The last three years have seen a large amount of activity in the telecoms infrastructure market in the UK, boosted by the rise and energy of alternative network providers (the “altnets”). However, with only 14 per cent of premises benefiting from FTTH, there is still a huge need for investment to meet government targets for fibre roll out and gigabit broadband. Investments have intensified in the last 24 months and CMS has worked on several headline grabbing deals for major altnets, infrastructure investors and senior lenders. In an article in November 2018 in JIBFL , we reflected on the characteristics of the then emerging hybrid financing for fibre roll outs. Two years later the trend has firmed up, though the actual parameters of each deal remain very different with the effect that the market has not yet commoditised. These are our 5 big take-aways from recent deals:
1. Fibre Assets as a “new” class of Assets
There are three main physical characteristics of fibre networks that need to be considered on a fibre financing transaction.
Fibre network assets are mainly a mixture of moveable property: fibre optic cables, ducts, subducts, chambers, other electronic apparatus. These can be more or less generically described. The difficulty comes when networks also contain rights of use over other entities’ networks. If such rights are integral to the network being financed, due diligence will need to be carried out to understand their terms, their longevity, their costs and whether they can be validly offered as security.
Another recurring challenge for funders is how to establish the location of fibre network assets over which they are purporting to take security. This is crucial to establish ownership in particular. Maps play a decisive role in this respect and whereas their absence is not necessarily fatal, it will cause considerable additional difficulties and delays on a deal. Even with a map, the main difficulty is that the fibre assets are often buried underground at an uncertain depth and alongside other utilities, pipes and networks. So shy of digging, the exact location of the assets may not be known at any one time, making the idea of perfecting security by putting a plaque on the assets (as might be the case for other moveable property) utterly impractical, if not impossible.
The requirement to dig also presents additional issues in terms of access for the purposes of lifecycle maintenance and upgrades, and the usual provisions in finance documents requiring access to be granted to secured assets. It is self evident that one cannot dig manholes on a whim. On public highways, the highway code will need respecting and relevant permissions may need to be sought. On private land, the company will have to ensure that it has appropriate wayleave agreements in place (which funders will want to due diligence). Either way, provisions relating to access requirements will need to be drafted carefully to ensure that they do not overreach what a company can give.
2. Interconnectivity with other Infrastructure
Fibre networks are rarely built in isolation and will often rely on the infrastructure of another entity. For example, networks may be built using BT Openreach’s poles or ducts or require access to exchange buildings. Other infrastructure networks may also be used such as electricity, rail or even sewer networks, but in practice this is less common (and the Government is considering this further as part of its review of the Access to Infrastructure Regulations). The reason for this is that most FTTH networks built by altnets are ‘last mile’ networks and therefore will rely on other infrastructure to reduce the time it takes to build the network and to bring down construction costs. Anything that speeds up realisation of an investment will help with bankability, but it comes with its own set of considerations.
It will be vital for funders to understand the dependence of the fibre network on the other infrastructure: what would happen should the contractual arrangements enabling the use of the external infrastructure terminate, could it be easily replaced, how would a failure in such infrastructure affect the fibre network and what rights does the network owner have or need, etc.? Depending on materiality, it may be necessary to build in covenants, or even prepayment events, to prevent or deal with issues linked with the underlying infrastructure.
In this context, and coming back to our earlier mention of access, gaining access to the relevant fibre network will mean respecting the arrangements in place with the owners of the underlying infrastructure. Investors will want to know that network owners have appropriate access rights to carry out any necessary repairs or technology upgrades that might be required during the network’s asset life.
3. Homes passed / Homes connected as Financing Triggers
Financing arrangements relating to new build fibre roll outs may have varying triggers for the deployment of capex facilities (conditions precedent to a loan) and to measure success/health (financial covenants), but the vast majority of deals where the network is to be used for retail services will contain references to ‘homes passed’ and ‘homes connected’. These concepts need to be carefully defined to ensure the borrower has access to money when it needs it to fund the roll out but also at the same time so the lenders can ensure that the borrower delivers the roll out at a manageable pace and with a level of market risk which is within the parameters of the lenders’ credit conditions.
The concept of ‘homes passed’ is fluid and will be bespoke to the particular circumstances of that transaction and the network owner’s business plan. The intention being to introduce a measure to establish whether the network is sufficiently near to homes so that once the network is developed enough those homes can be counted as a potential new customers. There are all sorts of refinements possible here by reference to distance, cabinets, poles, etc.
The homes passed concept is a fundamental measure of the physical extent of the deployment. However as a measure of success, it is limited if the network exists but is not used by paying customers. This is usually indicated by the number of ‘homes connected’.
The concept of homes connected, by contrast to the concept of homes passed, is “relatively” simple as it entails a subscriber paying for connection services. The higher the percentage of homes passed that will, or are likely to, become homes connected the more certainty of income there will be which will help with the bankability of a project. There are however some niceties that can be introduced. For example, whether homes should be counted as ‘connected’ where everything is operational and ready for service but they have yet to formally subscribe for services. This will be important for borrowers where it is unrealistic to expect customers to sign up to pre-sale contracts in advance of the network being completed and if there is little or no existing competition which could in a down side scenario adversely impact take up projections.
However, this may not work for lenders where they are funding a more targeted network build to a particular site or development with a high risk of overbuild or in a rural location where capex costs are high.
An additional element of complexity is how to count multiple-unit dwellings and at which point units in such dwellings count as homes passed or homes connected. Again, there are varying points of reference here depending on the deal and the specificity of the relevant network.
4. Wholesale Agreements
Whilst the concept of homes connected is a good measure of future income the reality of contracted revenues can be more complex particularly in the retail market. It will be important for a fibre network owner to have a wholesale agreement with an operator, or better still, to be neutral and have a number of wholesale agreements. Such wholesale agreements are highly valuable and, depending on their tenure and the credit profile of the counterparty, highly bankable. Whilst overall returns may be lower than a pure retail offering, the reduced market risk and longer term more stable returns of such wholesale agreements will be particularly attractive to institutional investors looking to invest in infrastructure categorised as core (especially since the COVID crisis).
These agreements are often heavily negotiated and their provisions will be carefully diligenced by investors. During their negotiation it will be crucial for the network owner (whether it has current secured debt financing, is negotiating some in parallel or envisages that it will have some in the near future or during the life of the wholesale agreement) to bear in mind provisions which may impact or be viewed negatively by lenders – such as termination provisions and revenue re-openers – and, at the very least, allowing disclosure to financiers and security to be taken over the contract.
Depending on the materiality of the wholesale agreement for the business and its cashflow, the operator may be designated as an anchor tenant and various protective provisions may be required in relation to it (and its parent guarantor and/or any third party bond provider (if applicable)). These provisions might range from events of default in case of insolvency and insolvency events to “softer” controls around maintenance of the credit worthiness of the relevant operator with a decrease triggering a cash trap or cash sweep.
Certain specific provisions in the wholesale agreement may have an impact on the terms of the financing documents. For example, if delays to completion of the roll-out could result not just in termination of the wholesale agreement but also in financial penalties being incurred (which aren’t passed down to sub-contractors) or a decrease in revenues, the funders may look to introduce early warning triggers into their finance documents so that there is an opportunity to resolve any such issues. Another example would be provisions dealing with any letter of credit or bank guarantee provided by the operator for the benefit of the network owner.
The final recurring point is whether direct agreements should be sought between the lenders and the operators. This is often the subject of debate but heavily resisted by the borrower, especially in the context of hybrid financings where the borrower may be looking to exploit multiple revenue streams and require the flexibility to change operators rather than being tied into one contract that underpins the whole financing (as would be the case in a more traditional project financing structure).
5. An Evolving Regulatory Environment
Financiers to fibre network must understand the regulatory environment in which the network owners operate. This is relevant to understand the financial prospects of the borrower, and whether the regulatory context supports its business ambitions, e.g. with appropriate investment incentives or measures to facilitate network roll-out, such as Ofcom has been introducing in the UK. It is also relevant to understand what risks a network operator faces.
Facilities agreements usually contain obligations on borrowers to comply with existing regulation and have any relevant authorisations or permits required to exercise their business in place.
Certain regulatory powers or authorisations may also come “with strings attached”, which may need to be dealt with. For example, for the purpose of Code Powers (which include rights to install equipment on private and public land, including on public highways without a streetworks licence), companies are required to have ringfenced funds in place to fund any liabilities due to public highways authorities in the event of e.g. insolvency. These can be provided in the form of bank guarantees, performance bonds, letters of credit or even cash collateral. This will need express permissions and possibly security carve outs.
Subsidies also require consideration to the extent a specific company relies on such subsidies, especially if it does so materially. In the UK, subsidies include those administered by Building Digital UK (BDUK) as well as various voucher schemes, such as the Gigabit Broadband Voucher Scheme or the Rural Gigabit Connectivity Programme. Assuming this is acceptable from a credit perspective, a funder will want to understand the terms and conditions of the relevant subsidies and the consequences of failure to meet conditions. Early warning signs and penalties may need to be drafted depending on how badly breaches or changes in circumstances may affect the business.
Finally, the growth of (foreign) investment controls is particularly relevant to the telecoms sector, and can have important repercussions for an investor’s exit strategy, impacting the pool of available buyers, if the operator’s network or assets are regarded as sensitive by the Government. In the UK, a new National Security and Investment (NSI) Bill was introduced to Parliament on 11 November 2020. If adopted in current or similar form, it will bring about a wholesale reform to the current regime by introducing a hybrid mandatory and voluntary regime. The Government is currently proposing to introduce mandatory notification requirements for certain transactions in 17 sectors, backed by wide-ranging powers for the Government to “call in” transactions for review. Communications is included in those sectors, and the current proposed definitions, which the Government is consulting on until 6 January 2021, would essentially capture any public or private electronic communications network or service.
Some Final Thoughts
The ongoing coronavirus crisis has made it clear, if it was not already, how critical our communications infrastructure is and how vital it is to upgrade it to make it fit for the digital economy and the future. Telecommunications is one of the winners from the lockdown restrictions and the deal pipeline for fibre roll out financings sees no abating. With participants adopting such diverse business models there may never be a ‘one size fits all’ approach to the terms on which investments are made. Nevertheless we expect the above trends to slowly consolidate and the most efficient formula to emerge to fit specific parameters.
 “TMT Finance: communications infrastructure finance” by Anne Chitan, Katie Duffield and Charles Kerrigan, Butterworth Journal of International Banking and Finance Law, November 2018, pp639-641.