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November 18, 2007
On the issue of Anchor Tenancy
Anchor tenancy has long been part of the dialog in municipal wireless. Basically, the term anchor tenancy has been used to describe one form of revenue assurance that is made by local government to a private-sector partner who commits to deploy a wireless network in a city. As the pullback of private investment in municipal Wi-Fi networks has played out this year, anchor tenancy has moved onto center-stage. But despite all the attention it has received, there has been little thoughtful analysis to look at whether and when it’s appropriate, what level of commitment should be required, and at what point does an anchor tenancy commitment go overboard.
First, let me say that anchor tenancy should be viewed as a responsible approach by local governments who are committed to private-ownership business models. Requirements for anchor tenancy serve to motivate many cities to think about and analyze cost savings, cost avoidance and productivity gains that may be possible by mobilizing their workforce. Anchor tenancy could be thought of as a tactic resulting from the broader approach of “demand aggregation,” an approach to procurement that has been used extensively in both the public and private sectors over many decades.
That said, there are several things about anchor tenancy that are really troubling to me. First, I can’t recall a single case where large-scale private investments in building commercial infrastructure have been so dependent on these kinds of revenue assurances. For example, billions have been invested in cellular networks over the years, and at no point were cellular companies standing with their hands out requiring revenue assurances before putting up a tower. AT&T and Verizon are moving forward with substantial investments in their u-Verse and FIOS networks, again with no guarantee of revenue or return. And even Clearwire’s and Sprint’s nationwide WiMAX investments, while maybe being a little rocky from time to time, don’t require consumers to pre-order services. So, this leads me to conclude one of two things; either there is an inefficient market and a broken business/revenue model for municipal Wi-Fi, or there is an unreasonable expectation for ROI by the private operators considering these investments. Unfortunately, I believe it is both.
Taking a side-track for a moment on the above issue, consider this; Clearwire stated in its 2006 prospectus leading up to its IPO that “[w]e estimate that our subscriber penetration rate for our U.S. markets that were in operation for more than six months as of March 31, 2006, expressed as a percentage of covered households, had generally reached at least 5%.” Contrast this with EarthLink’s pullback, which began at a time (July) when it had only just began marketing commercial services in its first major market (Philadelphia) and it suggests an unreasonable expectation for achieving a return on invested capital. To be fair, there are many factors that may have given EarthLink the insight to conclude so early that the model wasn’t viable, but the time invested trying to get cities to “step up and make meaningful anchor tenancy commitments” might have been better spent evaluating and tuning the business/revenue model.
In addition to the basic reliance on anchor tenancy, I’m troubled by the level of commitments that have been requested. Having negotiated numerous public-private-partnerships in this area, it has not been uncommon to find myself across the table from an operator asking for anchor tenancy commitments of 5-25-40% of the capex estimates for the entire network. In one case, an operator had the nerve to lay on the table a request that equaled 300% of the capex required! While it’s easy for a local government to toss out the 300% request and conclude “I’ll just build my own darn network,” it’s not so easy to peg the right number between 5%, 25%, 40%. How did these operators typically come up with these numbers? Well, lets just say it seemed less motivated by understanding the cities real need, and more by understanding their own inside or outside risk sharing requirements.
Digging into this a little deeper, I propose that a good place to start for the municipality is to consider what percentage of the total addressable market is made up of municipal employees vs. consumers and businesses at large. The Houston-EarthLink agreement provides a useful case study to consider these issues.
In the agreement that was negotiated, Houston committed to $500k per year for five years, or $2.5m. The network was estimated to require $43m in capex to build. Houston has somewhere in the neighborhood of 30,000 municipal employees. And the City of Houston has approximately 2 million residents. When you look at this admittedly over-simplified analysis, you find that Houston employees represent only 1.5% of the addressable market, but it was willing to commit 5.8% of the capex required in the form of advance revenue assurances. And in the end, its partner wasn’t willing to proceed with the deployment? In short, Houston was more than doing its part, but there’s only so much it can do if a partner has an unreasonable expectation for ROI, a struggling core business, a low tolerance for investment risk, and/or a broken business/revenue model.
Some will argue that this back of the envelope approach doesn’t consider other reasons that may justify higher levels of commitment by local government. For example, municipal governments may have needs that go beyond services for employees, such as in the case of parking meters, vehicles, video cameras, etc. That’s a fair point, but I would argue that this “upside” for municipal use is offset by the fact that my above analysis did not consider the business community as part of the addressable commercial market (I only referenced consumers/residents.)
Others will argue that these networks will contribute substantial social and economic benefits to the community, which should justify additional “investment” by the city. On this point, I agree that what economists call "positive externalities" may result from these networks being deployed. But I propose that “buying these benefits” through inflating a city’s telecommunications budget is probably not the best policy approach to use.
Another issue that needs to be considered in an anchor tenancy analysis is the net present value (NPV) of the revenue assurances being offered. For example, $2m in years one, two and three has a lower NPV than $4 million in year one and $1m in years two and three, even thought the total anchor tenancy in both scenarios is $6 million.
Anchor tenancy will likely continue to be part of the municipal wireless dialog and debate, and as I noted above, it is a responsible approach for local governments to consider when pursuing a private-ownership business model. But, at the point where anchor tenancy commitments go beyond the Wi-Fi services that local government can reasonably consume for its internal needs, cities are “skating on the subsidy ice,” and this becomes a policy issue - not an IT budgeting issue.
Finally, private operators will have to wake up to the fact that just because local governments are “involved” in this market, does not mean that an appropriate role for them is that of a venture capitalist or a bank. Operators need to focus on building a business case to justify their investments that doesn’t depend on anchor tenancy, but welcomes it if it has value for both parties. This is the kind of incentive that will drive the behavior needed to fix an inefficient market.
Posted by Greg at 08:51 AM | Comments (0)
November 17, 2007
Breaking up is hard to do
So, EarthLink has made its next move, with its CEO stating yesterday that “[a]fter thorough review and analysis of our municipal wireless business we have decided that making significant further investments in this business could be inconsistent with our objective of maximizing shareholder value.” As expected, that’s carefully worded CEO-speak, and when combined with a statement about the current business having a book value of about $40 million, one can speculate about what this means.
Let the negotiating commence.
I propose that the statements by EarthLink’s CEO actually send two messages; In addition to the classified ad above, which might have the effect of soliciting parties who want to get in on a fire-sale, it also opens the door for cities where EarthLink has agreements and performance obligations to renegotiate terms – the most meaningful of which would relate to anchor tenancy – as a way to avoid less desirable outcomes under an Assignment.
Philadelphia is probably the most interesting case to dig into to understand exactly how difficult the break-ups will be. Since it was one of the early agreements to be negotiated, it lacked some of the safety-net provisions that EarthLink was successful in negotiating in later deals. For example, let’s look at the Assignment provisions in the Street Light Use Agreement for Philadelphia.
Section 17.16 deals with the issue of Assignment, and it says: EL shall not assign this [Street Light Use] Agreement, or any portion of it, without the prior written permission of PAID and the City, which permission may be withheld in their complete discretion, and any such assignment made without such consent shall be void and shall not operate to relieve EL from any of its obligations or liabilities under this Agreement;
That seems pretty clear; an Assignment would have to be on the City and PAID’s terms, but there are at least a couple of loop-holes.
..provided, that EL is entitled to assign this Agreement without the consent of PAID and the City pursuant to the sale or transfer of all or substantially all of the assets or stock of EL, or pursuant to a transfer or assignment pursuant to a reorganization or merger or assignment to a subsidiary that is wholly or majority owned and controlled by EL;
OK, so EarthLink can assign the Agreement if they sell or transfer all of the assets of EarthLink, Inc., or if they “spin out” the EarthLink Municipal Networks (EMN) division in such a way that it remains wholly or majority owned by EarthLink, Inc. But there’s more:
..provided, that EL shall remain responsible for defaults or damages under the Agreement caused by such entity and for such entity’s performance of the Agreement.
So, EarthLink doesn’t get out of its performance obligations by spinning out EMN, even if it could find outside co-investment. Finally, this provision turns to the issue of what Assignment authority the City has.
PAID, with the City’s approval but otherwise in PAID’s sole discretion and upon written notice to EL, may assign the Agreement to another City-related authority or agency created pursuant to the Pennsylvania Municipal Authorities Act of 1945, as amended, or the Pennsylvania Economic Development Financing Law, Act No. 102, approved April 23, 1967, as amended, that has substantially the same powers, purposes, and authority as has PAID, including the power and authority to enter into and to carry out and perform this Agreement.
This one’s more difficult to interpret as a layperson, but it basically says that The City can choose to assign its own authority in the Agreement, so long as the assignee has the authority to carry out its performance obligations.
That’s a layperson’s interpretation of just one provision of one EarthLink Agreement in this area. New Orleans, Anaheim and Corpus Christi will have their own specific issues. In many later agreements, EarthLink negotiated language that gave a little more “wiggle room” in areas where cities could terminate the agreement or control things like assignment. Often this language was worded to say that “..such approval could not be unreasonably withheld [by cities.]”
So begins the next chapter in the EarthLink municipal Wi-Fi novel. The inevitable break-ups that lay ahead will probably get much more attention than is healthy for a market that has more important business to tend to. The overall market marches forward in so many ways; new projects launched by cities, ad-hoc deployments by FON and Meraki gaining momentum, CBS deploying in mid-town Manhattan; Apple introducing a Wi-Fi specific store; WiMAX providers stumbling a bit and leaving the window open longer for municipal Wi-Fi – just to name a few. The fascination with EarthLink in this market has become like a reality show of sorts; a waste of time; not very productive; but somehow impossible to turn away from.
In a future post, we’ll pick up the issue of what can be learned – now that EarthLink has cleared up any confusion about its intent in this space - from municipal wireless Round 2 (we consider Metricom Ricochet to have been Round 1) and whether three times will be the charm – or a final nail in the coffin. We’ll also tackle the issue of whether anchor tenancy and institutional-use are actually the Advil for all municipal Wi-Fi aches and pains, which some have suggested that it is.
Posted by Greg at 10:23 AM | Comments (0)
November 12, 2007
The Airline Industry, Wal-Mart, and Google
Google. It’s rapid ascent to wealth and power continues to captivate the media, analysts, Wall Street and consumers. This has led to a constant stream of speculation and rumors about “Google’s next move” in virtually every part of its business - and more importantly, in markets it needs to re-engineer to feed its hungry growth and profit engine.
The most intense Google-speculation so far in 2007 has focused on its efforts to break up the wireless telephone duopoly dominated by AT&T and Verizon Wireless. Its strategy to promote open, high-capacity wireless networks is so multi-faceted, it can strain the grey matter of almost any business strategist trying assemble the pieces into some cohesive grand-plan. From plans to participate in the upcoming 700 MHz spectrum auction, to strategic partnerships with carriers planning WiMAX networks, to deploying free metro-scale Wi-Fi across its home town, to its recent launch of the Open Handset Alliance; Google seems to be everywhere and no-where at the same time in the wireless market.
It’s easy to get caught up in the endless speculation about what Google might do; could do; will do. And it’s also easy to think about Google’s strategy overall as somehow being different; unique; fresh; without precedent. I mean, there has never been a company quite like it, and the markets it touches are too vast, emerging, and dynamic for historical business case studies to be of much use, right?
Well, not so fast. As I will argue below, the kind of market tension that exists between Google and the telco industry has existed in many industries before, over decades if not centuries in business. There is much that can be learned from how similar show-downs have played out in these industries, and much that can be used to predict the unpredictable; Google’s next move.
First, the airline industry provides some useful insight.
In the late 1990s, five airlines controlled about 80% of the air travel market in the U.S.; roughly an $80 billion industry. These airlines had become frustrated by the rise of online travel agencies such as Expedia and Travelocity, who had in a sense begun to insert themselves between the airlines and consumers, and the top airlines decided to do something about it by forming their own online travel agency; Orbitz. Rather than paraphrase a well-documented case study, I’ll provide an excerpt from Wikipedia.
Orbitz constituted the airline industry's response to the rise of online travel agencies such as Expedia and Travelocity, as well as the continued increase in [reservation system] fees, and trailed its major competitors by several years. Continental Airlines, Delta Air Lines, Northwest Airlines, and United Airlines, subsequently joined by American Airlines, invested a combined $145 million to start the [Orbitz] project in November 1999. It was code-named T2 — some claimed, meaning "Travelocity Terminator" – but adopted the brand name Orbitz.
As this article states, "Orbitz began selling tickets in June and by February it had topped $1 billion in revenue. By contrast, it took Seattle-based Expedia, which debuted in October 1996, about four years to reach $1 billion in annual revenue. It took Travelocity, which debuted in March 1996, about three years."
To make a fairly long story short, Orbitz was challenged on anti-competitive grounds by almost every industry and government regulator imaginable, but in the end, it went public in 2003 (the airlines held 70% of the outstanding stock and over 90% of the voting power.) It was acquired in 2004 by Cendant for $1.25 billion, and later in 2006 by The Blackstone Group, a private equity firm, for $4.3 billion. It is generally assumed that Orbitz “did what it was supposed to do” for the airlines; it leveled the playing field, some would argue even too far in its own favor.
What does this have to do with Google? Well it spells out one strategy that Google could adopt to deal with the wireless carriers. In this scenario, Google would partner with companies who share its goal for open, high-capacity wireless networks that don’t favor the network owners’ software and services (Apple comes to mind of course) and create or acquire the assets needs to create a viable alternative. Om Malik’s post just this morning of a rumored Google acquisition and spin-off of Sprint is a great example of this option. The airlines demonstrated that you don't have to "get into the business" of providing online travel services; you just have to make sure that someone if in the business of doing it the way you want it done.
Another case study highlights a second strategic option; Wal-Mart and the credit card industry.
Since the 1980s, Visa and MasterCard have accounted for 70 percent of the credit card market, and some argue that these companies have controlled their payment networks to advantage their bank members. In the 1990s, some merchants became large enough to exert their own leverage on these payment networks. For example, Wal-Mart, Sears and Safeway joined forces to eliminate fees and rules imposed on them by MasterCard and Visa. In 2005, Discover and Wal-Mart (the nation’s largest retailer) launched a new credit card.
Again, the relationship between Wal-Mart and other retailers’ strategic response to Visa and MasterCard, and Google’s strategic options to deal with the wireless duopoly are clear. A credit card payment network is akin to a wireless network. Visa and MasterCard are AT&T and Verizon; and Google is the Wal-Mart of the Internet search and content business. Google says to AT&T and Verizon, “if you keep controlling consumers over your network, in a way that disadvantages my content and services, I’ll have no choice but to build an alliance to finance an alternative to your networks.”
Despite the similarities, this option is fundamentally different from the airline industry’s response to Expedia and Travelocity. If Google were to use the Wal-Mart strategy, it would likely involve forming a strategic partnership with a wireless carrier. Ideally this would be a third-place, underdog player who is struggling to compete with the big-two players, but who has certain useful assets (licensed spectrum and tens of millions of consumers.) Once again, Sprint comes to mind; but of course T-Mobile could be a powerful ally as well.
So, will Google “be like Wal-Mart” and do a strategic deal with Sprint to prop up its apparently weak investor sentiment for WiMAX, or “be like United Airlines” and join forces with Apple and others to acquire and spin-off Sprint into the model of what it wants a wireless operator to be? Or is Google truly different; will it do something brilliant and without precedent? Who knows, but the Google-speculating that has become a national pastime is sure to continue.
Posted by Greg at 02:25 PM | Comments (0)