Fiber network build-outs are still going strong, even as the pace of those builds slowed a bit in 2022. Our colleague Craig Moffett warns that the fiber future isn’t looking quite as bright due to an emerging set of economic challenges that could reduce the overall rate of return on those build-outs. Rising costs, reflecting labor cost inflation, equipment cost inflation, and higher cost of capital, all point to diminished investment returns for fiber overbuilds. Craig wrote in a note to clients:
Our by-now familiar tally of planned competitive fiber builds for 2022 started the year at to 6M or so homes passed. By early Spring it had climbed to 7M. It currently sits at ~8M. Next year’s number is flirting with 10M. All for an industry that has never built even half that many in a single year. As we approach the end of the year, however, it is clear that the actual number, at least for this year, will fall short. The number is still high, to be sure… but lower.
There does not appear to be a single explanation for the construction shortfall; some operators blame labor supply, some permitting delays. And some, of course, are actually doing just fine. For the industry as a whole, however, notably including AT&T, by far the nation’s largest (fiber) overbuilder, the number will almost certainly end the year meaningfully below plan. Costs appear to be rising, as well. Here again, there is no single explanation. Labor costs are frequently cited, but equipment costs are rising as well. For example, despite construction shortfalls, AT&T’s capital spending show no such shortfall, suggesting higher cost per home passed. Higher cost per home passed, coupled with a higher cost of capital, portend lower returns on invested capital.
If, as we expect, investment returns for fiber overbuilds increasingly prove to be inadequate, the capital markets will eventually withdraw funding. Indeed, this is how all bubbles ultimately pop. There are already signs of growing hesitancy. To be sure, we don’t expect a near-term curtailment; operators’ plans for the next year or two are largely locked in. Our skepticism is instead about longer-term projections that call for as much as 70% of the country to be overbuilt by fiber. We believe those kinds of forecasts are badly overstated.
As recent as its Q3 2022 earnings call, AT&T has reiterated that it’s on track to expand its fiber footprint to more than 30 million locations by 2025. The company deployed fiber to about 2.3 million locations through the third quarter of this year, but appears hard-pressed to meet its guidance to build 3.5 million to 4 million fiber locations per year.
Given that the fourth quarter is typically a slow construction period, AT&T “looks to be well behind its deployment goals,” Moffett wrote. “If the company retains the pace of deployment in Q3, they will end the year 675K homes short of their goal, or an 18% shortfall compared to the midpoint of their target.”
But AT&T isn’t alone. Lumen has also fallen behind its target, as has TDS and altafiber (formerly Cincinnati Bell) and Altice USA. Those on track or ahead of pace include Frontier Communications, Consolidated Communications and Verizon.
The analysts at Wells Fargo recently lowered their fiber buildout forecasts for 2022 and 2023. They cut their 2022 forecast for the US to about 8 million new fiber locations, down from 9 million. For 2023, they expect the industry to build about 10 million locations, cut from a previous expectation of 11 million.
Though overall buildout figures are still relatively high, some operators recently have blamed a blend of reasons for the recent slowdown in pace, including a challenging labor supply, permitting delays and rising costs for capital and equipment.
“Labor costs are frequently cited, but equipment costs are rising as well,” Moffett noted. “For example, despite construction shortfalls, AT&T’s capital spending show no such shortfall, suggesting higher cost per home passed.”
And, like the pace of buildouts, the cost situation is clearly not the same for all operators. While Consolidated is seeing the cost per home passed rising to a range of $600 to $650 (up from $550 to $600), Frontier expects its costs to remain at the expected range of $900 to $1,000.
But more generally, Moffett believes the returns on those investments “will only weaken further as buildouts are necessarily pushed out to less attractive, lower density, markets.”
One takeaway from that, Craig warns, is that fiber overbuilding is poised not only to generate lower returns that originally hoped, but that there also will be upward, not downward, pressure on broadband prices.
With respect to the pace of fiber build-outs, there’s heavy demand for labor for today’s overbuilding plans, and it will only get heavier as the $42.5 billion Broadband Equity, Access and Deployment (BEAD) program gets started.
Remedies are out there, with Moffett pointing to the Fiber Broadband Association’s rollout of its OpTICs Path fiber technician training program earlier this year as one example. ATX Networks, a network tech supplier, is contributing with the recent launch of a Field Personnel Replenishment Program.
But they might not completely bridge the gap. “These efforts may help expand capacity, but they are unlikely to fully meet demand, and they are almost certainly not going to forestall near-term labor cost inflation, in our view,” Moffett wrote.
With rising equipment costs and the cost of capital also factoring in, Moffett views a 20% rise in fiber deployment (for both passing and connecting homes) a “reasonable range” in the coming two to three years.
Moffett wonders if network operators will be forced to raise prices to help restore returns to the levels anticipated when fiber buildout plans were first conceived. While it’s unclear if competitive dynamics will allow for that, “it does appear to us that expectations of falling ARPU [average revenue per user] are misplaced,” Craig wrote.
But the mix of higher cost of capital and deployment for fiber projects, paired with deployment in lower density markets or those with more buried infrastructure, stand to reduce the value of such fiber projects further.
“Capital markets will sniff out this dynamic long before the companies themselves do, and they will withdraw capital. This is, of course, how bubbles are popped,” Moffett warned.
The MoffettNathanson’s report also provided an update on broadband subscriber metrics. US cable turned in a modest gain of 38,000 broadband subs in Q3 2022, an improvement from cable’s first-ever negative result in Q2. Cable saw broadband subscriber growth of 1.2% in Q3, down from +4.4% in the year-ago quarter. U.S. telcos saw broadband subscriber growth fall to -0.5% in Q3, versus +.06% in the year-ago quarter.
Meanwhile, fixed wireless additions set a new record thanks to continued growth at both Verizon and T-Mobile. However, T-Mobile’s 5G Home business posted 578,000 FWA subscriber adds in Q3, up just 3.2% from the prior quarter.