Will Private Equity Move into Connectivity Also Lead to Adjacency Moves?

Brightspeed, the new connectivity provider formed by assets purchased from Lumen, is setting up its headquarters in Charlotte, N.C. Basically representing the assets comprising the old CenturyLink, Brightspeed serves mostly rural areas across the U.S. Southeast, Midwest and South Central regions. 

source: Brightspeed 

The business plan to be executed by new owner Apollo Global Management focuses squarely on an upgrade of the largely-copper physical plant to fiber-to-home for internet access. 

Brightspeed plans to build an XGS-PON network operating initially at 1 Gbps. But one new objective is ensuring that the Wi-Fi experience inside the home better matches the bandwidth of the access pipe. 

What consumers experience as the “speed” of the access network these days is measured by the performance of the Wi-Fi in-home network. Brightspeed is expected to incorporate more measures to enhance the Wi-Fi coverage and speed indoors as an essential part of its “upgrade internet speeds” push. 

The strategy rests on some short-term and some long-term value drivers for the new owners. Near term, Brightspeed believes its cost of FTTH infrastructure will be subsidized by new subsidies for building broadband plant.

That changes the investment calculation and helps improve the payback from new investment. 

Low borrowing costs also are a reason for the push. 

The longer-term goals are different, representing a belief that the fiber access assets will provide an alternative asset to stocks, bonds and other “turnaround” assets in the Apollo portfolio. The hope is that Brightspeed will provide predictable cash flow from a business with competitive moats.

That is similar to the thesis for owning airports, toll roads, seaports or other forms of infrastructure that have been investment targets by private equity and institutional investors. 

In 2020, investment in telecom infrastructure represented as much as 35 percent of private equity deal value in the United States, according to Preqin. 

There are other shifts as well. The financial return from ownership of traditional infrastructure assets is not as high as the returns from operating such businesses. In many cases, the return “as a data center operator,” for example, can be as much as double the return from “simple connectivity” business models. 

The perceived upside now comes from additional expected opportunities in edge computing, private networks, internet of things and digital infrastructure in general. The argument is that many cloud or edge computing ventures are  more valuable when combined with connectivity.  

In addition, scale should increase potential returns, which is one reason for additional investments. 

Also, a significant presence in the connectivity value chain increases the ability to participate in adjacencies, such as::

• Data centers, including colocation services

• Structured cabling 

• Distributed antenna systems (DAS)

• Electrical, aerial and underground fiber deployment 

• Civil construction 

• Small cell or micro cell installations 

• Indoor DAS and outdoor DAS integration

What is not clear so far is whether “wholesale access” will be a significant part of the Brightspeed business model or not, as is the case for some other FTTH business plans preferred by private equity investors.

Are FTTH Payback Models Sustainable? What's Good for Private Equity Might Not be So Good for Operators

Some of us would admit to being surprised at the payback models  for fiber-to-home deployments, the degree of business moat protection some believe FTTH offers, and therefore the value of such digital infrastructure assets, compared to other assets such as cell tower sites, data center or edge computing assets. 

Looking back over 25 years of business model assumptions, it is quite startling how much the underlying assumptions have changed. Subsidies now play a bigger role, offering in some cases a 20-percent to 30-percent reduction in capital investment in rural markets. 

On the supply side, though demand is not altered, private equity investment now means more capital is available to accelerate build timetables. 

But the most-shocking change are the revenue assumptions for consumer locations. These days, the expected revenue contribution from a home broadband account hovers around $50 per month to $70 per month. Some providers might add linear video, voice or text messaging components to a lesser degree. 

But that is a huge change from revenue expectations in the 1990 to 2015 period, when $150 per customer was the possible revenue target. In some cases, revenue up to $200 per home location was considered feasible. 

Expectations now hinge almost exclusively on consumer home broadband. 

“Our fiber ARPU was $61.65, up 5.3 percent year over year, with gross addition intake ARPU in the $65 to $70 range,” said John Stankey, AT&T CEO, of second quarter 2022 results. “We expect overall fiber ARPU to continue to improve as more customers roll off promotional pricing and on to simplified pricing constructs.”

Lumen reports its fiber-to-home average revenue per user at about $58 per month.

Recent presentations also have shown fiber-to-home home broadband average revenue per user of about $63. 

source: Frontier Communications 

Granted, most larger ISPs believe they can boost ARPU over time, by adding features, adding speed tiers and moving customers to higher-priced plans with higher usage allowances. 

Market share or installed base is the other huge assumption. Can most providers expect to get 20 percent take rates or as much as 50 percent? And what other assumptions about operating cost are necessary to create a sustainable business case at 20-percent share? 

Most incumbent telcos deploying FTTH have been able to get 40-percent market share after several years of marketing. But is a terminal rate around 40 percent to possibly 45 percent (or even 50 percent) reasonable in most cases? If not, where is that possible? 

On the supply side, capital investment benefits from government subsidies and to some extent infra cost declines, though construction costs are stubborn. So while some larger ISPs hint at per-passing network costs as low as $600, others report costs closer to $1,000 per passing, with connection costs of $550 to $600 per customer. 

source: Matt Nicholson Lewis 

The point is that even with subsidies, lower infra gear costs and new investment sources, the demand expectations for consumer services have been slashed as much as two thirds over the past several decades. Many ISPs no longer expect revenue contributions from voice or entertainment video sources, and must build their demand models based solely on internet access. 

The largest ISPs might still expect some revenue contribution from voice or video services, but seem to be modeling higher expectations for business connectivity or contributions to mobile infrastructure cost models. In other words, the cost of small cell infra is aided by the consumer FTTH investment. 

Ultimately, we will see whether  FTTH really underpins a business that provides a competitive moat, while throwing off predictable cash flow. It seems more likely that private equity could succeed in transforming a legacy copper-based access business into a fiber access business, with a boost in equity multiples that will justify the effort.

That might well be a different question than asking whether FTTH really is a real estate or infrastructure asset on par with airports, toll roads, electrical and gas utilities. Much of the bet relies on limited competition. The argument that the first FTTH provider in a suburban or urban market gets 40 percent market share is likely correct. 

That has a reasonable chance of being correct even if two equally competent providers operate their own FTTH networks in a market. 

Some believe the first-mover advantage in a rural market could be substantial enough to support higher market shares. 

But it remains a valuable exercise to ask whether the FTTH business model is sustainable on an operational business on the revenue scales now being seen. 

That is a different question than asking whether a private equity buyer can boost multiples--and then sell the asset--by replacing copper access with optical fiber access. 

As a matter of operating economics, it still seems unclear whether FTTH networks generating only $50 to $70 per month in residential revenue are sustainable, assuming legacy provider cost structures. A small, lean upstart should have an easier time, as embedded costs are lower than those found at legacy firms. 

Not Every Acquisition Works Out

Not every acquisition works. Not every asset disposition is driven mostly by profit taking. Sometimes loss limitation is at work. And though many institutional investors or private equity firms have one business model for telecom infrastructure assets, service providers often have a different model. 

That difference in models explains why many institutional and private equity firms now are buyers of assets while many service providers are asset sellers. WindTre might be next. Lumen and Telefonica are among recent sellers. So was Cincinnati Bell.

Telecom Italia could move as well. 

Because we can” or “because we should” might explain a good deal of asset disposition behavior in the connectivity business these days. 

Optus owner Singtel, for example, is said to be mulling the sale of a stake in its Australian access facilities, a move that would allow Singtel to raise cash. 

Such opportunistic moves--as always--are driven by a combination of seller need, buyer interest and a broader rise in the value of optical fiber access and transport assets for investors in search of alternative assetshttps. 

Low interest rates mean lots of capital is available, while high valuations for other traditional assets also are driving investor interest in lower-valuation, higher-return financial vehicles and something more akin to a private equity approach to investing by institutional investors such as pension funds. 

Buyer interest has grown the value of optical fiber assets or the ability to create them,  while sellers are enticed by such higher valuations to monetize access network assets as they earlier monetized cell tower assets. Singtel itself sold a majority stake in its Australia cell towers in 2021. 

No doubt owner's economics still are important. But the issue is whether full ownership is required to reap that value. In a growing number of cases, partial ownership seems to be viewed favorably.  

In other areas, co-investment deals are changing the economics of optical fiber investment. 

For a number of reasons, the business model for telco and cable TV fiber to home is changing. A higher degree of government subsidy support; a desire for investment in FTTH facilities as alternative investment and competitive dynamics in the home broadband industry all mean the business case for FTTH improves. 

As one example,Cable One is part of a joint venture with GTCR LLC,  Stephens Capital Partners, The Pritzker Organization and certain members of the management team to build optical fiber to premises networks by Clearwave Fiber.

Clearwave Fiber holds the assets of Cable One’s subsidiary Clearwave Communications and certain fiber assets of Cable One’s subsidiary Hargray Communications. 

At the same time as capital investment requirements are changing, there is a shift in the assumptions about business model. 

In the late 1990s FTTH was seen as the only viable way for telcos to take market share in the linear video subscription business from cable TV operators. So the revenue upside was subscription video and internet access speeds. To be sure, video arguably was seen as the bigger revenue driver, as late 1990s telco FTTH speeds were in the 10 Mbps range. 

Bundling (triple play or dual-play) also was seen at that time as the way to compensate for competition-induced account losses. While telcos or cable each competing across the voice, business customer, internet access and video entertainment markets might have fewer total accounts, revenue per account from triple-play services would compensate. 

But something else now seems to have changed. A decade ago, independent internet service providers began to attack the market increasingly based on one service: home broadband. To be sure, many independent ISPs tried a dual-play or triple-play approach for a time. 

But nearly all eventually settled on a home broadband-only approach. Since virtually all independent ISPs face both telco and cable TV competitors, the single-product business model makes some concessions on potential revenue that necessarily must be balanced by lower capital investment and operating costs. 

The latest developments are that such tradeoffs are seen as feasible even for incumbent telcos: in other words, the business model increasingly relies on broadband as the foundation, with some contributions from voice. Video (linear or streaming) plays a lesser or no role in revenue assumptions. 

There are other changes. Subsidies have been rising for broadband deployment, and that also changes the capex requirements. Some of the investment in optical fiber also is helped by the denser optical fiber networks necessary to support 5G networks. Essentially, the payback model is bolstered by the ability to defray some optical media costs from mobile service revenue opportunities. 

Also, 5G supports home broadband using the same transmission facilities as does mobile service, often offering a chance for mobile operators to compete in the home broadband business at relatively low incremental cost. That also helps lower the cost of fixed network FTTH as more revenue is wrung from the installed assets. To the extent that higher revenue produces incrementally higher free cash flow, more capital is available to invest in additional FTTH facilities.

The incremental cost of consumer home broadband is lower once a dense trunking network must be put into place to support small cell mobile networks. 

Also, the value of FTTH facilities has changed as rival investors (institutional investors, private equity) view consumer broadband as a legitimate alternative investment. That boosts the equity value of an FTTH network and supplies new sources of investment. 

Also, the cost of FTTH construction has improved steadily over the past few decades. Also, the expected reduction of operating costs from fiber networks, as opposed to copper networks, now is well attested. So there are opex savings. 

FTTH remains a challenging investment, nonetheless. But it is noteworthy that assumptions about the business model now have changed for incumbent and new providers as well. Where it once was thought an FTTH upgrade virtually required revenue from three services, in an increasing number of cases the investment can be justified based on home broadband alone. 

In greater numbers of cases, the primary value of home broadband is supplemented by some revenues from other sources. But where a triple-play might have produced $130 per month to $200 per month revenues, home broadband might produce $50 to $80 a month. 

That projects increasingly are feasible with a $50 monthly revenue target and adoption around 40 percent to 50 percent shows how much the capex and opex assumptions have changed.

When Private Equity Gets Involved, There Usually is a Problem

Private equity investors over the past couple of decades have mostly tended to get involved in ownership of telecom companies primarily during the Internet investment boom of the late 1990s, and generally in roles similar to that of venture capital.

Occasionally, private equity gets involved only in smaller or moderate-size telecom deals where there is distress of some sort. That has been the case for Portugal Telecom and Hawaiian Telcom.  

U.S. private equity firms Warburg Pincus and Apollo now are evaluating a bid to buy Deutsche Telekom’s T-Mobile Netherlands division, valuing the deal at more than 3 billion euros ($3.4 billion).

The lack of service provider bidders points to the nature of the issues. The Netherlands is a highly-competitive market with little room for growth, and which is consolidating.

One issue is that the Netherlands mobile market is saturated, with growth shifting to Internet access, especially as provided by triple-play providers lead by cable operator Ziggo and KPN, with cable operators gradually assuming a bigger role.

source: Telecompaper

KPN had about 50 percent of the mobile market in 2010, while Vodafone and T-Mobile each had

All markets in Western Europe, Ovum predicts, will see year-on-year revenue declines by 2019.

Western Europe will see a compound annual growth rates of -1.7 percent between 2013 and 2019.

All 17 Western European markets will see revenue decline over the next five years.

FTTH Payback Models are Way More Complex These Days

If you are the sort of person who has followed the investment case for fiber to the home over a long period, you are well aware that payback periods are moderately long. You might also profess a reasonable belief that the payback analysis has gotten more complicated of late. 

Among the reasons: more of the payback might come from business customers, arguably less from consumer customers. More of the payback might come from attributed value for owners of mobile access services and less from services for customers of the fixed network. 

There are new investors in digital infrastructure whose estimations are financial rather than as operators of such assets. Such financial investors might not be as riveted on longer-term operating value but rather a chance to boost the valuation of assets before selling to longer-term investors. 

All of that requires a more-complicated analysis than was the case 30 years ago, when the analysis might generally be more simple: expected revenue gains from consumer services.  

It no longer is so clear that a quick, high level analysis still hinges largely on consumer revenue per account, for example, even if that might represent the principal direct revenue sensitivity.  

For example, where it once was possible to estimate consumer account revenue at perhaps $120 a month, as was the case for internet service providers selling home broadband plus entertainment video plus voice services, many ISPs now report that typical recurring home broadband revenue is more on the order of $50 to $70 per month. 

So revenue sensitivity also is potentially different for firms with other contributors, whether that is the value for mobile revenue generation, business services or wholesale upside. Pure-play home broadband ISPs almost always must contend with lower revenue per account than multi-play service providers with meaningful voice, video or other revenue drivers, including incremental revenue from mobile services that the FTTH investment supports. 

Some multi-play providers, including cable companies, also must contend with a major platform change similar in magnitude to a copper access telco upgrading to FTTH, though always with higher per-account revenue assumptions than a pure-play home broadband supplier. 

Firm	Breakeven Years	Investment per Home Broadband Account, Triple Play or Dual Play	Revenue per Account
Shentel	5-7	$1,500-$2,000	$100-$150
Google Fiber	3-5	$1,000-$1,500	$70-$100
AT&T	7-10	$1,500-$2,000	$100-$150
Comcast	10-15	$2,000-$2,500	$120-$170
Private Equity	7-10	$2,000-$2,500	$120-$170

If we assume that home broadband is the sole revenue driver, and that customers will routinely buy service plans at the upper range of available service plans (gigabit per second or multi-gigabit service plants), the payback models are a little more stringent.

Firm	Breakeven Years	Investment per Home Broadband Account	Revenue per Account
Shentel	10-12	$1,500-$2,000	$70-$100
Google Fiber	7-9	$1,000-$1,500	$50-$70
AT&T	12-15	$1,500-$2,000	$70-$100
Comcast	15-18	$2,000-$2,500	$90-$120
Private Equity Investor	10-12	$2,000-$2,500	$90-$120

The payback models are worse if the typical ISP has only home broadband as the primary revenue source and recurring revenues are at the lower end of what investors expect, about $50 per customer account, to start with, growing over time to higher levels over time, allowing for some annual increases in revenue per account. 

Firm	Breakeven Years	Investment per Home Broadband Account	Revenue per Account
Shentel	15-17	$1,500-$2,000	$50-$70
Google Fiber	10-12	$1,000-$1,500	$30-$50
AT&T	17-19	$1,500-$2,000	$50-$70
Comcast	20-22	$2,000-$2,500	$70-$90
Private Equity	15-17	$2,000-$2,500	$70-$90

The payback case might be longer if one has to include borrowing costs to acquire assets and then invest in FTTH. And one might argue that no private equity firm will hold assets for the full period required to earn an expected return. 

Among the obvious other imponderables are the differences in asset valuation that might be the driver, not the payback period or the typical recurring revenue, but mainly the arbitrage on assets whose value is boosted. 

Competition, demand assumptions and therefore revenue-per-account expectations are different. The implied value for supporting core mobile operations now is a factor. Business revenue arguably is more dynamic. 

And investment objectives are a new issue for some classes of investors. 

The upshot is that FTTH payback models are much more complex than was the case 30 years ago.