Public Private Partnerships

p-3Today’s blog is talking about public / private partnerships (PPPs). This is an area of the telecom world where I see the potential for significant growth in the next decade. Increasingly, rural towns and counties are looking at their inadequate bandwidth and are clamoring for something better. Generally such communities just want somebody to bring them bandwidth. But when nobody steps up to do that, many of them are now taking steps to do it themselves.

And there lies the opportunity. There are very few communities that want to be in the telecom business. Most of them are in the water and sewer business and some of them have municipal electric companies, but these are all monopoly businesses. Most cities are very uncomfortable when looking to enter a competitive business. Given a choice they want somebody else to be in the bandwidth business and will only take that path if they see no alternative.

It’s a natural reaction of a local cable or telecom company to look at communities that are building fiber systems as threats, when instead they are opportunities. You can’t blame them for wanting adequate broadband. They look around the country and see that rural America is becoming a world of broadband haves and have-nots. Most urban areas now have decent broadband, but many rural areas still no or slow broadband that putting their citizens and businesses behind the rest of the country. While the FCC may define broadband as starting at 4 Mbps download, this is totally inadequate for a household today and certainly doesn’t cut it for the business community. Communities that don’t get enough broadband are worried that they will become irrelevant. Their populace will slip away. Kids won’t stay in the area when they graduate. Being on the wrong side of the broadband divide is a scary place to sit today.

My advice to small telcos and cable companies is that you ought to be the first one in the door to these kind of nearby communities offering to help them to find a solution. And if these communities are in your own service territory you need to listen to them – because if you won’t help them they will find a way to get what they feel they need.

Communities that feel strongly enough about bandwidth are generally willing to contribute money to bring a solution, and that creates an opportunity. I know of one community that went to an ILEC and said that they would be willing to pay for a fiber network in their town, have the ILEC operate it, and then hand it to the ILEC for $1 when the financing was retired. Incredibly, the telco turned down this opportunity (which still has me scratching my head).

There are a number of successful business plans that I have seen for PPPs between cities and local ILECs. Consider the following:

  • Operator Only. The municipality can build a network and then hire somebody to operate it. Operating another network can create a good new long-term revenue opportunity for a telco because it lets you leverage your existing backoffice and technical staff and to turn some of their time into revenue.
  • Building a Project Jointly. Another option is for both parties to make an investment. This can be a tricky option to make work because this makes you a financial partner with a City. It is vital under this kind of arrangement that both parties fully understand the other’s goals and motivations for being in the business because it’s hard to maintain a partnership where the partners have different goals. This kind of arrangement also calls for some creative financing since you are likely marrying commercial loans and municipal bonds. But there are many examples of this kind of opportunity working.
  • City as an Anchor Tenant. Under this scenario the ILEC will build the network, but you would have the City, the schools and other key broadband customers sign on as long-term anchor tenants to help assure you of the revenue stream.

If you are in a rural area the chances are that these opportunities are all around you. Telcos tend to think about expansion in terms of how much money you are able to borrow to build new networks and grow. But by looking at PPPs you can leverage your borrowing power with the borrowing power of the municipality and together you can build more, and faster than either of you could have done on your own.

I have been in a number of partnerships myself and have seen some that work great and some not so great. But generally if partners are realistic about what they need to achieve it can be made to work well. Getting the financing and governance right are essential so as to head off future problems before they happen. At CCG we probably have more experience in creating these kinds of PPP arrangements as anybody in the industry and we can help you do this right.

Public Private Partnership Financing

Wipe our Debt

Wipe our Debt (Photo credit: Images_of_Money)

Yesterday’s blog talked about finding partners for telecom ventures. Today I want to talk about a specific kind financing. Commercial companies have often complained that municipal telecom ventures get an advantage because they can borrow with bonds instead of normal commercial loans. And this makes me laugh because having worked with a lot of ventures financed in both ways I can’t see any particular advantages to bonds over commercial loans.

It has always been generally assumed that because bonds normally carry a lower interest rate that they are a far better deal than a bank loan. But let’s look at the realities of bonds used for telecom projects:

  • Bonds do generally have lower interest rates. But looking back over the history of commercial versus bond financing, the spread between the two interest rates in has usually not been very big. Certainly when we hit market conditions where there is a big benefit for tax-free bond interest rates then bonds can be a really great deal, but this has generally not been the case.
  • Bonds require that you borrow all of the money up front, meaning that everything you borrow goes into escrow and you begin paying interest on the money from the day you close on the bond. Commercial loans generally start projects with construction financing, meaning that you only take the cash as needed by construction and only pay interest on the money that has been borrowed.
  • It generally takes around three years for a new telecom venture to get a positive margin, and so a normal aspect of bonds financed for this purpose is capitalized interest. This means that the borrowing must include the funds required to make the interest payments, and often principle too, for the first three years of the project.
  • Many bonds have required the borrower to have a debt service reserve fund. This is essentially self-insurance to hedge against a default and normally this would mean doing something like borrowing an extra amount of money equal to a year’s principle and interest and keeping it in escrow against a time when there might be a full or partial default on bond repayment. And this money accrues interest expense for the entire term of the bond.
  • Depending upon the bond credit rate of the borrower, some bonds also require bond insurance. This is similar to the debt service reserve fund and has the borrower taking out an insurance policy that will guarantee one year’s payment on the bond in case of default. These policies are paid in full upfront at the beginning of the bond. I have seen bond issues that have both a debt service reserve fund and bond insurance.
  • Bonds have longer terms. It is not unusual for bonds to have terms of at least twenty years and I have seen bonds as long as thirty years. This is a mixed blessing. While having a longer term lowers the payments a little each year, the new business is saddled with debt for decades. In the long run this keeps the pressure on a bond-funded venture to always perform to a pretty high level. However, once any business is debt free they can perform at a lower level and still be quite successful without having to cover debt payments.
  • There are significant fees to be paid up front to sell bonds. There are bond sellers who specialize in finding buyers for bonds, but they charge a significant fee up front. The legal expenses requires to issue bonds are generally also much higher than the costs needed to borrow commercial debt.
  • When taken as a whole, these various items add costs to a bond issue and it’s not unusual to see the size of a bond issue be 20% to 25% higher than an equivalent commercial loan. That extra borrowing generally more than offsets the savings from interest rates and in reality I think that bond financing is generally more expensive than commercial financing.

Because of this there is a big opportunity for public private financing. If a venture can get funds from both sources through a public private partnerships then you can benefit by the best of both worlds. Consider, for instance a financing that is 1/3 bonds and 2/3 commercial. It would have the following advantages:

  • The bond money could act as equity and mean that no other equity is required for the project.
  • The smaller bond size means relatively small capitalized interest and other bond costs.
  • Some of the project is spread long-term with the bulk being medium-term, making it easier to make debt payments in the early years.
  • The bond can be used to cover the early debt payments on the commercial loan, eliminating the need for capitalized interest.
  • Construction can be done using normal construction debt financing.

I recently looked at a structure like this for a client and this public private financing looked to be superior to both normal bond and normal commercial financing. So there is a strong financial incentive for telecom partnerships between commercial and public entities.

In my next blog I will talk about what it takes to be good partners. It’s not always easy.