Cook County Fiber To The Home

Doug Dawson, of CCG Consulting provides a summary of the financial and customer considerations that went into creating the business plan for the Cook County Broadband network project.

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Business Plan Summary

CCG Consulting has prepared a full business plan for the fiber project. CCG has over 375 clients and has prepared over 200 business plans for clients. The business plan begins with the engineering study prepared by CCG. This engineering study placed a fiber on every street and road in the County. CCG looked at local construction costs using recent construction done in the County by Arrowhead electric. Arrowhead also had a thorough knowledge of such issues as easements and rights-of-ways, and the cost of obtaining these was included in the study.

How can one judge if a business plan is sound? Municipal ventures are judged in a different way than commercial ventures. Commercial ventures are judged by two financial measurements – the ability to generate cash and in having a positive net income. These are the parameters that banks and Wall Street look at commercial ventures. However, municipal ventures are measured in a different way. The typical municipal venture is considered successful if it is able to repay the debt borrowed to finance the project. Further, a municipal venture is expected to generate enough cash to keep the business self-sustaining without needing additional cash from the government.

How does the proposed broadband business look in Cook County? Every new start-up business loses money until it reaches a point where revenues surpass operating expenses. One of the ways to measure a business is to look to see when revenues exceed operating expenses, that is when the business is covering the cost of daily operations. This is measured by looking at a financial ratio called EBITDA, which is earnings before interest, taxes, depreciation and amortization. EBITDA looks at revenues minus direct operating expenses. The new business is Cook County is expected to have a positive EBITDA by the end of 2011, meaning that by then the revenues should be greater than operating expenses.

The other way to look at a new business is by looking at the ability of the business to generate cash. In order to generate positive cash a business must cover operating expenses, the cost of debt and the cost of adding yearly new assets for the network. The new business projects to be cash positive by 2012 and remain cash positive into the future after that. This is somewhat fast for this type of business and can be credited to the fact that the grants should pay for most of the project, lowering the amount of debt that must be covered directly by the project. The current business plan projects that the project will generate $13M in cash over the life of the bonds. The business plan already includes routine reinvestment of capital into the business to keep the technology current. This extra cash could be used over and above routine capital budgets to make improvements to the network. However, the excess cash could also be returned to the County government, although this is generally not allowed until bonds are retired. Most systems with excess cash first use the cash to pay off bonds early before returning cash to the government.

This business is rated by CCG to have a high chance of success. There are several factors for this positive assessment. First is the results of the residential survey which show that over 90% of the residents of the County say they would strongly consider buying products from this new network. This positive response is further strengthened by looking at the demographics of the County. This network will be bringing needed services to those living outside of Grand Marais and one would think that a very large majority of customers in the County would buy services from the network. Further, the products offered on the network will be a better value than the products currently available in the County, so residents of Grand Marais should also find the network attractive.

Network Costs

The estimated costs to build the network and operate the business are as follows:

The largest individual cost of getting into the broadband business is the cost of the fiber network. Unit prices for construction are based upon a completed cost per mile and include rights-of-ways and easements, permits, construction materials, construction labor, inspection and splicing. These costs estimates were derived by the use of a detailed engineering estimating tool that estimated costs of each component of cable cost including cost of materials, hourly labor rates, etc. The grant financing requires that any project funded by the grants pay a ‘living wage’ which is a wage level calculated for every County in the country. The costs for fiber construction, shown on a per mile basis is:

• $39,585 per mile of aerial fiber. The project will be building 325 miles of aerial fiber.
• $54,369 per mile of buried fiber. The project will be constructing 187 miles of buried fiber, all on the backbone network.
• The model also includes fiber drops to customers estimated to cost $1,386 for a resident and $1,293 for a business each, installed.

The new business will be buying and renovating an existing building and renovating to act as a central office hub. There are several buildings in the County that meet the requirements, with a total cost for purchase and renovation of $1,015,000. This is estimated to save $500,000 compared to the cost of constructing a new building. The network will includes six neighborhood hut sites for FTTP electronics priced at $80,000 each.

The projections also include a cost for network electronics needed to light the fiber and to control the routing on the network as follows:

• Two Core MPLS routers at $250,000 each.
• Two GigE routers at $92,500 each.
• Six OLT chassis in huts costing $65,000 each plus 21 initial OLT cards costing $36,000 each.
• Seven EDFA chassis and numerous cards and fiber splicing averaging about $81,000 each.
• Residential ONT devices at customer sites at $547 each, installed, and business ONTs at $2,468.
• A new voice switch priced at $650,000 installed.
• A cable TV headend capable of providing analog and digital channels at $2,285,000.
• Digital settop boxes costing $173 each and DVR capable settop boxes costing $480 each.
• Furniture and computers for thirteen new employees
• $500,000 in inventory consisting of spare fiber, spare cards for the various electronics and some settop boxes and ONTs.
• A provisioning software system costing $350,000 that is used to convert a customer order onto the triple play hardware.
• An OSS/Billing system for $700,000 that does things like taking order, tracking installations, taking trouble reports, tracking hardware, issuing installation orders, etc.

Revenues

The first sales to customers are expected by October 2010. Sales will slow in the beginning while the new business makes sure that the network is functioning properly. Sales are projected to go rapidly in 2011.

Revenues for the project were based upon setting rates that are a little cheaper than the rates in Grand Marais today. The concept is to provide products that are a little cheaper than the competition while also being enhanced. Of course, the first enhancement is providing the products on a high-quality fiber network. The cable picture should be cleaner, the telephone calls clearer and the data speeds much faster than what is available today. However, there more enhancements in the plan:

• Telephone service will come with a number of features included in a basic line. The County also plans to offer a flat-rate unlimited long distance package.
• Cable TV will offer more channels than Mediacom.
• The cable system will also have the latest bells and whistles. The initial launch will include around 60 HD (high definition channels which will have great clarity delivered over fiber. The system will include pay-per-view movies, sports events and special events like wresting. The system will offer a DVR box that will let you record shows to watch later. Probably yhe biggest enhancement will be Video on Demand (VOD). VOD will offer the ability to view a huge number of shows and movies at any time. For example, if a customer subscribes to HBO, then many of the shows and movies shown on HBO are available at any time. Shows on VOD can pause, fast-forward and rewind like a DVD player. The most exciting plan for VOD is to work with various groups in the County to produce local programming. These local shows, things like high school sports, school plays, government meetings, parades, little league games, etc, will be available to watch at any time, for free.
• Data speeds will be spectacularly faster. First, the data products to the Internet will be symmetrical, meaning that the upload speeds will be as fast as the download speeds. This will give customers the chance to participate in truly interactive processes with the ability to receive and send data simultaneously. The speeds offered also will be ‘honest’ speeds, meaning that the advertised speeds will almost always be the speed the customer actually gets. In copper systems customers very often get lower speeds than they have purchased.
• The County also plans to offer an Intranet within the County. This means that any customer that buys internet access will also get a free 100 Mbps connection to anybody else on the fiber network. Over time we believe that the businesses, organizations and citizens in the County will find all sorts of uses for this kind of connectivity. This feature makes this network the equivalent of any network anywhere in the world.

The business plan relied on the following basic prices. Note that there were many other products in the business plan, but these are the primary ones that drive most of the projected revenue.

Video

Expanded Basic Cable (67 channels): $48.00

Digital Cable: 185 channels for $60.00

Digital Settop Box: $5.00

Movie Channels: $12.00 each

DVR Service: $13.00

Premium HD Package: $5.00

Internet

Residential

10 Mbps Download, 10 Mbps Upload $29.95

20 Mbps Download, 20 Mbps Upload $39.95

30 Mbps Download, 30 Mbps Upload $74.95

Business

10 Mbps Download, 10 Mbps Upload $64.95

20 Mbps Download, 20 Mbps Upload $99.95

50 Mbps Download, 50 Mbps Upload $199.95

Telephone

Residential Service: $18.44

Business Service: $36.84

Long Distance – By-the-minute, 5 cents, no minimum commitment

Unlimited long distance - $20 per month

Calls to Canada, most of Europe, most of Mexico – 5 cents per minute

Expenses

There was a detailed analysis by CCG to estimate the cost of operating the network. Again, CCG has a lot of experience in helping the launch of new networks, but CCG also works closely with many clients who have been offering the triple play for many years. This experience helps CCG understand the true cost of operating this kind of business. Many of CCG’s clients use the CCG models as budgetary models after launch because of the great detail within the models.

Following are some of the major expense assumptions:

• CCG projected that the business would require thirteen employees. The model contains projected salaries and benefit for the employees. The County is planning on working with Boreal Access to function as the general manager on the project. Some of these thirteen jobs represent existing positions are at Boreal that would wrap into the project, while most of the positions are new. It is anticipated that twelve of the positions would work at Boreal while one new position for an accountant would be at the County (who will keep the books for the business).
• Pole attachments are needed to connect to existing poles at $17 each per year. Arrowhead Electric currently owns 8,562 poles while the electric company in Grand Marais owns 450 poles. A very small number of poles are owned by Great River Electric.
• Internet backbone expense at about $60 per megabit. This is the cost of buying wholesale Internet access out of the twin cities. If some of the other grants proposed by other entities get approved this cost could drop to $20 per megabit.
• Programming costs to buy TV networks were estimated at industry prices. It is assumed that the new business would join the National Cable television Cooperative, which is where all small cable companies have banded together to buy programming. This Coop I now large enough with over 14 million customers that they get rates as good as the large cable companies.
• Various types of interconnection costs were estimated to connect to the voice network.
• $200,000 of marketing expenses were estimated during the first three years.
• $520,000 of consulting costs were projected during the first three years.
• The plan also includes $240,000 of unspecified start-up costs during the first year to cover unexpected costs.
• The plan includes general operating and maintenance costs for vehicles, computers, electronics, and fiber.
• Costs were estimated for accounting , legal, insurance, human resources and other overheads.
• Billing is budgeted to cost $160,000 by the third year, which includes maintenance on billing software.
• The business plan includes the interest and principle payments on the expected bonds.
• The business would incur no taxes since the County is tax exempt.
• However, by law various taxes will still be billed to customers.

Cost of Debt

The business plan assumes the County will receive a federal grant that will pay for most of the project. Further, the business plan assumed that the project would receive $9M in funding from the 1% sales tax initiative and would require a bond of around $9M to finance the rest of the project.

The business plan model assumed an interest rate of 5%. It would be expected that the bonds to finance the project would be sold in early 2010. There is no way to guarantee what bond rates might be by early next year, but the County’s bond advisors looked at current bond rates in early September 2009 and they see several bond alternatives that are lower than the projected 5% rate.

Customer Penetration Rates

One of the key assumptions in any business plan is the number of customers projected for the business. This business plan looked at the following customer penetration rates by the end of the third year of the business (2012)

Telephone

Full-time Residents 60%

Seasonal Residents 44%

Businesses 45%

Cable TV

Full-time Residents 70%

Seasonal Residents 50%

Businesses 19%

High-Speed Internet

Full-time Residents 68%

Seasonal Residents 49%

Businesses 64%

How can we put these penetration rates into context? One thing we can do is to compare the residential penetration rates to what residents told the County in the recent survey. That survey produced the following results:

Question: Would you buy telephone service from a local provider if they could save you money?

Yes 92%

Maybe 6%

Question: Would you buy TV from a local provider if you could save money from your current bill?

Yes 77%

Maybe 16%

Question: Would you buy high-speed Internet from a local provider if it could get much faster upload and download speeds at a discount from DSL prices?

Yes 81%

Maybe 11%

Question: Would you switch your TV, phone and data services to a local provider if they offered each service at a lower price than you pay today?

Yes 90%

Maybe 8%

It has been CCG’s experience in the past that a well-designed customer survey is a good indicator of the eventual success of a broadband business. CCG has conducted numerous surveys and has then seen how these businesses perform in the marketplace. With that said, CCG has never seen a survey anywhere in the country where more than 90% of the public says they would buy services from a new network. There certainly exists the possibility that the business will perform much better than predicted by the business plan.

There is one further topic to discuss concerning customer penetration rates. Generally, a business plan will ask to borrow enough money so that they can complete an expected business plan without having to borrow a second round of bond money. As an example, if we were to set the business plan at a 50% penetration rate, there is a good likelihood that the business would get more than 50% penetration. In such a case, the new business would need a second round of financing to cover the cost of the fiber drops and the electronics at each customer. Thus, in this business plan CCG has set the penetration high enough to lower the possible need for a second round of bonds to complete the project.

As noted above, this business generates about $1M per year in excess cash after year 3, and thus the number of customers required for the business to be self-sufficient is lower than the penetration rates included in the model. The actual penetration rate needed to make the new business successful is around 50%. Assuming the new company can execute on the business plan and offer a quality network and product, it is hard to imagine that the new business won’t get at least 50% of the customers in the County when one considers the survey results and the fact that much of the County has no broadband today.