The FTTH Cliff May Not Be Upon Us
September 5, 2023 | Recently, I was sitting in a meeting with the head of a large infrastructure fund. During the course of our discussion I was pitching ideas in different silos of the digital infrastructure space. It was interesting because this particular client was one of the few infra funds who does NOT have an investment in the fiber-to-the-home (FTTH) space.
When I broached that subject he looked at me and said:
“Jennifer – you have done this longer than me. Where we are right now is analogous to March of 2001 for the telecom investments and you remember what happened that dreadful June 2001 day…..”
My guess is many of our readers may not. That June 2001 day he was referring to was when the telecom bubble went “Pop!” While it was caused by WorldCom’s fraudulent accounting, it had ripple effects across every layer of telecom. It was a very dark time for the sector.
Leaving that meeting I kept thinking of this commentary. My instinct was to immediately agree because, while it has been 22 years, the scars from that period are still deep (at one point all 25 stocks I followed as an analyst added up to $67 in absolute dollars!).
But as I thought about this conclusion further, there was some sort of disconnect. Why? That little voice in my head kept going back to all the securitizations that have recently been done in the space. These should not be overlooked or ignored. In the “explain it to me like I am a 3 year old” description of what a securitization really is, here is a good two minute watch: What is Securitization? - YouTube.
In order to appreciate how they have recently impacted the telecom sector, one should look at the specifics of Frontier’s recent capital raise. Earlier this month, Frontier was able to raise $1.6B Asset Backed Securities (ABS) in debt with a commitment for an additional $500MM variable funding note. Perhaps most importantly, 80 percent of these notes were rated investment grade. While Frontier was the first publicly traded company to secure funds backed by fiber-to-the-home assets, others in the space have embraced similar structures (Allo, Hotwire, MetroNet and Ting). My strong guess is Frontier will not be the last deal of its kind.
In this transaction, Frontier created a wholly owned bankruptcy-remote special purpose vehicle to hold its fiber assets and associated customer contracts in the Dallas metropolitan area and receive all payments from existing and future residential and business customers. This ABS debt was secured against roughly 800,000 fiber locations.
Based on New Street’s calculation, Frontier is raising debt at close to 10x EBITDA. On a per home passed basis, this implies $2,600 per location. However, this includes 275,000 copper locations with penetration less than two percent. Assuming zero value here, New Street estimates the value per fiber location is $3,400. To put this in perspective, this represents roughly 2.5x – 3x the cost to build.
This brings up the obvious question. If there is more scrutiny, restrictions and (major) compliance on banks than ever, the banks (and their respective Investment Committees) must be very comfortable with the FTTH model.
In listening to the recent earnings call circuit, it was a comment from one of the companies in the vendor community which serves many of these FTTH players that gave me the ‘ah ha’ moment I was waiting for. When asked about the securitization trend sweeping the industry and how it should be viewed in regard to his customers’ longer term outlook he noted:
“I think anytime that a growth industry can gain access to investment grade capital for a portion of its future financing needs, that’s a good thing for that industry”
I could not have said it any better myself!
History is on our side here as well. For those who are too young to remember, the moment that the tower industry started to embrace the securitization market (and move away from the high yield market) was the milestone the towers needed to become the darlings of the telecom infrastructure space. The proceeds towers received from these securitizations were used to refinance existing debt, finance expansion, and fund acquisitions of other wireless tower portfolios. A 2018 Morningstar report noted U.S. asset-backed securities outstanding backed by cell phone tower leases were $5.9B and grew to $13.0B in 2018. We estimate this number is well north of $15B today. And, despite recent multiple compression in public tower stocks of late, many digital infrastructure investors still see the towers as the prettiest girls at the dance.
So going back to my original conversation with that client worried about the ghosts of 2001 coming back to spook us, the bank activity and enthusiastic acceptance of this model may be suggest that the future is not as scary as those days of old.