ILEC Anxieties Outweigh Impact of Stimulus

Catherine Moyer, director, legal & regulatory affairs, Pioneer Communications, &  chairwoman, OPASTCO

Catherine Moyer, director, legal & regulatory affairs, Pioneer Communications, & chairwoman, OPASTCO

December 16, 2010 – While federal broadband stimulus outlays will begin to have an impact on various rural pockets around the country in the year ahead, the state of uncertainty arising from economic trends and unresolved regulatory issues appears to be outweighing any positive impact generated by stimulus spending.

“These are uncertain times for everyone,” says Catherine Moyer, director of legal and regulatory affairs at Pioneer Communications who also serves as chairwoman of OPASTCO (Organization for Promotion and Advancement of Small Telecommunications Companies) and as a board member of CoBank, a cooperative bank focused on rural infrastructure.

When it comes to infrastructure investment, “people are looking at the long term and wondering if the cash is there,” Moyer says.

Shirley Bloomfield, CEO of the National Telecommunications Cooperative Association (NTCA), echoes Moyer, commenting, “There’s a huge amount of uncertainty.” There are even instances of companies who had applied for stimulus funding turning it down out of concern they won’t be reimbursed for costs incurred in advance of the government disbursement.

“A lot of people have been fronting money for these stimulus projects,” Bloomfield says. Given the state of politics and the emphasis on cutting spending to trim the deficit in Washington, she suggests it’s a legitimate concern to wonder, “What happens if the stimulus money is rescinded?”

Tempering this bleak state of affairs is the fact that in some localities, totally apart from any government impact, there’s enough competition, economic growth or some combination of both to drive spending on high-capacity networks, including ever more fiber-to-the-premises (FTTP) projects. Over 450 of the 600 network service provider customers currently using access platforms sold by Calix are deploying some portion of FTTP lines from the access modules, says Geoff Burke, senior director for corporate marketing at Calix.

“We’re seeing a bit of polarization amongst the IOC (independent operating company) customer base,” Burke says. “There’s a lot of ambiguity with regard to the economy and the future of USF (Universal Service Fund) funding.”

He adds it boils down to how operators answer three questions, and he suggests in all cases the answers point to spending now rather than waiting. “Will interest rates go lower than they are today is a key influencing question,” he says. “The reality is they won’t.”

Will competition be less robust at some point in the future? No, he says, considering cable and satellite aren’t going to go away while the coming of 4G opens up a channel for even more competition. And, thirdly, he asks, “Are my subsidies going to be any better than they are right now? No. They’ll be the same or less. There’s no better time than now to start network buildouts.”

For companies who see things this way, stimulus support at best is icing on the cake, since they’d be taking these steps one way or another. “Things are happening outside the broadband stimulus,” Burke says. “The momentum behind fiber access is very strong.” (See related story, p. 23.)

Chad Duvall, a principal in the accounting firm of Moss Adams LLP, agrees. “My speculation is that we’re seeing more investment in fiber-to-the-home and more loop-based investments,” Duvall says. “They’re trying to get the investments in place under the existing regime, knowing that, at some point, it will be cut off.”

This is smart business, he adds. “While cash flow is on the decline, operators have to invest today in order to preserve their long-term prospects,” he says. “They need to future proof their networks and hope the existing cost-recovery rules stay in place for the investment that’s already been made.”

Countervailing Forces

But for all the momentum that might be building in some areas, many companies see too many negatives in play to take the plunge on upgrades and expansion, and often those that do want to spend can’t find funds to borrow. One key factor is the revenue losses resulting from the attrition in voice subscribers lost to wireless substitution, cable competitors and other factors.

According to the 2009 Telegree Alliance Rural Telecom Industry Benchmarking Study, landline loss amounted to 3.4 percent in 2009. This trend coupled with other losses, such as a drop-off in the volume of voice traffic, produced a reduction in operating margins of 37 percent over the past five years, the study says.

“How do you put a 15-year loan program on a cash flow that is declining,” asks Rob West, senior vice president at CoBank. He says he sees little confidence that the National Broadband Plan will do anything to stem the continued decline in access revenue for rural telephone companies.

“CoBank and RTFC are looking at [lending limits] of two to three times debt to cash flow,” notes Bill King, president and managing partner at JSI Capital Advisors. “It wasn’t long ago that it was four to five times cash flow.”

Stimulus Impact

Things should be looking up, given the two agencies responsible for allocating broadband stimulus money have now identified recipients for the entire pool of $7.2 billion. This includes $4.7 billion from the Broadband Technology Opportunities Program (BTOP) fund administered by the Commerce Department’s National Telecommunications and Information Administration and $2.5 billion in congressionally appropriated grant money from the Broadband Initiative Program (BIP) administered by the Rural Utilities Service (RUS), which was able to expand the sum to $3.5 billion.

The BIP process was generally targeted to existing RUS borrowers in rural areas, while the BTOP grants tended towards mid-mile, sustainable broadband projects to bolster growth in economically distressed areas, upgrade services and to serve community colleges and public safety entities. BIP consisted of a combination of grants and loans, while the BTOP was exclusively grants.

“By leveraging our funding to provide loans as well as grants, we have been able to stretch our $2.5 billion appropriation from Congress to over $3.5 billion,” said Jonathan Adelstein, Administrator of RUS, in a speech he gave October 1 to NARUC (National Association of Regulatory Utility Commissioners). But, he added, it was far less than needed.

“Despite the record funding in the last two years, the demand from good projects outstripped the available funding,” Adelstein said. “In the broadband program we were only able to fund one out of ten projects. We had to make heart-breaking decisions. Some very good projects could simply not get funded.”

While RUS is not positioned as a lender of last resort, leaving so many deserving projects on the drawing boards doesn’t bode well for private funding, he said, given that “sources of private credit [are] extremely tight.” Indeed, he added “An important private sector rural telecommunications lender recently told the FCC that it was cutting back lending to rural telcos by 40 percent.”

While most spending of funds so far has focused on design and environmental review aspects of the projects, that’s about to change, says Sam Harlan, director of advanced technology for CHR Solutions, which provides engineering and other consulting services to service providers. “Stimulus effects might have an impact in 2011,” Harlan says. “Because the projects have to be completed in the [mandated] timeline, the next three years will be very busy and active.”

The equipment vendors echo this view. Occam’s CEO and president Bob Howard-Anderson, speaking to analysts on a recent webcast, said, “We anticipate service awards from the service providers to access equipment vendors will occur over the next two or three quarters with stimulus awards spread out through 2012.” He suggested that the access portion of the stimulus would be between 15 and 20 percent of the total awards.

Regulatory Uncertainty

In terms of the total impact on the market from government action, however, it can be argued that uncertainty arising from unfinished business at the FCC under the congressional mandate for a National Broadband Plan (NBP) has been a significant negative counterforce. In 2010 the FCC’s agenda included over 60 notices of proposed rule makings (NPRMs), notices of inquiries and task force projects associated with the NBP, with nearly half the items still pending going into 2011.

Most worrying to ILECs is the government’s intention to shift from exclusive reliance on voice-centric supplemental funding based on the USF and intercarrier compensation to a regime that includes the Connect America Fund (CAF) based on broadband cost analysis. Still in the NPRM stage, the proposed changes establish a far less certain funding mechanisms under CAF than has been the case with USF in the eyes of many companies.

For example, in a recent letter to the FCC, Kansas-based independent People’s Telecommunications said: “Peoples will require predictable and sufficient USF or CAF to continue providing affordable quality services to our rural customers. If the proposals, as set forth by the FCC in the Notice of Proposed Rulemaking are implemented without an adequate and sustainable USF revenue replacement, Peoples Telecommunications, LCC may no longer be considered a financially viable business because its ability to meet future debt service requirements will be seriously threatened.”

In a letter to FCC Chairman Julius Genachowski, Adelstein said: “RUS financing is dependent on sufficient, specific and predictable revenues. USF support and ICC [Intercarrier Compensation] are among the factors evaluated in virtually every RUS loan. Only 4 out of the 480 active borrowers of the RUS Telecommunications Infrastructure loan program did not receive rural high cost USF support.”

Adding to the anxiety is the fact that, with the attrition in voice subscribers, the USF contribution, at 15.5 percent, is at an all-time high, prompting fears that a debt-sensitive Congress will act to cap or even reduce the allowable percentage without there being a compensatory adjustment on the CAF side. “We find ourselves in a place where we’re waiting for the rulemakings to come out,” says OPASTCO’s Moyer. “2011 will be a very interesting time, especially over the next six months.”