Key Legal Issues in Fibre Network Acquisitions and Investments
This is the second post in a three-part series focussing on key legal issues in data centre, fibre and towers acquisitions and investments. See our post on data centre investment here.
The ever increasing demand for connectivity is set to lead to a transformation of the digital infrastructure on which the telecoms sector is built. The huge amount of capital required to upgrade telecoms networks is creating opportunities for investors in the fibre, towers and data centre asset classes, and as the importance of the transformation of these networks grows (as underlined by the current pandemic situation), so does the value of this critical infrastructure.
The demand for data hungry services such as video streaming, video conferencing, gaming, social, file sharing, cloud, messaging, music etc. is continuing to increase. Simultaneous demand for high speed data services by many users can push the limits of existing broadband connections. To support this growing dependence on and demand for digital services, Gigabit-capable broadband connections – in the form of fibre infrastructure that can support fast download and upload speeds, large amounts of data and many users at one time – is required. Fibre infrastructure is also important for supporting the deployment of 5G mobile broadband networks.
In the UK, the Government’s approach to full-fibre networks is to encourage private sector investment through a competitive market to deploy fibre infrastructure (with Government funding provided to support areas which will not be reached by commercial investment).
Infrastructure funds and institutional investors are showing an increasing appetite to invest in Gigabit-capable broadband networks as one of the fundamental building blocks of the digital economy, attracted by their infrastructure-like characteristics and the potential IRR and cash yields for these types of assets.
This post highlights selected key legal areas for an acquisition of, or investment in, a UK fibre network provider.
|Cost and time to build||The deployment of a fibre network is a complex, costly and time-consuming construction project requiring various planning permissions, street works licences, permits and wayleaves.
There are a range of policy measures being implemented in the UK to reduce time and cost to build, including improvement of wayleave processes, reducing barriers around street works licences, allowing the use of narrow-trenching for fibre network deployments as well as the liberalisation of planning permissions. The terms of access to BT’s physical infrastructure access portfolio to enable operators to share BT’s existing duct and pole infrastructure (to install sub duct or cable in BT’s access duct and attach and maintain equipment on BT’s existing owned poles) have also been improved.
It is important for investors to understand the range of permits, licences and permissions required to install and maintain the fibre network, and to ensure compliance with the related terms and rules.
|Installation and maintenance of fibre networks||Many fibre networks in the UK will look to leverage the ducts and poles owned by BT using BT’s physical infrastructure access service (to reduce the cost of deployment), as well as the fibre provider’s own infrastructure and equipment on public and private land.
Given the scale and complexity of fibre network deployments, fibre providers will benefit greatly from obtaining Electronic Communications Code (Code) powers. Using section 50 licences may not be viable given the significant number of section 50 licence applications which would be required which the highways authorities grant at their discretion. As a Code operator, the fibre provider would also benefit from the permitted development rights under Town and Country Planning legislation, as well as the rights and remedies in respect to privately owned land.
|Regulatory compliance||The provision of retail broadband services and wholesale broadband services (to enable ISPs to provide retail broadband services) will likely constitute the provision of an electronic communications network and / or electronic communications services and will therefore be subject to regulation set by Ofcom.
Due diligence should verify that the fibre provider holds, and has complied with, the necessary licences and authorisations relating to its business activities.
|Regulatory risk||Investors will need to understand the applicable regulatory landscape thoroughly, as well as any likely changes over time. For example, in the UK Ofcom has indicated that it will, in most areas of the UK (“potentially competitive” areas), require BT’s Openreach to offer an entry-level superfast broadband service which has a download speed of up to 40 Mbit/s.
The level this price is set at and the areas where it applies could have an impact on a fibre provider’s business case – if the price of the entry level service is set too low it could encourage competitors to enter the market in those areas using BT’s wholesale product.
|Demand risk||There is a risk associated with customer demand and willingness to pay for higher bandwidths provided by fibre, especially if building out a fibre network in areas already covered by incumbent (or other) providers of fibre, where competition will exist. There are however a number of countervailing factors, which investors will need to model.
For example, in rural areas there is a propensity to subscribe for and pay higher prices associated with fibre as broadband connectivity tends to be worst in those areas. In other words, there are increased benefits of having fibre broadband to people and businesses in those areas. Furthermore, this demand risk can be mitigated to a degree by demand-side subsidies, such as the UK Government’s Gigabit Broadband Voucher Scheme to bridge the gap between the returns which a fibre network investor would require and the current willingness of households and businesses to pay for these services. There is also evidence to suggest that early investments in fibre in the UK appear to have generated the required rate of return.
The anchor tenant model used by CityFibre and Gigaclear’s demand aggregation approach have been cited as important factors behind changing attitudes.
|Overbuild risk||As identified above, there is a risk that a competitive network is built in the area where the fibre provider deploys its fibre network. A mitigating factor, at least in rural areas, is that installation costs tend to be higher in such areas which may serve to limit competition and the risk of overbuild (and incumbent’s and other major fibre provider’s plans tend to focus on the lowest cost installations and leave the remaining installations for nascent fibre companies). The availability of government support to develop rural fibre networks can on the other hand increase the risk of overbuild.|
|Health and safety risk||A challenge for fibre providers is how a large scale civil engineering program can be delivered efficiently whilst maintaining health and safety compliance.
Much of the physical construction work will be sub-contracted out to specialist Tier 1 and 2 civils companies. But sub-contracting the work does not necessarily mean that the fibre provider is subcontracting all the health and safety responsibilities.
Fibre providers will, regardless of any sub-contracting, hold key statutory duty holding roles. The penalties associated with non-compliance include criminal conviction and fines of up to 10% of group turnover. There is also the associated reputational impact.
Investors should also be aware of the implications of the 2015 changes to the Construction (Design Management) regulations and the associated allocation of responsibility for risk mitigation and health and safety.
|Labour and supply chain disruption/sub-contractor risk||COVID-19 has the potential to cause widespread labour disruption, resulting in the potential inability of a subcontractor to perform the subcontract, or for delays and work re-sequencing. Any significant labour or work disruption may impact the deployment schedule.
The impact of COVID-19 on supply chain has also been substantial. As the pandemic continues to spread across the globe, manufacturing and transport of materials required for the deployment may become increasingly difficult.
It is important for investors, fibre companies and their subcontractors to understand the full end-to-end supply chain on all construction materials, and in particular, long lead items imported outside of the UK.
|Business model||If the business of the fibre company is focussed on providing wholesale services to enable ISPs to provide retail broadband services, there is a customer concentration risk that is not prevalent in a retail business model.
To some degree the risk of customer churn is mitigated by medium-long term contracts, but the risk of customer default/insolvency nevertheless exists. The term of wholesale contracts will need to be carefully thought through and drafted, and made as robust as possible.
|Technical obsolescence||One of the risks associated with a fibre business model is technological obsolescence i.e. another technology displacing fibre during the life of the asset. For example, 5G coupled with fixed wireless access (FWA) in rural areas may be an economically viable way to replace copper networks in areas where houses are widely dispersed.
The rollout of 5G across Europe should substantially improve the service that FWA can offer. Without the need to lay underground cabling, FWA can offer lower deployment costs and the potential for quick installation. That said, full-fibre is likely to be preferred to FWA in most cases, in particular due to full fibre’s superior speed and latency characteristics as well as the ability to upgrade without the need for further civil works. The speed of mobile technology is also more variable than fibre and the high frequencies of 5G mean an interruption to the line of sight could impact performance. 5G signals are also largely short range so mobile networks will need to be densified. Finally, the evidence shows that the demand for data is increasing and fibre (compared to 5G/FWA) will be the key technology needed to meet this demand.
|Asset life/costs||The asset life of a fibre-optic cable is typically 20+ years. Whilst fibre is generally more reliable than copper, costly maintenance and repairs can be required during its lifespan, and significant technology upgrades to the equipment connected to the fibres will be required during this period. These costs should be modelled as part of the overall project costs.|
|Ownership of assets/rights to use and access||Investors should verify the fibre provider’s ownership or rights to use the material network assets currently used in the business, including both fibre which is directly owned and any which is subject to a lease or indefeasible right of use.
Investors may also want to look back to construction contracts for existing fibre networks if constructed by a third party on the fibre provider’s behalf.
Investors should also assess the fibre provider’s access to termination and interconnection access points (for its own network) i.e., how secure are its rights to use these third party owned/controlled points to operate its network.
|Cyber security||Given that fibre networks will be/are being used to carry customers’ data traffic, it will be important to understand the nature and significance of any vulnerabilities in the network infrastructure, the potential scope of the damage that may occur in the event of a security breach and the extent and effectiveness of the cyber defences the fibre provider has put in place. An appropriate evaluation of these issues could impact the value an investor places on the asset.|