Infra funds wary of fibre sector’s struggles as challenges take hold

Infrastructure funds and investors are experiencing significant struggles with fibre investments in North America and Europe amid a series of sectoral challenges, Infrastructure Investor can reveal.

Companies building out networks have endured a multitude of issues such as threats of overbuild, competition and increased construction risk thanks to inflation and higher interest rates. As a result, some returns in the sector have been depressed.

According to sources, Astound Broadband – a US-based internet, TV and home phone services provider, acquired by Stonepeak from TPG in an $8.1 billion deal in August 2021 – and rural Canadian internet provider Xplore – bought by Stonepeak in a $2 billion deal closed in July 2020 – are both currently performing significantly below the 12 percent IRR typically targeted by Stonepeak’s flagship infrastructure fund series.

S&P Global Ratings, which has held a negative outlook on Radiate HoldCo, Astound’s holding company, since June 2022, wrote in a December report that it was “uncertain if the company can stabilise subscriber trends and penetration levels in the current competitive and macroeconomic environment”.

It estimated that Astound’s 2023 earnings growth would decline up to 2 percent on flat broadband revenue growth, while headwinds are expected from “significant integration missteps” from the $661 million bolt-on acquisition of WideOpenWest in 2022. S&P also noted challenges in refinancing upcoming debt maturities while generating positive cashflow as a result of higher interest rates.

Astound has a 40,000-mile fibre network across several US states. That figure stood at 23,000 miles when Stonepeak acquired the company.

Meanwhile, S&P last month downgraded its credit rating on Xplore from CCC+ to CCC-. Citing a heavy debt burden amid the elevated interest rate environment, the ratings agency “expects subscriber losses will continue to pressure Xplore’s operations in 2024 such that it may be unable to adequately cover its mandatory fixed charges (interest, debt amortisation, and maintenance capital expenditure) with its EBITDA”.

S&P last year reported the company’s broadband subscriber base declined 12 percent in 2022 to about 366,000, attributed to losses from its legacy fixed wireless and satellite offerings, as well as increased costs to upgrade and expand the company’s network.

Xplore is held by Stonepeak Infrastructure Fund III alongside Astound. The latter also received capital from SIF IV, as well as a significant amount of co-investment capital. SIF III, on the whole, was generating a 14.6 percent net IRR and a 1.5x net MOIC at the end of Q3 2023, according to a January presentation delivered to the Employees’ Retirement System of Rhode Island.

Stonepeak declined to comment for this story.

Continuing in North America, Ohio-headquartered Everstream has also been experiencing underperformance. The company was bought by AMP Capital in 2018 for $330 million, which included a debt package of $210 million.

Everstream, which provides fibre to mid-sized and large enterprises across a 27,500 mile route, is now ultimately owned by DigitalBridge following its acquisition of the AMP Capital global infrastructure equity platform in February 2023, latterly renaming it Infrabridge.

However, Infrastructure Investor understands that the company had to seek covenant waivers from lenders late last year and that lenders expect to take over the asset this year, despite a $1 billion refinancing deal agreed in April 2022, led by Societe Generale. Sources have said that Everstream is marked by Infrabridge at an equity value of 0. Figures released by DigitalBridge last month in its Q4 2023 earnings showed Global Infrastructure Fund II, the 2017-vintage $3.4 billion vehicle in which the asset is held, displaying a net IRR of less than 0 percent and a net MOIC of 0.82x.

DigitalBridge declined to comment.

On the public side, activist investor Elliott Investment Management released a public letter in November to US-based towers and fibre operator Crown Castle urging the company to change course on its fibre strategy. Elliott said Crown Castle had invested $19 billion in its fibre strategy over the past decade, yielding “a paltry 6 percent” return on invested capital.

“When interest rates were near zero, these ROIC metrics were insufficient to create value; today, Crown Castle would be better off buying US Treasuries. We believe the public market applies intense scepticism towards the fibre strategy and values the business at ~$1 billion today, implying that the company’s pursuit of this strategy has destroyed approximately $18 billion of value,” the letter stated.

Crown Castle announced a strategic review of the fibre business in December.

Fibre troubles in Europe

Markets in Europe, notably in Germany and the UK, have also seen stress on some companies amid the rise of altnets challenging large telecom incumbents such as Deutsche Telekom and Openreach, respectively.

Last February, German fibre provider Glasfaser Direkt opened insolvency proceedings following the withdrawal of support of John Laing – owned by KKR – which had acquired the company in April 2021.

German telecoms-focused investor CarMa acquired the group in April, and in a statement following the deal attributed the insolvency to “the changed market situation and the associated challenges such as inflation, supply chain difficulties and increased construction and material costs”, in addition to John Laing’s withdrawal of funding.

Also in early 2023, InfraVia’s HelloFiber joint venture with Liberty Global – a plan to rollout fibre across Germany – was scrapped, albeit before capital could be invested, Bruno Candès, partner at InfraVia, told Infrastructure Investor last year.

“By far and large, the problem was massive inflation of capex, massive bottlenecks in terms of securing construction capacity in the short- to medium-term, and as a result to reach scale quickly would mean a deterioration of equity returns projection below what we did initially underwrite,” he said.

In the UK, rural broadband provider Broadway Partners, which was acquired by Downing for £145 million ($183.6 million; €169.6 million), was taken into administration in June last year, with the administrator Benji Dymant explaining in a statement that “the sector has been facing a number of adverse macroeconomic issues, including rising interest rates and inflation, in a highly competitive environment”.

In September, Broadway Partners was acquired by Voneus, a UK rural broadband provider that first received funding from Macquarie Capital in 2019 and further support from Israel Infrastructure Fund in 2021. September’s announcement also saw Tiger Infrastructure Partners add support by merging its portfolio companies SWS Broadband and Cadence Networks into Voneus.

Causes of concerns

As detailed, overbuilder markets have combined with rising rates and increased costs to create a much tighter market in terms of returns for these investments than existed previously.

“We’ve heard multiple providers say that, on the margin, they’re not seeing the return on investments they had been expecting, particularly from more recent builds, making them incrementally more cautious about future build plans,” Vijay Jayant, head of Evercore ISI’s media and communications services research team, wrote in a research note last year.

Part of this squeeze includes a rise in the costs of building new networks. The US Fiber Broadband Association last month released an in-depth Fiber Deployment Cost Study, revealing that labour accounts for the dominant cost when deploying new fibre networks.

The research, caveated by the fact that costs vary across the US depending on location and type of build, revealed labour contributed to 73 percent of the build cost for an underground network, where a majority of networks are built. Previous research in 2022 had put labour costs at about 60 percent of a project’s total cost. The study surveyed fibre providers and contractors across the country, with 59 percent of respondents estimating costs to rise up to 10 percent in 2024.

Despite this, the research found that homes passed in the US by fibre increased by 13 percent in 2023, equal with the previous record-setting year, with 46 percent of locations in the US now serviceable by fibre.

In Germany, significant focus has been placed on overbuilding, with some of the altnets criticising Deutsche Telekom for “strategic overbuilding” where the altnets have already invested. Indeed, in October, the German Association of Local Utilities reported that 62 percent of its member companies have been overbuilt or changed plans due to the threat of overbuild. Some projects have been cancelled entirely as a result of Deutsche Telekom’s plans, according to the report.

Valuations of fibre businesses became a concern during 2020 and 2021 as investment in the space soared as a result of the pandemic, with McKinsey analysis previously stating that fibre valuations reached multiples of 19.7x in 2021. That appears, in some cases, to be being trimmed.

“I think [fibre] is where you’ve seen the biggest degradation in multiples. Fibre-to-the-home, there were some deals that got done in the crazy days of covid in the mid-20s [multiple]. I think you’re seeing those multiples retreat down to the 10x-14x range,” Marc Ganzi, chief executive of DigitalBridge, told the company’s Q4 2023 earnings call last month, adding that “certain fibre models are pricing well and certain fibre models aren’t even pricing”.

Ganzi added: “I think fiber still has a shake-out in pricing and in the M&A landscape. And we’ll continue to track that space pretty carefully.”

As the market matures, it may well be that a wave of consolidation is on the cards.