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Defining the Broadband and Technology Future for Your State Transitioning to Internet in Rural America

Defining the Broadband and Technology Future for Your State Transitioning to Internet in Rural America. Michael J. Balhoff, CFA July 27, 2012. Background. Michael J. Balhoff, CFA Headed sell-side equity telecom research group (16 yrs ) Six annual Wall Street Journal All-Star awards

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Defining the Broadband and Technology Future for Your State Transitioning to Internet in Rural America

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  1. Defining the Broadband and Technology Future for Your StateTransitioning to Internet in Rural America Michael J. Balhoff, CFA July 27, 2012

  2. Background • Michael J. Balhoff, CFA • Headed sell-side equity telecom research group (16 yrs) • Six annual Wall Street Journal All-Star awards • Focused coverage of rural telephony and regulation • Balhoff & Williams/Charlesmead Advisors • Representative clients • Telecom: NCTA, Comcast, AT&T, Verizon, SBC, Embarq, CenturyLink, Frontier, FairPoint, Windstream • Energy: NorthWestern Energy, Anchorage ML&P • Financial Community: Merrill Lynch, Silver Point Capital • Recent briefings for White House, FCC, Secretary of Agriculture, Rural Utilities Service, NARUC, MACRUC ALEC, July 27, 2012

  3. Overview • The rural problem • Confused concepts—tax/subsidy v. investment • Confused beneficiary—companies v. consumers • Significant and ongoing investment • Little factual/financial discipline in assessing policy • Federal reforms affect the states • Significant cuts in federally-supported funding • States left to address problems with services and rates • Recommendations about state USF • The state’s choice is unavoidable • More rigorous analysis of problem and policy • Evaluate potential mechanisms to support investment ALEC, July 27, 2012

  4. The Problem ALEC, July 27, 2012

  5. Confusion: Tax or Investment • Critics use terminology that confuses/biases the dialogue • “Subsidy” is a payout to an individual or industry • “Taxes” are unpopular assessments • Support “inefficient LECs” (real beneficiaries: consumers) • Conceptual USF history—wide customer base supports ubiquitous network “investment” creating value for all • Easier concept when telecom was a monopoly • USF is even more critical, but complicated, in competitive world • Need to target USF on regions where competitive markets fail • USF/implicit support were not and are not subsidies/taxes • USF and ICC support are investments • Generate ROI in terms of social and economic benefits • Efficient investments supplement other investor dollars ALEC, July 27, 2012

  6. Policy Drivers of Higher Fund ALEC, July 27, 2012 ILEC non-access funding from $2.16B (’03) to $1.37B (’11) Total ILEC USF from $3.15B (’04) to $2.92B (’11) Growth in overall USF is due to new policy factors

  7. Rural Customer Networks Financial Performance of All Wire Centers without USF Payments • Texas Study (2007) on 350,000 rural lines excluding USF . . . • 77% WCs -9.7% ROI • 13% WCs 2.9% ROI • 10% generated 10%+ ROI ALEC, July 27, 2012

  8. Outside of Rural Towns Source: Balhoff, Rowe & Williams, LLC 2007 • More striking is the finding that outside of rural towns, 52% of the lines generate negative returns (average -7% return on investment) • Total uneconomic lines are . . . • All lines outside towns, which were 52% of the total • Plus 18% of total lines (in towns generating a negative return) • Equals 70% of total lines uneconomic without USF ALEC, July 27, 2012

  9. Discipline in Evaluating Problem • June 2012 rural broadband usage data • Wireless today is not a real BB solution • Net neutrality questions (wireline v. wireless rules) • Rates of $30-$60 for wired services that are unlimited • Wireless LTE—$100/month for 10 GB; $10/GB overage • Wireless: 20GB/month~$200; 30GB~$300; 40GB~$400 • Assumption about wireless fails the USF rate-test ALEC, July 27, 2012

  10. Focus on the Real Problem • Core problem in many rural areas—economic market failure • Critics say that “competition” will solve, however . . . • Verizon is getting out of rural business • AT&T announced it has no rural broadband solution • Cable avoids economically irrational areas • No one will bid where there is a market failure • The real problem is high cost to build/operate consumer networks in certain regions • Problem for large and small carriers • Greenfield builds will be expensive and probably risky • Cable, wireless, urban carriers do not have same problem ALEC, July 27, 2012

  11. Federal Reforms Affect States ALEC, July 27, 2012

  12. Approximate USF/ICC Reductions • Federal reforms (2011) • Rural USF/ICC rev. loss • Revenue reductions assume changes in HCLS, ICLS, Safety Net Additive, $250 per line per month cap, ICC reductions, and changes to ROR • The rural industry could have annual revenue reductions of nearly $1 billion in 2020 from reforms • Cumulative reductions could be $5.2 billion from 2012 to 2020 according to NECA Estimates by National Exchange Carrier Association ALEC, July 27, 2012

  13. USF/ICC as % of Total Revenues Source: Confidential company information; Balhoff & Williams, LLC ALEC, July 27, 2012

  14. Illustrative EBITDA Outlook Source: Estimates by Balhoff & Williams, LLC ALEC, July 27, 2012 • Simplifying assumptions • EBITDA margin = 33% • USF + access = 75% of revenues • Cost benefits of reforms = 0% • USF reform and effect of ICC reduces EBITDA margin in this illustrative analysis; the margin slips from 33% to 12.6% by 2020 • Interest expense (4%-6% of today’s revenues) would eliminate much of residual cash flow by 2020, leaving ILEC with little cash for capex or principal repayment

  15. Recommendations ALEC, July 27, 2012

  16. Understand the Outcomes • Operating • Reduced or eliminated near-term capital investment (likely no increase) • Proximate reductions in personnel and other operating costs • Financial • Increased cost of capital • Insufficient recovery, skepticism/avoidance of sector by debt and equity investors • Consolidation may occur (complicated by financial risks/potential bankruptcies) • Customer service • Growing urban-rural divide in terms of investment/telecommunications services • Rates will rise for rural services less-than-comparable to those in urban areas • Policy • COLR becomes more problematic due to underfunded or unfunded mandates • Services will no longer be “comparable” in urban and rural regions • Private-public partnership fails; no one may bid at reverse auctions ALEC, July 27, 2012

  17. Specific Recommendations • Focus state policymakers on reforms • Reforms’ effects on all state consumers • State USF investments • Analyze and understand the policy issues • Escalating rural customer demand for BB services • How economic welfare can be achieved most effectively • Understand the options in terms of state mechanisms • Dollars required for state supplemental funding • How funding might be collected and distributed ALEC, July 27, 2012

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