Lockdowns have boosted the need for digital connectivity in homes. Tim Perry looks at the investment opportunities and challenges arising from the push for faster fibre
Data demand has exploded, and legacy copper networks are struggling to provide the data speeds households and businesses need. Full-fibre networks are widely regarded as the technology of choice to meet increasing demand, due to their reliability, capacity to provide high speeds, and cost efficiency. But European coverage is variable; the UK has just 12% coverage compared with 86% in Spain.
Governments are increasingly aware of the benefits of high-speed internet provision, how it can facilitate growth and the importance of country-wide access to promote inclusive development, as set out in UN’s 9th Sustainable Development Goal.
This is creating significant opportunities for private-sector investment in underserved areas.
Developing key infrastructure
Between 2007 and 2017, global internet traffic grew by more thaan 20 times, driven by increasing applications of data. Recently, traffic has also been fuelled by large swathes of the population based at home during the COVID-19 pandemic.
This voracious appetite for data means massive investment in infrastructure is needed to support transmission and storage. To achieve the EU’s 2025 targets, an estimated €500bn of investment is required. A large part of this will be taken up by network roll-out.
There are several common data transmission technologies. They include satellite broadband and cellular networks (4G and 5G), which can deliver internet connectivity to buildings through fixed wireless access (FWA). Each technology involves trade-offs between user experience versus installation and operating costs.
Fibre-optic networks use light as a signal, allowing higher data speeds, lower latency – less delay between the data instruction and action – and less signal deterioration. Many networks currently employ fibre-to-the-cabinet, where fibre-optic cables run to the street cabinet and then make use of old copper cabling, reducing performance. In contrast, ‘full-fibre’ networks – or fibre to the premises – use fibre all the way to each building, enabling speeds up to 20 times faster, providing the best user experience of all the competing technologies.
“Investors contemplating full-fibre need to appreciate the idiosyncratic nature of the sector”
FWA is rarely used, but the rollout of 5G across Europe over the next decade should substantially improve the service it can offer. However, 5G signals are largely short range, so mobile networks will need to be ‘densified’, which involves installing many micro-cells and laying fibre to cell towers.
The relative competitiveness of constructing a full-fibre network versus deploying FWA depends on factors including the capacity of the existing cellular network, and the density and distribution of housing. Where full-fibre networks exist, the higher operating costs of 5G coupled with FWA will make it difficult for the latter to compete.
Fibre: a complex investment
As a result of the technology’s superiority, full-fibre networks offer the potential to generate long-term income.
In the UK, the government suggests fibre investors are compensated over 15 to 20 years, or longer. But the ability to generate stable income varies. Many businesses involve high-demand risk, where revenues depend on customer take-up and subscription fees, both of which can be affected by competition.
Nevertheless, there are factors that help to mitigate investment risk, most notably the growing demand for data and the essential nature of the service, for which there is evidence. In Japan, where full-fibre is available to 99% of premises, 79% have subscribed. In Europe, Spain leads the way with 86% coverage and 63% take-up, despite having some of the most expensive broadband services.
Additionally, investors can target specific business models to mitigate risk. For example, connectivity tends to be slowest in rural areas, where installation costs tend to be higher – but this disincentivises competition, leading to more monopolistic positions. There are likely to be greater benefits for users in rural communities from full-fibre networks, which might lead to a greater propensity to subscribe or more willingness to pay higher subscription fees. As a lower priority for large network providers, the rural niche tends to attract newer network providers.
Using a retail or wholesale model also affects the risk profile. Under a retail model, network providers sell internet and telephone packages directly, where profitability is linked to customer take-up rates and subscription fees. Under a wholesale model, the network provider sells the use of the network to internet service providers (ISPs) under longer-term contracts, and the ISP takes responsibility for selling on.
The wholesale model can provide longer, more predictable revenue from higher-quality counterparties, but it significantly reduces upside potential and networks must be sizeable to attract ISPs.
Opportunities and risks
Well-established networks tend to carry less investment risk, with demand, build and competition risks mitigated by their size and market position. That being the case, larger networks tend to trade at higher multiples, limiting potential returns.
Greater upside is likely to be had in newer network providers, which tend to have more exposure to demand risk. This can be mitigated by examining the competition to ensure the take-up rate will justify investment. In addition, it might make sense to delay rolling out new fibre loops until enough customers have confirmed their intention to subscribe, ensuring strong returns.
Construction risk also comes into play with greenfield strategies. Nevertheless, rolling out full-fibre networks is technically more straightforward than construction in many other infrastructure sectors. Costs and risk can often be mitigated by using existing duct and pole infrastructure and partnering with strong, aligned management teams. Once complete, individual network expansion projects can generate revenue immediately.
Investors contemplating full-fibre need to appreciate the idiosyncratic nature of the sector. Different regulatory and competitive environments, consumer demand drivers and business models all impact a network’s risk profile.
Nevertheless, demand for data is growing fast, and full-fibre delivers significantly better user experiences than other technologies at lower ongoing costs. Full-fibre is also a key enabler of faster mobile connectivity via 5G. This suggests it will be difficult for new technologies to compete with an existing fibre network and is supportive for the longevity and stability of cash flows.
History shows high levels of take-up in those countries that have well-established full-fibre networks. This suggests exposure to demand risk will be well rewarded, with retail models offering the greatest upside potential.
Tim Perry is an associate director in the real assets research team at Aviva Investors