract private bidders to build and operate the most financially attractive projects.

They bring private money in to take the place of tax money and in British Columbia this is getting things like hospitals and roads built without putting all of the burden on the taxpayer. Additionally, projects built with private money cost less to build. We know all of the horror stories of cost overruns on government-built projects and that doesn’t happen when there are financial incentives for the private entities to build things efficiently. In fact, a few hospitals were built so far ahead of schedule in BC that the province was not ready for them.

One of the biggest complaints against government fiber projects in the US is that government has no business operating a competitive business. The P3 model eliminates that complaint as well since it attracts qualified operators to build and run projects. The telephone companies in the US should all be in favor of having a P3 structure here since it would help them to finance new fiber projects. Smaller and mid-sized telecoms have always had trouble finding capital and a P3 fund would bring money that might not be found elsewhere.

And of course, while I have a bias towards funding and building fiber projects, a state P3 fund would fund almost any infrastructure project that has a demonstrable cash flow such as hospitals, water systems, roads, railroads and bridges. I keep reading that we have a multi-trillion dollar infrastructure need in the country which is far greater than the combined borrowing capacity of governments. So we need to wake up and look north and use the P3 idea along with any other idea that will let us dig ourselves out of our infrastructure hole. America is crumbling and P3s are one part of the solution that could be implemented immediately.