Private Equity, Overbuilder and Telco FTTH Payback Models are Very Different

Firms backed by private equity have different business models than other long-term operators of connectivity assets. PE-backed firms aim to create value (typically double the asset value within seven years) and then sell the assets. 

That is a different model than used by connectivity service providers who operate for the long term, where fundamental issues of free cash flow, revenue growth and profit, as well as the ability to pay dividends, are the key constraints. 

And so it is with investors in fiber-to-home assets. 

Back in the heady days of 1996, when the Telecommunications Act of 1996 became law, business models for firms providing connectivity services changed in a big way. For legacy providers, maintaining market share became the key issue. For attackers, gaining share became the obvious key issue. 

Beyond that, the imperatives were different. Legacy providers, operating their businesses for the long haul, could not adopt the “fast growth rather than profits” models as used by many attackers. At a time of “easy money” and “we want you to grow fast” attitudes of key investors, that made sense for attackers.

And, as has been true for many software startups, long-terms operating profits were not the goal. Instead, fast growth in a “hot” area was the objective, since such firms had reasonable expectations they would simply be bought out at some point before they ever reached “terminal value.”

That, at least, is what one has to assume when looking at the costs of FTTH networks and costs to actually connect customers and earn a profit on those services.

The reported cost per-home-passed (CPHP) for underground FTTH deployments ranged from $1,600 to $2,600, according to a recent estimate by Cartesian researchers. The CPHP for aerial deployments was lower than those of underground, ranging from under $700 to $1,500 for respondents in suburban and urban environments, and $1,300 to $2,700 in more rural areas. 

source: Fiber Broadband Association 

Actually connecting a paying customer adds another $600 to $830 in drop costs. 

source: Fiber Broadband Association 

So the per-home cost of serving a paying customer includes an attributed cost of building the network; an assumption about take rates and then the cost of the drop and installation; plus operating and marketing costs. 

Take rates matter. At a 50-percent take rate, for example, the per-customer cost of the network can range from $2,600 to perhaps $5,200, with an additional $600 to $800 in drop costs, for a per-customer network cost ranging from a “best case” of perhaps $3,200 up to perhaps $6,000. 

But that is just the network platform. One would have to add in operating and marketing costs, plus any debt service and loan principal repayments. Operating and marketing costs might range from about $210 per year to $800 per year, per customer, according to some estimates. 

Cost Category	Low Estimate ($/year/subscriber)	High Estimate (/year/subscriber)	Sources
Network Infrastructure	$100	$500	FTTH Council: $200-$300,  Deloitte: $300-$500
Operations & Maintenance (O&M)	$25	$75	FTTH Council: $40-$60. Analysys Mason: $25-$35
Customer Acquisition (CAC)	$50	$150	BroadbandNow: $50-$100, Analysys Mason: $60-$150
Customer Care & Billing	$25	$50	Analysys Mason: $25-$35,  Leichtman Research Group: $30-$40
Marketing & Sales	$10	$30	Analysys Mason: $10-$20,  Leichtman Research Group: $15-$25
Total Operating Cost	$210	$805	Sum of individual ranges

And one might have to add interest charges and eventual debt principal repayment in addition to those charges. 

And there is a possible additional range of investments as well. Some firms must first acquire copper-based legacy telco assets first, before starting the FTTH upgrade, either to own and operate over the long term, or to sell the assets in five to seven years. 

Transaction	Date	Buyer	Seller	Asset Type	Homes Passed (M)	Price (USD Billion)	Cost per Passing (USD)	Source
Brightspeed - Lumen assets (20 states)	Oct 2022	Brightspeed	Lumen	Fiber	0.3	3.0	10,000	Reuters
Consolidated Communications - NewWave Communications	Aug 2022	Consolidated	NewWave	Fiber	0.18	0.65	3,611	Fierce Telecom
Windstream - MetroNet Holdings (FL)	Aug 2022	Windstream	MetroNet	Fiber	0.06	0.28	4,667	Fierce Telecom
Frontier Communications - Verizon (WA, OR)	Dec 2021	Frontier	Verizon	Mixed (Fiber & Copper)	0.14	1.05	7,500	Fierce Telecom
Allo Communications - Lincoln Telephone & Telegraph	Nov 2021	Allo	Lincoln	Mixed (Fiber & Copper)	0.11	0.21	1,909	TelecomTV
Ziply Fiber - US Cellular assets (WA, OR)	Oct 2021	Ziply	US Cellular	Fiber	0.12	0.51	4,250	Fierce Telecom
CNSL - Searchlight Investment	Jan 2020	Searchlight	CNSL	Mixed (Fiber & Copper)	0.71	0.425	600	CNBC

In many cases, the capital investment to acquire assets is equal to, or more than, the cost to add the FTTH upgrade. But that’s where the business case lies. If one assumes a copper asset can be purchased for $600 to $800 per passing, but then an upgraded FTTH asset can be sold for $5,000 to $10,000 per passing, that is the business case for making all the investments in FTTH. 

It might still be a difficult business case for a shorter-term owner, but “buying copper assets; upgrading to FTTH and then selling” can work. 

The payback for longer-term operators always has been equally challenging, if not more challenging, and has gotten arguably tougher as total account revenues including voice and video entertainment have dwindled, forcing the payback model to be based on home broadband alone. 

The main point is that FTTH payback models for private equity investors and service providers are quite distinct. What makes sense for a PE firm might not always make sense for a legacy fixed network service provider or an “overbuilder.” 

That is perhaps one reason why GFiber (owned by Alphabet) has not purchased copper telco fixed network assets before upgrading them. As with other “overbuilders,” GFiber has simply built its own greenfield FTTH networks from scratch.

C-Band is a Huge Deal for Verizon: Extends Home Broadband Addressable Market from 25% to Virtually 100%

One iron rule for internet access services is that if one has enough bandwidth, access speeds can be very high. For mobile operators, bandwidth expansion can come in a few ways: adding more spectrum, building smaller cells or deploying better modulation techniques or radios.

In that regard, for 5G, mid-band spectrum has been key for firms such as Verizon, which have had less mid-band spectrum than others. The difference is striking. 

After deploying C-band spectrum, Verizon mobile peak speeds “go from 9 Mbps to an amazing 2.4 gigabits per second,” said Hans Vestberg, Verizon CEO.

That has implications for home broadband as well, as, in principle, peak speeds might reach gigabit per second levels. And that, in turn, is important because it dramatically extends the addressable market for fixed wireless from perhaps 25 percent of buyers to perhaps 99 percent of buyers (those who buy home broadband at speeds up to about 2 Gbps, and do not require symmetrical access)

True, Verizon has millimeter wave assets to deploy in urban areas, but C-band means fixed wireless has higher bandwidth in suburban and rural areas as well. 

For Verizon, which has a smaller fixed network footprint than many of its leading competitors, that really does matter, as it means Verizon can compete for home broadband customers who want higher speeds in most U.S. geographic areas. 

Of a total of 140 million U.S.  homes, AT&T’s landline network passes 62 million. Comcast has (can actually sell service to) about 57 million homes passed.

The Charter Communications network passes about 50 million homes, the number of potential customer locations it can sell to.

The number of Verizon homes passed might be 27 million. Lumen Technologies never reports its homes-passed figures, but likely has 20-million or so consumer locations.

The point is that Verizon cannot easily expand its fiber to home footprint outside its historic service areas, for reasons of investment magnitude. So fixed wireless makes eminent sense for a firm that can presently reach only about 19 percent of U.S. homes using its fixed network. 

The same sort of logic holds for T-Mobile, which historically has had zero access network fixed network footprint. There is neither time nor money for T-Mobile to wire the entire country, or even a substantial part of it, using FTTH. 

So C-band is a really big deal. It extends Verizon’s home broadband addressable market from about 25 percent of homes to up to 100-percent of homes.

Implicit Questions about Payback from 5G and FTTH

Though there still is no firm consensus about the number of firms that a home broadband market can support, the math suggests that in markets with one or more smaller specialist providers, as many as five firms could sustain themselves. When competition across a full market is necessary, it is possible that, in some markets, that number drops to about three.

Globally, observers note that take rates for the new FTTH services often run in the 20 percent of homes passed up to 40 percent of homes passed range, with the threshold for a payback generally being somewhere around 35 percent on a blended basis.

In other markets there are two ubiquitous providers and several small specialists who serve only parts of a city. It is too early to know how the long-term market will shape up, as most of those new contestants are just entering the market now, or have operated for only a handful of years.

Still, those possibilities far exceed older thinking about access markets, when it was assumed only a single provider could sustain itself. In some markets, we already see that two access providers, competing on a whole-city basis, can sustain themselves.

Many other large questions, such as the role of wholesale mechanisms, open networks, the role of mobile versus fixed networks and the mix of revenue from consumer and business customers, all are open questions at the moment. Nor can we rule out some eventual move, in some markets, back to monopoly regulation of fixed network access services.

A related question is the ultimate shape of mobile service provider markets as well. At the moment, many observers believe markets with four leading mobile operators are unsustainable. Those observers believe markets will stabilize only when the number of suppliers is reduced to three (or perhaps fewer, in some cases).

Much of the debate over "fair share" mechanisms in the European Union countries seems to revolve about support for mobile networks rather than fixed networks.

But observers might also have questions about the sustainability of private equity investments into fiber-to-home networks as well, and for similar reasons: payback on potential investments.

According to consultants at Bain and Company, private equity investors have poured about $32 billion into building fiber-to-home networks between 2019 and 2022. It is not clear whether that sum also includes the cost of acquiring copper access assets that are then rebuilt using FTTH, though.

Payback can be obtained at lower levels when construction costs are low, such as in rural areas and when aerial construction is possible, rather than underground. Payback periods also are affected by other issues such as the availability of wholesale transit or access fiber, ability to pull new cables through widespread duct infrastructure, government subsidies and so forth. 

The point is that profitability often hinges on local conditions, including the level of expected competition from other internet service providers. 

source: Bain and Co. 

Other studies and transactions might confirm the risk involved. In many cases, before an FTTH network actually is built, a firm will buy an existing telco service provider business. That can add $1,000 per home to the payback model for an eventual FTTH build. 

Metric	Description	Example
Construction costs	The cost of building and deploying an FTTH network, including the cost of materials, labor, and permits.	$1000 to $1200 per location passed; perhaps $2,000 - $4,000 per household if existing copper assets are purchased.
Asset purchase costs	The costs associated with purchasing the necessary equipment and infrastructure for an FTTH network, such as fiber optic cables, routers, and switches.	$500 - $1,000 per household
Take rates	The percentage of households in a given area that subscribe to an FTTH service.	40% - 60%
Demographics	The characteristics of the population in a given area, such as age, income, and education level, can impact the demand for FTTH services.	Higher-income and more educated households are more likely to subscribe to FTTH services.
Housing density	The number of housing units per unit of land can impact the cost of deploying an FTTH network and the number of potential subscribers.	Higher housing density can make it more cost-effective to deploy an FTTH network.

Some recent transactions, especially those made by private equity, have involved purchase of existing telco assets, with the intention of building FTTH to change the revenue model. But that also can effectively double hurdle rates for earning a financial return, all other things remaining equal. 

In other words, instead of building a greenfield FTTH network for about $1100 per passing, the acquisition cost, plus FTTH cost, can effectively double the payback hurdle. 

Transaction	Date	Buyer	Seller	Asset Description	Number of Homes	Cost per Home
Apollo Global Management to acquire Lumen's copper access assets	2022-07-25	Apollo Global Management	Lumen Technologies	Copper access assets in 20 states	10 million	$600
KKR to acquire Consolidated Communications	2022-02-01	KKR	Consolidated Communications	Copper access assets in 21 states	1.3 million	$900
EQT to acquire Frontier Communications	2020-10-09	EQT	Frontier Communications	Copper access assets in 25 states	2.4 million	$1,000