The North American telecom industry, long seen as a mature investment vessel, has undergone a striking renaissance over the last decade. Lenders and investors, including more than half of the 100 largest global infrastructure funds, poured hundreds of billions of dollars into the market, driven primarily by three forces:
The critical importance of fibre internet: With unmatched speed and reliability, fibre has become the cornerstone of the U.S. government’s effort to bridge the digital divide and ensure equitable access to high-speed internet, except in the most rural and remote areas.
The perceived stability of fibre investments: Fibre is future-proof and the ultimate upgrade to copper, which dates all the way back to Alexander Graham Bell. Hence, it can be considered an essential, sustainable, and long-lasting asset class.
Government funding: Over the past decade, tens of billions of taxpayer pounds have flowed into ambitious broadband deployment programmes aimed at connecting underserved communities.
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Notwithstanding this continued demand, investor focus is increasingly shifting as well to the data centre market, which promises higher returns. While fibre investment remains strong, lenders have raised concerns with fibre buildouts becoming more capital and opex intensive and an increase in overbuilds. These concerns can, however, be successfully addressed and overcome.
To reignite the fibre market, especially in rural unserved and underserved areas, the U.S. launched its latest government initiative, the $42 billion Broadband Equity, Access, and Deployment (BEAD) programme. Managed by the National Telecommunications and Information Administration (NTIA), BEAD intends to bring fibre networks to the most neglected parts of the country. The programme prioritises fibre buildouts, and fibre deployment makes up a majority of states’ use of funds. For example, Louisiana is allocating 95% of its deployment funds to fibre. Similarly, even for more rural states, fibre represents most of the funding for broadband buildouts – Nevada, for example, is using more than 80% of its deployment funds for fibre. But for all its promise, lenders must approach BEAD with caution.
The takeaway for lenders: The fibre industry has evolved, but its fundamentals remain unchanged. Companies still need substantial investments to deploy, operate, and monetise their fibre assets.
BEAD is a great accelerator, but it is also a hedge. The programme runs the risk of possibly damaging viable business strategies if fundamentals are ignored. For the reasons why, we just need to look at the recent past.
BEAD vs. RDOF: Those who don’t remember history are doomed to repeat it
BEAD is not the first taxpayer-funded broadband deployment programme, and past efforts have had mixed results. The Federal Communications Commission’s (FCC) $20 billion Rural Digital Opportunity Fund (RDOF), launched in 2019, shares BEAD’s mission to close the broadband gap. However, RDOF has faced significant setbacks, with many operators falling behind rollout milestones and others defaulting entirely. Delays or cancellations in rollouts negatively affect investors' growth and EBITDA projections, forcing them to potentially inject more capital than initially planned, especially on pricey network equipment. Similarly, lenders are discovering that the loans they issued carry a higher risk of default than initially anticipated.
In crafting the BEAD programme, the NTIA wisely leveraged lessons learned from RDOF in an attempt to mitigate slow rollouts, unrealistic bids, and defaults. While BEAD and RDOF share the same ultimate goal, BEAD is structured to avoid (at least some of) RDOF’s pitfalls:
Although the changes implemented in BEAD represent lessons learned and significant improvements over RDOF, receiving BEAD funding itself does not guarantee success. Many industry experts remain cautious, highlighting possible challenges that operators must address to ensure the programme's effectiveness. We've discussed some of the critical concerns around BEAD funding in a previous article.
The same cautious approach applies to broadband lenders, especially given the valuable lessons they learned from the setbacks of RDOF and other federal and state broadband deployment projects. While BEAD offers promising opportunities for return on investment, lenders must establish clear expectations and requirements to protect their capital and avoid making the same mistakes twice. We believe they can do so through a four-stage process.
Stage 1: Pre-application—The role of letters of credit
Lenders must carefully assess their involvement in broadband deployment programmes to ensure they are funding the right operators and protecting themselves against risks such as failure to deploy or bankruptcy. The letter of credit requirement, a key component of the BEAD application process, helps lenders make smart choices by validating an operator’s financial stability.
However, this assurance comes at a cost—typically 1-3% of the total guaranteed project amount. This means for a $50 million project, the letter of credit requirement could possibly cost lenders between $500,000 and $1.5 million annually, impacting project viability.
To address these concerns, lenders should:
• Scrutinise the operator’s business plan: Plans must incorporate contingency costs, realistic timelines, and compliance with municipal and regulatory requirements. For instance, many projects underestimate municipal coordination expenses, leading to delays.
• Manage cost risks: The downside of careful business plan scrutiny is potentially unearthing risks that could increase the cost of letters of credit. Operators might, in certain cases, even have to start paying interest costs before securing the bid, furthering project risk. To best protect themselves, lenders should balance out perceived risks with the financial burden. Additionally, lenders can turn to other financial instruments such as performance bonds or guarantees from institutions with strong ratings, such as those holding a Weiss safety rating of B− or better.
Striking the right balance between stringent financial requirements and cost efficiency is essential to maintaining competitiveness without compromising safeguards. Lenders should ensure that operators utilise the relaxed letter of credit requirements to decrease financial burdens and increase cost-efficient buildouts meeting programme timelines.
Stage 2: Disbursing funds—Comprehensive due diligence on BEAD operators
Before committing funds, broadband lenders must carefully evaluate whether operators have the capability and resilience to succeed. Does the operator have a track record of effective rollouts? Is their bid feasible under current market conditions?
Due diligence should focus, among other things, on:
• The operator’s historical performance: Investigate the completion rate and timeliness of similar projects. Operators with an 80% or higher success rate in prior engagements demonstrate higher reliability. For example, a third of RDOF investments failed, but defaults occurred not just because of failures to complete projects–numerous projects failed because of an operator winning a reverse auction but failing the “long form” review, resulting in a pre-authorisation default.
• Feasibility studies: These should address supply chain constraints, escalating material costs, and regional labour availability. For example, the broadband sector has seen fibre optic cable costs increase by more than 20% in the past three years.
• Community engagement evidence: Surveys or stakeholder meetings can highlight an operator’s alignment with local needs, enhancing project credibility.
• Contingency planning: Business plans should allocate at least 10-15% of the budget for unforeseen costs, such as inflation-driven material price hikes or weather-related delays.
Stage 3: During the project—Financial protection structures
To ensure broadband deployment projects are completed successfully, lenders must establish strong financial protection measures. These include safeguards that prevent the misuse of funds along with metrics that demonstrate project milestones.
Effective strategies include:
• Delayed draw: A delayed draw project allows broadband operators to only draw additional funds when needed, which manages cash flow more efficiently. Lenders can, for instance, set parameters tied to important project milestones for operators to access funds.
• Performance metrics: Track measurable outcomes such as the number of households connected, miles of fibre deployed, and adherence to timelines. Operators achieving 95% of their planned milestones are significantly less likely to face project disruptions.
By aligning broadband deployment funding with clear, trackable outcomes, lenders can mitigate risks and enhance project accountability. Regular monitoring mechanisms and collaboration with subject matter experts (SMEs) can help lenders detect early warning signs, enabling timely intervention.
Stage 4: Long-term success—Building resilience against failure of deployment, bankruptcy, or unforeseen circumstances
To lessen the risk of financial difficulties, lenders should adopt financial models that augment continuity and flexibility.
Key considerations include:
•Consider open-access network models: From an operator's perspective, open access in many instances fosters competition and can reduce costs, helping to address challenges with monetising underlying infrastructures. From a lender’s perspective, open access ensures that infrastructure can be easily used by other operators if the original operator exits or goes under. This can be even more valuable within an asset-backed security deal, where fibre networks together with customers can seamlessly transition.
• Structuring agreements with lien and collateral clauses: Prioritise lender claims on tangible assets, such as fibre networks or equipment, in the event of default.
• Securing comprehensive insurance policies: Include coverage for construction delays, natural disasters, and operational risks to protect against unforeseen setbacks.
Broadband lenders will play a pivotal role in the success of fibre rollouts. By asking these and other critical questions, conducting proper due diligence, and implementing robust financial and operational safeguards, they can most effectively secure their interests while empowering operators to fulfil the broadband deployment programme’s mission.
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