Notwithstanding the attention 5G garners, telecommunications companies—from large, diversified companies such as AT&T to smaller operators like Frontier Communications—still provide internet service to millions of customers over antiquated copper infrastructure. The traditional “playbook” used to manage these copper-based businesses was to run them for cash, merge them with similar assets to realize cost synergies, and use the cash generated to pay dividends to shareholders.
As an alternative strategy, investing to upgrade the copper networks to something more competitive was rarely seen.
This paradigm has changed recently, however, with a number of companies pivoting to aggressive investment programs to upgrade their copper plant to fiber.
Why the change in strategy?
- Copper is a dying technology; the speeds it provides are simply too slow to be competitive and the “tail” on the business is shorter than originally thought.
- Broadband-first models have enjoyed notable success, creating recurring, high-margin subscription-based revenue streams with attractive uptake rates in markets where they have been deployed.
- Upgrading to fiber “future-proofs” the network (there is no technological threat to fiber-based service).
- Multiples for fiber-based networks are robust.
We view this change in strategy as a positive for creditors. The cash currently being generated by the copper businesses is being invested to improve the network (a.k.a. our collateral), instead of paying out dividends to shareholders. And while there is near-term pressure on free cash flow as capital expenditures ramp up, we are comfortable with this trade-off to enhance long-term asset value.
We note that execution risks exists. Most critically, an assessment must be made regarding what portion of the legacy copper network can be upgraded, at what cost, and over what time period. While fiber-based data service is an attractive consumer proposition, there is a substantial “build and hope they come” element embedded within these projects. In addition, the evolving competitive environment, be it 5G technology or satellite-based broadband from companies such as SpaceX, points to potential competitive pressures in the future.
Notwithstanding the risks, we generally view these new fiber-upgrade strategies as an overall positive for creditors.