Why I am Thankful – 2017

Every year at Thanksgiving I take a pause to look at the positive things happening with the small carrier industry. This is not the easiest year to make a list because we currently have an FCC that clearly is in the pocket of the big ISPs like Verizon, AT&T and Comcast. While some of the new FCC policies supporting those big companies will benefit all ISPs, in many cases the FCC decisions are given the big ISPs a leg up over competition. But there are still things to be thankful about in our industry:

Demand for Broadband Intensifies. In the work I have been doing in rural communities it’s becoming clear that broadband has moved from a nice-to-have feature to a must-have commodity. I see evidence of this in several different ways. First, rural communities and their citizens are making a lot of noise to politicians about not having broadband. The broadband issue has become the top priority in many communities. I also see evidence of rural broadband demand when looking at the high penetration rates that come from projects being built in areas that didn’t have good broadband. Over the last few years I’ve seen such projects getting customer penetration rates between 65% and 85%. I call this a good news topic for rural carriers since it means there are still lots of opportunities for expansion, and enough customer demand to help pay for broadband projects. It’s not a positive that there are still so many communities with no broadband, but the positive here is that communities are making demands, which is the first step towards finding a solution.

Public Private Partnerships are Thriving. Very few government entities want to be an ISP and they are instead hoping to find commercial partners to bring better broadband to their communities. In just this last year I’ve worked with half a dozen local governments that have contributed funding to public private partnerships, where the government acts like the bank and the ISP owns and operates the network. Since rural broadband projects are often a challenge to finance this is a promising new trend.

ACAM Money is Financing Fiber. The ACAM money from the Universal Service Fund is being used to expand fiber and advance broadband in rural areas all over the country. The fact that some rural communities are getting fiber is helping to drive the demand for other who want the same thing. We’ll have to wait until next year to see of the CAF II reverse auctions drive similar results.

Wireless Technology Getting a Lot Better. I have a lot of clients who are now deploying point-to-multipoint radios for broadband deployment. Over the last three years these radios have improved dramatically. They are more reliable, almost approaching plug-and-play. By combining multiple frequency bands they deliver bigger broadband pipes, faster speeds and a much-improved customer experience. Depending on customer density the networks can be designed to deliver 25 Mbps to a lot of customers with some speeds as fast as 100 Mbps. There are still big issues with the technology in heavily wooded or hilly areas, but there are a lot of places where the technology is now delivering a great broadband connection.

New Revenue Opportunities Materializing. While voice revenues continue to decline and many of clients are getting clobbered on cable TV, I see a number of them doing well with new products. I have clients getting decent penetration rates with managed WiFi. I have some clients doing well with security. And I have clients making some good margins on smart home technologies. Selling new products is out of the comfort zone for many small ISPs and it requires some new thinking to successfully sell a new product – but I’ve seen enough success stories to see that it can work.

The Latest on Federal Broadband Infrastructure

There is a lot of talk in DC of working towards a federal infrastructure funding plan this year. So today I’m going discuss some of the latest news about infrastructure, particularly as it affects broadband funding.

Shovel Ready Projects. A few weeks ago the White House said that they only favored funding ‘shovel-ready’ projects. meaning those projects that have already had enough engineering and financial work done to understand the costs and benefits. The President said that he didn’t want to fund projects that would then take ten years to get started, something that is not that unusual for highway projects.

Size of the Funding. US Transportation Secretary Elaine Chao last week said that the administration’s infrastructure plan would be for $1 trillion spread over ten years. That’s the first time we’ve heard any specific numbers and time frame. There is no telling at this point whether the funding would be spread evenly over the years. Secretary Chao said the details of the plan would be released later this year.

Including Broadband? Secretary Chao said that that “the proposal will cover more than transportation infrastructure, it will include energy, water and potentially broadband and veterans hospitals as well.” This certainly tells us that broadband funding is not a sure thing at this point.

Probably Not Outright Grants. Secretary Chao also reiterated what the administration had said earlier that any funding was going to favor public-private partnerships and was not likely to directly fund projects. This has always been expected, but this doesn’t tell us anything about the nature of the support. There was talk during the transition of the infrastructure plan to heavily favor using tax credits, meaning that it would favor and induce large companies to invest in infrastructure.

I suspect the idea of public private partnerships for roads tells us to expect a lot of new tolls roads. Advisers to Trump have said they would rely on federal tax credits and public-private partnerships rather than federal spending to pay for a new infrastructure program. The concept of public-private partnership is a bit puzzling when it comes to broadband in that there are many states where local governments can’t participate in broadband or are severely restricted from doing so.

FCC’s Position. FCC Chairman Ajit Pai said recently that any broadband funding ought to be handled through the Universal Service Fund mechanisms since it already has the processes in place to handle such funding. The Chairman came out heavily in favor of significant broadband funding for rural areas as well as funding what he calls Gigabit Opportunity Zones that would provide tax incentives for serving low income areas.

Bipartisan Support for Broadband. In early February 48 US Senators from both parties sent a letter to the President supporting the idea that any infrastructure plans should include funding for broadband. My guess is that this is due to the complaints that all politicians are hearing these days from those without adequate broadband.

Democratic Alternative. And of course, since this is Washington DC, there is also an alternate infrastructure plan. Senate Democrats unveiled an alternative $1 trillion plan that would more directly fund infrastructure with mostly outright grants. Their plan includes not only roads and bridges, but also broadband networks, hospitals run by the Department of Veterans Affairs, and schools. In general there is a lot of Democratic support for broadband funding and the plan allocated $20 billion for broadband. I guess the trillion dollar question will be if this is a topic that might find some bilateral agreement.

What are the Odds? When it comes to Washington and politics I don’t have any better crystal ball than anybody else. But it does look like there is bipartisan support for doing something with infrastructure and even more bipartisan support to make sure that broadband is included in any funding package. It’s probably a good time for small service providers to make sure that your DC representatives hear from you. And it’s a good time for those without broadband to yell even louder.

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.

Three Years and Counting

2014_Rolling_Sculpture_Car_Show_67_(1969_Porsche_911_S)Today is the three year anniversary of this blog. I started writing this blog as a way to force myself to keep up with industry news. During the first month of writing the blog I worried that I would quickly run out of topics. But I underestimated then how dynamic our industry has become. The changes from just three years ago are amazing. Instead of running out of topics I often have to toss away topics because I can’t get to them fast enough.

I mostly write about the topics in the industry that I find most interesting, but I must be striking a chord because I pick up new readers to the blog daily. I now know that I am the only one writing daily about broadband and related topics and it makes me happy to see that others find these topics to also be of interest. Just since I’ve started this blog we’ve seen the following changes in the industry (and this is a short list):

An Activist FCC. The current FCC has waded into more new topics than any other FCC in my memory. The most significant one is the net neutrality decision that reclassifies broadband as a regulated service. But there have been many other rulings from this FCC. There was a time a few years ago when industry pundits predicted that regulation was dying, but it has done just the opposite.

Exploding Demand for Broadband. The penetration rates for broadband have continued to grow and in urban areas it seems like we are getting close to the time when everybody that can afford broadband has it. But there are still huge numbers of rural homes and businesses without broadband and they are starting to stridently demand it.

Growth of the OTT Industry. While Netflix has been streaming content a little longer than I have been writing this blog, the whole OTT phenomenon has really taken off in the last few years. Netflix now claims over 75 million customers and there is now a growing host of other OTT providers. Online video has completely transformed the Internet and video is by far the majority of online traffic.

New Products from the IoT. There are new products available to carriers for the first time in many years. I have a number of clients who are now successfully selling security and a number of them are getting into home automation and the many other related services associated with the Internet of Things.

Use of WiFi instead of Wires. It’s become recently obvious that the large ISPs have abandoned home wiring for delivering data. They now bring bandwidth into the home to a central WiFi router and don’t install wires to anything else. But a single WiFi router is already not sufficient for high-bandwidth homes and the next trend in this area is going to be the networking of multiple WiFi routers.

Services in the Cloud. More and more services are moving to the cloud. Carriers can buy voice and cable TV programming from the cloud today, something that was unimaginable just a few years ago. It was always assumed that expansive bandwidth made cloud cable TV impractical, but as bandwidth prices continue to tumble it makes more sense to buy programming from the cloud instead of building or maintaining a cable headend.

Public Private Partnerships. There were very few Public Private Partnerships a few years ago and now it’s something that everybody talks about. This is particularly relevant in rural America where communities are willing to kick in money to find a broadband solution. But we are even seeing this in urban areas, such as the deal just announced between Google Fiber and Huntsville.

Erosion of Landline and Cable Customers. Landline penetration rates are now under 50% nationwide and we are starting to see the erosion of traditional cable customers. The challenge for the next few years will be for triple play providers to find ways to replace these shrinking revenues and margins.

Massive Realignment of Rural Subsidies. We’ve seen subsidies shrink for small telcos. Access charges are being phased lower and the Universal Service Fund is being redirected from telephone to broadband. This has put a lot of pressure on some small carriers, but anybody who survives the end of this shift will probably be ready to succeed in the long run.

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.

The Cost of Bond Financing

ppp_logoI have worked on fiber projects where the project has a choice to finance something through municipal bonds or through commercial loans. Such projects involve a government entity as well as a commercial partner. These public private partnerships are becoming more common as cities are looking for fiber and commercial companies are looking for help getting projects financed.

I have always told people that financing through municipal bonds is the most expense kind of debt possible. People at first don’t believe this until I show them. Afterall, the interest rates on municipal bonds is generally a lot lower, and in today’s market, and depending upon the rating of the bonds involved, you see 4% or 4.5% interest on bonds versus 7.0% – 10% interest on the equivalent commercial debt. And so people assume that municipal financing is a better deal.

In fact, around the country when the large incumbents try to pass laws that make it hard for municipalities to get into the fiber business they generally list the ability to obtain municipal financing as one of the big benefits that municipalities have over commercial firms. However, as the following numbers show, this is not true. Consider a project that is going to build a $30 million dollar fiber network. The project is also going to ask for $2.3 million in working cash to cover operating expenses. Following shows the financing using a revenue bond and using commercial debt.

Revenue Bond  Commercial Loan
Assets to be Built $30,000,000 $30,000,000
Fees $900,000 $100,000
DSRF $2,700,000 $      –
Bond Insurance $300,000 $      –
Capitalized Interest $6,500,000 $      –
Construction Interest $1,600,000
Working Capital $2,300,000 $2,300,000
Loan $42,700,000 $34,000,000
Interest Rate 4.50% 7.00%
Term 30 15
Annual Payment $2,621,419 $3,733,017
Total Outlay $78,642,566 $55,995,259

The first obvious difference is that you have to borrow a lot more money with a bond. Here are some of the reasons:
• Bonds require you to take the money in a lump sum and then pay interest on the full amount of borrowing during the time the project is being constructed. Further, bonds generally require the project to capitalize interest, that is borrow the amount up front to make the first three years of bond payments. In contrast, a commercial loan generally uses construction financing, meaning you draw the money as needed and only pay on what you have borrowed.
• Revenue bonds generally require a Debt Service Reserve Fund (DSRF) which puts one year of debt payment into escrow as a hedge against the project having trouble making the bond payments.
• Bonds often also require bond insurance, which is a policy that will make a full annual payment to bond holders should the bonds default.
• Finally, there are huge fees associated with floating bonds. There are many attorneys involved as well as substantial payments to bond trading desks for selling the bonds.

In this example, the bond debt is $8.7 million higher than the equivalent commercial debt. Bonds typically have lower interest rates and longer terms than commercial debt, and in this example mean that the annual payments are $1.1 million less per year. But there is a penalty to be paid for financing anything over a long term (like your home mortgage) and that is that you pay a lot more out over the life of the loan. In this example, the total cash outlay is $22.6 million higher for the bond debt, which is a 40% cash premium to pay for using bonds.

Municipal entities generally use bonds for several reasons. First, bonds rarely require any equity and the borrower can borrow 100% of the cost of the project. But the main reason that municipalities use bonds is that they are comfortable with this kind of financing and they don’t know anything else.

The problem this causes is that everything that the government builds in this manner costs more than if a commercial entity built the same project. I said the above example was for a fiber network, but it could just as well been for a water processing plant, a new high school, a new court house or any other municipal project.

We have an infrastructure crisis in this country and all of governments added together are capable of only borrowing a small percentage of the money needed to build and fix everything that is needed. So we need to abandon the bond model of financing a lot more often and start looking at public private partnerships as a way to get things done.