As published in the March Issue of SubTel Forum Magazine
By Sammy J. Thomas
March 30, 2022
Demand for new Submarine Cable capacity is being driven by seemingly unending double-digit annual growth in data traffic. Operations and ownership of new networks has shifted from consortium to private cables, with the latter able to support ‘Open System’ competitive services better and delivering more security to the OTTs and large Enterprises who need direct control of the underlying network assets. Their dependence on more reliable and protected network elements is critical to these large capacity users that also need to have more control and assurance of the quality of the network. Their needs have become more acute than traditional telco carrier demands, resulting in private operators becoming the lead submarine cable developers and their investors. Development and deployment of new submarine cable capacity increasingly utilizes a Condominium business model; a developer sells capacity ownership to individual operators within the same cable and retains responsibility for the maintenance of the cable. The Condominium business model can deliver very attractive economies of scale to the capacity buyers if the supporting Financial framework is calibrated correctly. A Financial plan needs to deliver three critical features to the buyers of capacity:
- Capital efficiency, with lowest possible cost of capital and cost of acquisition;
- Cost effective risk management and mitigation;
- Monetization valuation of the system assets over its operating
The submarine cable industry is a vital component of worldwide communications, carrying volumes of data traffic which are increasing annually at enormous rates. Over the past decade or so, the business model of the industry has changed from a utility-based consortium model, which managed capacity allocation on a cable among members of the consortium and relied on the credit ratings of the members to support necessary financing and confidence. Newer systems are relying on independent promoters to build and operate new cable capacity based on a condominium business model where the elements of cable capacity are owned, controlled and operated by independent operators. Applying a condominium business model, well known in real estate development, can bring new submarine cable systems online with superior capital efficiency compared to past system developments and with a clear path to monetization of value over the life of a system.
The old Utility business model relied on the legacy regulatory framework of the incumbent telco operators who typically joined in consortium partnerships to build and operate submarine cables. Financing arose from the telcos Capital expenditure program of each incumbent, financial returns were based on regulated rates for usage and interconnection, and financial risk was spread across the entire rate base of the incumbent. The submarine cable assets accruing to any particular member of a consortium cable were not material compared to the total asset base of each of the consortium members. Capacity allocation of a cable was managed by committee. In the era of low bandwidth services and low network utilization, the regulated business model worked because financing and risk mitigation were addressed, demand was stable, and monetization was not an issue. The system relied on the collective credit rating of the (incumbent) telcos in the consortium.
Bandwidth demand growth especially over the past decade has changed the submarine cable industry, and the underlying financial model is beginning to evolve with these changes. There was an interim period where non-telco developers began to build submarine cable systems using a modified version of the regulatory model. Investors would raise equity, construction financing would be arranged, the system would be built, and capacity would be sold. The investors were bringing the role of the consortium members to these projects without the large balance sheets of the consortium members. Credit risk (and cost of capital) was higher than before. Without the umbrella of a large rate base to absorb financial and business shocks as the consortium enjoyed, financial risk was concentrated on the investors of a single system with little opportunity to mitigate the risk. Several of the non-telco submarine cable systems during this period entered bankruptcy, and their assets were monetized for a fraction of their cost.
Clearly, another approach and business model was needed.
In the post-telco era of network operation, the OTT and Enterprise service providers are operating their networks for their own requirements, not to resell networks. Nor do they rely on telco network services. These new private networks are evolving the operating requirements of submarine cable infrastructure; utilizing network capacity as close to 100% as possible, configuring highly resilient transmission paths, and seeking low latency to boost the quality of their offerings. Service definitions reside in network nodes/data centers, requiring high performance network connectivity to support dynamic delivery of service with content to any end-user. These service definitions and content delivery requirements change during the day and across the year; directly managing the network to assure performance quality is a top priority of how these new networks are configured.
New capacity delivered by utilizing the Condominium business model offers several attractions allowing each User to be more involved in the network operations, while having the assurance the ‘Condominium’ or cable system is properly managed. The Users can gain significant economies of scale and lower acquisition cost compared to developing cable systems either on their own or within a consortium. None or very little coordination with other members in the Condominium is required. The portion of capacity (typically a Fiber Pair) owned by the User is exclusively managed by that operator.
Taking the experience of the Real Estate industry, successful system development and operation with a condominium model utilizes a different type of Financial plan to deliver the critical features of Capital Efficiency, Risk Mitigation, and Value Monetization compared to business models of long ago submarine cable development. Lower cost of capital is achieved by utilizing each customer’s credit, rather than on the developer’s credit. “BYOB” (Bring Your Own Balance Sheet) contributes significantly to increased Capital Efficiency. The large OTT and Enterprise network operators seeking network capacity have strong credit ratings and relatively low cost of capital compared to what a submarine network developer could provide. Risk mitigation is built around the stream of scheduled customer payments which are calibrated with the supply contracts to build and install the submarine system. These customer payments are guaranteed by third parties (e.g., bank letter of credit or insurance company trade credit).
Conversely, supply delivery is also guaranteed by third parties (e.g., bank guarantees or sureties). These cross guarantees mitigate the risk of not completing a system, assure the financing from customer payments is in place, and replicate the risk mitigation and low financial cost of the old rate base model. No Consortium committee or developer balance sheet is needed. Applying guaranteed customer payments over the construction period supplants bank financing and lowers financing cost.
Once the system construction is completed and regular operations begin (Ready for Service), risk mitigation focuses on assuring resources are available for continued maintenance and occasional repair to be managed by the system developer. Submarine cable interruptions due to external aggression (e.g., ship anchors) or technical failure (e.g., shunt fault) can be modeled with well understood predictive analysis techniques to determine expected frequency of cable interruption and severity of repair. Financial resources can then be built, using various insurance products, to assure rapid recovery from interruptions. The traditional approach is to accumulate reserves on the cable company’s balance sheet. Reserves cannot be declared an operating expense until they are used, while a premium paid for an insurance product to provide funds in response to a future event are classified as operating expenses. Clearly, the insurance model has better capital efficiency than the old reserve model. Moreover, the insurance coverage has a better risk profile for the company because the risk is typically shared among many insurance carriers.
If the risk modeling has been completed well to determine the controllable impact of interruptions and repairs, the remaining financial risks to the Condominium system arise from potential unrecovered cost inflation and/or changes in regulatory and government policies.
Valuation of a system for its remaining life provides a gauge to how well these remaining financial risks are addressed. Business consolidation with other businesses or assets presents a strategy to mitigate the remaining risks. The periodic cash flows of submarine systems are very predictable after implementation of risk mitigation. This predictability has value to certain entities which have predictable future liabilities. Matching the submarine cash flows with the future liabilities reduces the overall risk of both.
Monetization of network assets is the feature of calculating the value of those assets at every point in time over the life of the assets. That value is a measure of the financial efficiency of those assets and how well they are being utilized. Of course, the value can be used to monetize the assets in a variety of ways, such as sale, back leverage, or shares. The monetization feature of the Condominium financial model does not have an equivalent in the old rate base framework, since submarine cable assets were part of a larger asset base and at end-of-life assets would be retired in place. Monetization presents an attractive element to early-stage investors of new submarine cable system, providing an attractive exit opportunity with little need for conventional financing to build a system.
Financial innovation in the telecom industry has provided important leverage to accelerate the adoption of new technologies and respond to growing demand efficiently. An important example used to this day was the introduction of the “Indefeasible Right of Use” (IRU) which facilitated the allocation of transmission capacity of a physical cable among several unrelated operators. The IRU improved capital efficiency by lowering deployment costs through the economy of scale of multiple users who could utilize the plant independently of each other.
The IRU is now an element of most telecom plant development, using market forces to allocate capacity or fiber pairs of a common cable system among many operators.
Data traffic volume is projected to grow by double digits at least through the coming decade. The applications of data services will also evolve from caching content near users to delivering service applications to points on the edge of the network. Such applications will not only require greater capacity of transport, but a higher level of quality emphasizing lower latency and higher resiliency then required by today’s customers.
The new Condominium Business is very well suited to develop submarine cable systems which meet the requirements of network operators. If it is buttressed by an appropriate Financial model, the result is lower acquisition and financing cost, strong risk mitigation, and opportunity for monetization over the life of the plant. It avoids the need to allocate system capacity among users and frees each user to operate his capacity as their business requires. The Condominium business model, if well managed, delivers all of the benefits of older business models more efficiently and quicker.
Formerly an Executive Director of Telcordia Technologies responsible for strategy analysis and business development for the company’s software and management consulting business. Prior to Telcordia, Sammy J. Thomas held various senior management and director positions at NYNEX Telecommunications Company (now Verizon) and New York Telephone, including Chief Economist, Vice President – Financial Planning, and CFO of Greater New York Metro business unit. Over twenty-five years of telecommunications, software, and high-tech experience in diversified areas of strategic and financial planning, worldwide business development, financial management, marketing, operations, profitability management, forecasting, and business evaluation.