Infrastructure and institutional investors are increasingly turning their attention to digital infrastructure assets and the global rollout of fibre broadband. Fibre-to-the-home in particular is seen as an essential component of digital transformation and as providing a large pool of investment opportunities.

Though the sector has traditionally been dominated by telecoms players, recent years have seen more interest and deal activity from infrastructure investors and their lenders.

Investments can take a number of forms, such as individual projects underpinned by project finance structures and bank debt, or through equity investments in specialist fibre developers. This has led to buoyant M&A activity. Recent examples include:

• the sale of a 50% stake in Covage (an owner of 45 European networks) by Cube Infrastructure to Altice Europe (which comprises several infrastructure funds managed by AXA Investment Managers, Allianz Capital Partners and OMERS Infrastructure); and
• the sale by TalkTalk of its subsidiary FibreNation (owner of UK networks) to CityFibre (owned by funds managed by Goldman Sachs infrastructure fund and Antin Infrastructure Partners).

DLA Piper acted for Cube Infrastructure and TalkTalk on those deals.

All this activity is unsurprising. Infrastructure investors are increasingly categorising this asset class as “core” infrastructure (in the case of PPP deals where payments are paid or guaranteed by government) or, at the very least, as “core+” where there are elements of market risk. Depending on how a project is structured, this asset class could satisfy many of the criteria investors are looking for, such as:

• high barriers to entry;
• long-term and stable returns;
• recognised and established technology; and
• transparent and stable regulatory environments.

Various rollout strategies and business models can be used for the build and rollout of a fibre network. For example:

• a mass residential build v enterprise-focused builds covering metro areas or business parks;
• targeting defined coverage areas where there is less competition v taking a more widespread coverage strategy; and
• a rollout done on an entirely commercial basis v with public support of some kind.

Key issues for a network rollout

The strategy for network rollout and the inherent characteristics of fibre-to-the-home builds can affect whether an investor can achieve a stable long-term income stream. Here are some of the issues:

• Timing considerations. It takes time to build a fibre network, including building out network coverage to scale to reach more customers. The rollout of a mass residential fibre network can take longer, delaying the provision of access to customers, and also the realisation of investment. On the other hand, a more targeted enterprise build or a business park rollout can be more self-contained, and speed up realisation of your investment. Perhaps easiest of all is to incorporate a fibre build into a new residential or business development.

•  15-20 year payback periods. Fibre networks typically have a lengthy payback period given the high construction costs – perhaps 15-20 years.

• Asset life. The expected useful life of the typical optic fibre asset is as much as 20 years or more. Such a long tenure leads to the possibility that equity investors could seek to maximise the upside after the repayment of bank debt. Though fibre is generally more reliable than the copper alternative, this can still mean that repairs might be needed over time, and it’s also likely that significant technology upgrades will be required during the period.

  Usually, these upgrades can be achieved without needing major new civil engineering works (because the equipment used to “light” the fibres can be upgraded without the need for work on the fibre) and this should be modelled as part of the overall project costs.

• Market Risk and Subsidies. Depending on the type of rollout, there may be significant market risk – i.e. no assured base of customers for the network after the build is complete – especially if building out a fibre network in areas already covered by incumbent (or other) providers of fibre, where there may be competition. This means that investors will typically have to accept a significant degree of risk when compared with other types of infrastructure asset, such as a power station, where very long-term offtake agreements can be reached.

  More targeted fibre network builds – such as rollouts to business parks, new developments or specific enterprise locations like supermarkets and retail sites – may mean more certainty of income after the build is complete. It may be possible in these cases to get large enterprise customers to sign up for at least medium-term contracts as pre-sales in advance, in order to guarantee some income stream that may improve the bankability of a project for lenders. If the build is in a remote or rural area it may also be possible to obtain a public subsidy of some kind – subject to state aid rules – which can mitigate this risk significantly.

• Retail competition among fibre providers is based largely on price. Competition in the retail fibre market is largely commoditised: based on price, and retail prices for the same amount of bandwidth can change, perhaps quite significantly over the life of the asset. Due to long-term payback periods, this can increase the uncertainty of returns. Despite this, the average revenue per user for fibre broadband in Europe has been roughly stable at an average of EUR22 per month over 2011-2018.¹ As technology improves, customers expect greater bandwidths, meaning there will be a need for upgrades to the network infrastructure – but they also appear willing to keep paying a roughly constant amount.

• Technology obsolescence risk and 5G. Fibre is the current gold standard, and the current focus in many markets is on upgrading networks to full fibre (i.e. fibre to the home, from the exchange all the way to the end user’s premises, rather than fibre to a street cabinet and then legacy copper for the last stretch).² It seems unlikely that a newer and better technology will be developed in the next 10-20 years to replace it. That said, 5G mobile technology may represent a threat to elements of the retail broadband market – customers may find they can use 5G instead of a fixed connection to their homes. Although this is a risk to some fibre business models (especially those focusing on the residential market), even 5G will still require much more fibre to be built,³ albeit to serve multiple 5G base stations rather than homes. It’s also possible that the global trend in recent years of rapid increase in demand for fixed bandwidth to homes and offices will mean that even 5G will not be a suitable substitute for a fixed connection (which will likely always be faster and more reliable than wireless ones).

• Regulatory dynamics. The regulatory background is critical to a successful investment and investors will need to understand thoroughly both the position and likely changes over time. In the UK, for example, OFCOM has indicated it will, in most areas of the country (those said to be “potentially competitive”), require Openreach to offer a basic “anchor” broadband service at a regulated price (see our blog on fibre regulation in the UK). The level of this price and the areas in which it applies could have a significant impact on a competing provider’s business case.

  Regulation can also assist with build costs – for example, where an incumbent is obliged to offer access to its ducts and poles at a regulated price, this can mean a new fibre company can build out their network more cost-effectively and quickly. Of course, this also reduces costs for competing networks too, reducing the advantage that would otherwise be obtained by building a new network. In the EU, it may also be possible to take advantage of the (very complex) rules on “co-investment” so as to enter into a partnership with an incumbent operator to build a new fibre network and then have that new network protected from access regulation (see our blog on co-investment models for broadband infrastructure).

• Wholesale/retail. The owners of a fibre network will need to decide whether to offer wholesale or retail services, or both. If they offer retail services they will need to engage a sales and marketing team and invest in customer support. It could be difficult to do this successfully, especially if they’re trying to do so over a large area of the country. Offering wholesale services, on the other hand, can eliminate the need for these elements, and can reduce market risk (especially if combined with a medium-term financial commitment from a retail partner) – but naturally this is likely to mean lower returns overall, because some of the value will be captured by the retailer. 

Though some of these features could be new to some investors into the sector, we expect that the increasing sophistication among infrastructure investors coupled with the growing demand for rapid internet speeds to power the digital transformation will mean that an increasing number of infrastructure investors will seek to enter the market or consolidate their existing interests, particularly through M&A transactions.

Notes

1. Statistica (2019), average revenue per user of fixed broadband in Europe from 2011 to 2018
2. For example, the UK government has set a goal of achieving full fibre coverage by 2033
3. Ciena, 5G Wireless Needs Fibre, and Lots of It