Nov 18

Written by: Greg Richardson
11/18/2007 2:27 PM

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.

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