The Gift That Keeps on Taking: Municipal Broadband System in Lafayette, LA Showing Weakness

Last month, city auditors issued yet another warning to the municipal broadband system in Lafayette Louisiana, LUS Fiber. Rstreet.com reported the details of the recent advisory, published an in-depth case study on the Lafayette system, and noted that Lafayette auditors have voiced concerns about the network in each of their reports over the past two years. LUS Fiber is the just the next in a long line of government-owned broadband networks that have fallen far short of expectations.

According to the city’s financial reports, LUS Fiber reported $23 million in operating revenues, compared to $36.7 million that was forecast in its feasibility study for the fiscal year ended October 31, 2013. According to LUS Fiber’s original plan, the operation was projected to produce a profit of $902,000, but instead the system incurred a $2.5 million operating loss for the year. But the most telling number is LUS Fiber’s deficit of $47 million at the end of FY 2013, up from $37.1 million the year before.

LUS Fiber has tried to downplay these results by publicizing that the network is “cash-flow positive.” But that just means that LUS Fiber is taking in more than it’s spending on a day-to-day basis, but it does not properly acknowledge the network’s substantial long-term debt liability. The failure to produce promised-profitability puts taxpayers on the hook for LUS Fiber’s debt, which increased a staggering 27 percent from 2012 to 2013 according to Coalition for the New Economy.

And unfortunately for local taxpayers, data shows that municipal broadband systems like LUS Fiber are unlikely to find relief for their ever-increasing debt. LUS Fiber and other municipal broadband networks that offer landline broadband services and rely on the triple-play package – phone, cable, and Internet - to produce revenue are betting on a dying model. Based on a report from ISI Group, an equity research firm, BusinessInsider.com reported that nearly 5 million cable TV subscribers cut the cord in the last five years. The number of cable TV-only subscribers remaining could fall below 40 million next year, as the graph from ISI Group shows.

The weaknesses of LUS Fiber are regrettably common among municipal broadband networks. Free State Foundation scholars have tracked the failure of many government-owned networks, including Burlington Telecom’s February $10 million settlement with Citibank over loans to its ailing system. Other examples of municipal “broadband busts” include Mooresville and Davidson, North Carolina, Utah’s UTOPIA network, Chattanooga, Tennessee’s Electric Power Board (EPB) network Provo, Utah, Lafayette, Louisiana, and the N.C. Eastern Municipal Power Agency. 

Municipalities should view the consistent failure of government-owned networks as confirmation that the private sector is best suited to develop and manage broadband networks. Absent compelling evidence that private sector broadband providers will not make adequate service available in the locality, local governments should refrain from building out their own networks in order to protect their taxpayers from the high costs and high risks of broadband network deployment.

If local governments want to increase competition in their broadband markets, the best way to do so is to remove existing, costly, unnecessary regulations. This will incentivize private investment, remove barriers to broadband deployment, and promote the continued growth of today’s competitive communications environment. 

The FCC Should Not Preempt State Restrictions on Municipal Broadband

In the wake of the D.C. Circuit’s Verizon v. FCC decision, Federal Communications Commission Chairman Tom Wheeler laid out plans for the Commission’s approach to broadband. Those plans included a proposal to potentially preempt state restrictions on the ability of cities and towns to offer broadband services to their communities. At the Consumer Federation of America’s Assembly on March 21, Chairman Wheeler reiterated his plans to address state restrictions preventing state localities from building out municipal broadband services.

Chairman Wheeler should not move forward with these plans. First, Section 706 most likely does not provide FCC authority to preempt state laws. Second, government-funded networks do not bring real competition to localities and, most often, eventually cause more harm than good. Finally, the widespread failure of government-owned broadband projects proves that it would be unwise for Chairman Wheeler to push municipalities to pursue these often harmful ventures.

Nearly twenty states restrict local governments from entering into the business of providing broadband Internet service. These restrictions are sound policy, as they prevent local government conflicts of interest with the private sector, and they protect other local government programs and local taxpayers from the potential financial losses stemming from risky municipal broadband projects.

FSF scholars have discussed the problems stemming from government-owned broadband systems at length. In his February 26 Perspectives, Senior Adjunct Fellow Seth Cooper recently analyzed the legal implications of the FCC’s tentative plan to potentially preempt state-level restrictions on municipal broadband projects. Mr. Cooper found that “preemption would undermine local government accountability to state governments and to taxpayers” and “any attempt to interfere with the relationship between states and their local governments will run up against basic free market and federalism principles.” 

Federal law contains no clear statement authorizing preemption of state restrictions on their cities and counties going into the telecommunications or broadband Internet business. The U.S. Supreme Court has previously rejected federal preemption of state prohibitions on telecommunications services in Nixon v. Missouri Municipal League (2004). The Supreme Court expressly rejected claims that Section 253(a) of the Communications Act preempted a state statute prohibiting its cities and counties from offering telecommunications services. The Court based its decision on the "clear statement" rule and constitutional federalism problems posed by preemption of fundamental state sovereign functions. Also, a 1997 order by the FCC rejecting the preemption of a Texas restriction on local governments providing telecommunications services is an agency precedent that weighs against preemption.

Additionally, the principles of cooperative federalism dictate that a federal agency should not grant counties or cities powers that their respective states did not delegate to them. Chairman Wheeler’s February 19 statement, which included a proposal to examine “legal restrictions on the ability of cities and towns to offer broadband services to consumers in their communities,” has been characterized and reported as an effort to bring broadband to the citizens of municipalities. Municipalities are purely creations of the state. Municipal residents are citizens of the state. These citizens, as voters, indicate their political views, including whether they support legislation restricting municipal broadband initiatives, by electing certain state officials, from members of the state legislature all the way up to governor. FCC preemption of state-imposed restrictions on municipal broadband would impose on state citizens policies they do not support and would deprive them of recourse through their elected representatives.

While the D.C. Circuit arguably may have broadly construed the authority granted to the FCC under Section 706 in its recent Verizon decision, this authority is not likely to be as broad as the Commission's regulatory ambitions. And it most likely does not allow the FCC to interfere with state control over cities and counties to encourage broadband deployment absent a clear statement of intent by Congress. Constitutional principles, as well as Supreme Court and agency precedent, weigh against the legal support for FCC preemption of state restrictions.

There are also many fact-based reasons why preempting state restrictions on municipal broadband initiatives is unwise. In his March 7 Washington Times article, “FCC, Broadband and Fallacy of Government Competition,” FSF President Randolph May discussed how government systems thwart competition rather than enhance it, despite what Chairman Wheeler may believe. Mr. May concluded that “government systems pose inherent conflicts of interest with private-sector companies” by competing with them for rights-of-way, financing, and subscribers. And, these networks are generally subsidized directly by taxpayers or by government bonds carrying below market interest rates. Because building and managing broadband networks is not within the “traditional bailiwick and presumed competence” of local governments, these systems most often fail, and leave taxpayers and government bondholders “holding the bag."

I discussed the many examples of failed local government communications networks in a recent blog, including the recently publicized failure of Burlington, Vermont’s broadband network, Burlington Telecom (BT). For the past two years, BT has been fighting the claims of Citibank, its primary creditor, that BT owes it $33.5 million; the proposed settlement is for $10.5 million, which will be funded “largely” through non-taxpayer resources. Not surprisingly, the city has had to look to the private sector to help in funding the settlement.

Unfortunately, BT is only the latest failure in a longstanding pattern of money-losing municipal broadband projects. The towns of Mooresville and Davidson, North Carolina, faced multi-million dollar debts after acquiring the MI-Connection Communications System from the bankrupt Adelphia Communications cable systems. Utah’s UTOPIA network operated at a loss from 2003–2012, which caused “serious damage to the agency’s financial position” and resulted in total net assets of negative $120 million by 2011. Chattanooga, Tennessee’s Electric Power Board (EPB) network was built almost entirely at taxpayer expense. And last February, the Iowa state government sought to sell off its Iowa Communications Network. The Iowa network is one of the oldest government telecom systems in existence, but the debt it accrued over its history rendered the system unsustainable. Other municipal “broadband busts” include Provo, Utah, Lafayette, Louisiana, and the N.C. Eastern Municipal Power Agency.  Citizens Against Government Waste’s recent publication discusses these and other examples of poorly managed broadband networks, and CAGW urges the FCC not to push municipalities into competition with the private sector.  

In sum, Chairman Wheeler should not pursue his proposal attempting to “enhance competition” by encouraging governments to compete with private sector companies. There is plenty of evidence, both legal and factual, supporting the conclusion that preempting state restrictions on government-owned broadband systems is unsound and unwise. Instead, as Mr. May stated in his Washington Times article, “The proper way to encourage competition is to remove existing, costly regulations that no longer are necessary in today’s competitive communications environment and to refrain from adopting or threatening to adopt new ones.”

Another One Bites the Dust: Burlington Telecom’s Failure Shows, Again, That Government-Operated Broadband Networks Are Not The Solution

In a public statement on February 19, Chairman Tom Wheeler laid out his plans for the Federal Communications Commission’s approach to broadband in reaction to the D.C. Circuit’s Verizon v. FCC decision. Many of the proposed Internet regulations and policies Chairman Wheeler announced amount to “solutions in search of a problem,” as House Subcommittee Chairman Greg Walden stated.

Among those problematic “solutions” is Chairman Wheeler’s idea to potentially preempt state restrictions on the ability of cities and towns to offer broadband services to their communities. The idea to encourage localities to build their own networks was introduced as a way to “enhance competition.” Chairman Wheeler elaborated after the FCC’s open meeting on February 20 that “the operating hypothesis” regarding municipal networks “is that if local communities say they want more competition and want to work through their locally elected officials” to accomplish that, they should be allowed to do so.

The goal of increasing consumer choice in Internet access is a worthy one. However, the Commission’s “hypothesis” that local entities can achieve that goal has been proven wrong repeatedly. Government-owned systems have experienced widespread failure nationwide, and the localities have passed the cost of those shortcomings onto taxpayers. In contrast, the private sector has been the central source of impressive investment and efficient broadband deployment for years, and the Commission should not interfere with the healthy growth and evolution of technology and business models by favoring localities over private investors.

The most recent government-owned network that is in the news for falling short of expectations is Burlington, Vermont’s network, Burlington Telecom (BT). On February 3, Burlington Mayer Miro Weinberger said the city had reached a settlement with Citibank in its lawsuit over its loans on the financially ailing BT cable system. The BT system has been deteriorating for years. In 2011, the New Rules Project released a report, which found that “in little more than a year, Burlington Telecom went from being a hopeful star of the community fiber network movement to an albatross around its neck.” The report found that BT’s debt to the city’s cash pool reached $17 million by 2009, and BT’s management “grossly overspent even their own estimates,” with over half of all expenditures allocated to a nebulous “other charges” line item. These findings imply a lack of transparency, irresponsible spending, and potentially fraudulent use of funds.

For the past two years, BT has been fighting the claims of Citibank, its primary creditor, that BT owes it $33.5 million; the proposed settlement is for $10.5 million, which will be funded “largely” through non-taxpayer resources. Not surprisingly, the city has had to look to the private sector to help in funding the settlement. 

Many local governments have encountered the same fate after investing heavily on money-losing municipal broadband projects. For example, the towns of Mooresville and Davidson, North Carolina, faced multi-million dollar debts after acquiring the MI-Connection Communications System from the bankrupt Adelphia Communications cable systems. Starting in 2011, the towns owed over $7 million in annual debt payments for five years, which constituted one-fourth of the town’s operating budget each year. Utah’s UTOPIA network was built with the goal of achieving a positive cash flow in five years. Instead, the network operated at a loss from 2003–2012, which caused “serious damage to the agency’s financial position” and resulted in total net assets of negative $120 million by 2011. Chattanooga, Tennessee’s Electric Power Board (EPB) network was built almost entirely at taxpayer expense. According to a 2012 National Taxpayers’ Union report, EPB’s electric customers were responsible for financing a $160 million loan, its new Internet and cable television customers financing $29 million, and federal taxpayers financing another $111 million via the 2009 “stimulus” bill to build the network. By 2010, the network had incurred a combined $176.5 million in cumulative debt and experienced a downgrade in credit rating due to the “high degree of business risk and operating margins that are less predictable than the EPB’s traditional electric operations.” And last February, the Iowa state government sought to sell off its Iowa Communications Network. The Iowa network is one of the oldest government telecom systems in existence, but the debt it accrued over its history rendered the system unsustainable. Other municipal “broadband busts” include Provo, Utah, Lafayette, Louisiana, and the N.C. Eastern Municipal Power Agency.

FSF President Randolph May concluded in a blog last year that the “common denominator” among these and other government-owned systems is this: “Because of almost universal cost overruns and less than projected demand for the services offered, taxpayers typically are left to bear the burden of the ensuing financial distress, either by providing direct subsidies from government coffers or by providing indirect subsidies through premium guarantees for bond offerings used to finance the projects.” Running a telecom network is a complicated, capital-intensive, and risk-laden venture that should be left to the private sector, unless private operators have not shown a willingness to provide service.

FSF scholar Seth Cooper also highlighted the problems with empowering local governments to directly compete with private broadband Internet providers in a February 26 Perspectives. He found that in addition to exposing local taxpayers to financial risk and wasting community resources, allowing governments to assume “a dual role as public authority and as competing business proprietor poses inherent conflicts-of-interest for local governments. Such conflicts lend themselves to abuses of government power.” He also found that FCC preemption of state safeguards on government-owned broadband projects to prevent such abuses may exceed FCC authority and violate constitutional federalism principles. As such, both legal and policy-driven analyses support leaving broadband network ownership and management to the private sector.

Luckily for Burlington, Mayor Weinberger seems to have chosen to divest the city from the telecom business. He stated that private investors have a better chance of competing successfully in the “highly competitive, quickly evolving and capital intensive” telecommunications business, and he is right.

Chairman Wheeler recognized in his recent statement that since 2009, nearly $250 billion in private capital has been invested in U.S. wired and wireless broadband networks. Telecommunications companies are leaders in domestic capital investments. AT&T and Verizon ranked in the top five “U.S. Investment Heroes of 2013,” together investing $34.5 billion last year. The telecommunications and cable sector was responsible for $50.5 billion of investment in 2013, comprising more than one-third of total capital investments in the U.S. economy. And since 1996, cable operators have invested over $200 billion into broadband infrastructure. Additionally, private sector investors — and not local taxpaying residents — bear the financial risks should private systems falter.

As Free State Foundation scholars have frequently discussed, broadband investment will continue to come from the private sector if the proper policies are promoted. The FCC should focus on policies to incentivize private investment and remove barriers to broadband build-out. However, government-operated networks are not the solution to promoting broadband deployment, as the widespread failure of these systems continues to prove.

Google Goes to a Dollar Store

Last week Google went shopping at a dollar store – and came away with a fiber system. 

According to the April 18 Associated Press lead: "Google Inc. will pay $1 for a municipal fiber-optic system that cost $39 million to build, according to terms of the Internet company's agreement with Provo." 

That's Provo, Utah. 

The Provo acquisition looks like a good deal for cash-rich Google, which, by the way, said last week that it earned $3.3 billion during the first three months of this year. According to the AP: "Even as Google takes ownership of the municipal network, Provo will have to pay off loans for its construction for another dozen years, according to agreements released Thursday by city officials." 

In exchange for Provo selling its city-owned fiber network for $1.00, Provo's citizens will get upgrades to the current system and, supposedly, offers to subscribe to high-speed broadband services at reasonable rates. In the case of slower, basic service (5/1 Mbps), after payment of a $30 installation charge, the service will be free for a number of years. 

Late last week I wrote about the highly problematic nature of government-owned municipal telecom networks. In "Observing Troubled Government Telecom Systems," I chronicled the troubled history of some of these systems. The Provo municipal system is just one more example, among many. The Provo officials said the Google deal was a good one for the city "because the system hasn't been able to support itself." 

Of course, there are lessons here to be learned. Foremost, as I said last week in the "Observing" piece: 

"Governments should not enter the telecom marketplace with government-owned systems when private sector providers, with their own capital at risk, are willing to provide service. With the government systems' financial backing and subsidies from taxpayers - even if such backing and subsidies often are extracted unwittingly - along with various special privileges and benefits, it is exceedingly difficult for private sector companies to compete on an equitable basis with government providers." 

But with Google entering the local broadband marketplace in a few carefully selected cities, there is another important lesson as well. Just as private sector providers should not have to compete against government-owned providers – with their tax subsidies and other special privileges – so too should private providers not have to compete against other private firms like Google which are beneficiaries of government-conferred privileges.
  

When Google announced it was entering the Kansas City, Missouri market with its high-speed fiber service, in that case in competition with Time Warner Cable, it became evident that Google would be granted, as inducements, an array of special privileges and benefits extended by the city government.
  

According to compilations from various press reports, here is a list of some of the special privileges: 

•    Free space in city facilities for installation of central office equipment and for additional network facilities 

•    Free power for network equipment at city locations 

•    Free access to city “assets and infrastructure,” including conduit, fiber, poles, rack space, nodes, buildings, facilities, and land 

•    Right to build out only to neighborhoods demonstrating high demand for the service through pre-registrations 

•    Right to terminate the agreement for convenience at any time up to two years after actual construction commences on the fiber network 

•    Ability to build “fiber huts,” which are small buildings that house equipment, on city land at no cost 

•    Waiver of city permit and inspection fees 

•    Lower pole attachment rates than Time Warner Cable was paying 

•    Cooperation from city in efforts to allow Google to gain access to poles and rights-of-way owned or controlled by third parties 

•    Cooperation from city to obtain settlement-free interconnections with anchor institutions in city that have existing fiber and/or network connections 

•    Free access to detailed GIS data and computer tools, including location information on all facilities owned by city and, to the extent available, those of third parties 

•    Access to rights-of-way on property owned by city

•    Provision by the city of (1) an “Executive Sponsor” for the project at most senior management level of the city; (2) a single point of contact; and (3) a team of city officials to work with Google employees 

•    Regular (at least weekly) status meetings between city officials and Google for coordination of all matter relating to the project 

•    City approval of all applications and documents within 5 days 

•    Marketing support and education programs regarding the network, including direct mailings and community meetings 

I cannot vouch for the accuracy of the reports regarding each of the above privileges and benefits, but, for my purposes here, that is not necessary. The point is that municipal governments, whether in Kansas City, Austin, Provo, or wherever, should not offer one private sector provider government-conferred benefits that are not available on the same terms to other private competitors. While I am not certain of this, it is my understanding Kansas City may now have agreed to make the same terms available to Time Warner Cable, and others, as it is making available to Google. And press reports indicate Austin appears prepared to treat all private providers the same regarding city-conferred inducements.

I certainly am not opposed to Google entering the broadband marketplace in selected localities as long as the company does not receive special government-conferred privileges and benefits that are not available to its private sector competitors. Of course, this point applies not only with respect to local and state government-conferred benefits, but to any special privileges conferred at the federal level as well. 

More private sector competition is a good thing. What is decidedly not a good thing is for more governments to enter the telecom business with their own networks.

Observing Troubled Government Telecom Systems

As Yogi Berra said, "You can observe a lot by watching." 

There is now a lot of accumulated evidence – available for observing by those willing to watch – that government-owned and operated communications providers typically underestimate costs and overestimate demand when formulating their "business plans." 

In part, of course, this may be because, by definition, governments aren't schooled in developing realistic business plans in the way that for-profit businesses necessarily must be. Mostly, though, it is because the government planners know from the get-go that taxpayers, ultimately, will be back-stopping their telecom projects. This knowledge does not help focus the mind in a way that sharpens business plans. 

Over the years, FSF and others have chronicled the woes of many of these problematic government-owned telecom ventures, whether the misleadingly named UTOPIA project in Utah, or the troubled Mooresville and Davidson, North Carolina city broadband systems, the Lafayette, Louisiana fiber system, or the Iowa state telecom network. 

Without rehashing the gory details of each project here, the common denominator of these government-owned telecom systems is this: Because of almost universal cost overruns and less than projected demand for the services offered, taxpayers typically are left to bear the burden of the ensuing financial distress, either by providing direct subsidies from government coffers or by providing indirect subsidies through premium guarantees for bond offerings used to finance the projects. 

You can observe a lot by watching these government-owned telecom projects. But, still, despite the record, there are unceasing calls by some for more government systems and municipalities still embark on the projects. 

Speaking of observing, an April 14 editorial in the Raleigh, N.C. News and Observer caught my eye. Entitled "An Intolerable Monthly Jolt," the paper excoriates the N. C. Eastern Municipal Power Agency, comprised of 32 municipalities, for a series of bad decisions over the years that has lead to the government agency's customers "paying rates 40 percent higher than the state average and over 50 percent higher than Duke Energy's." Duke is the state's leading private electric power provider. Aside from the hardship to individuals, the editorial points out that "no job-bearing business is going to take up in a town that charges half again as electricity as most of the state." This is true. One option, according to the News and Observer, is the sale of the agency's power generating assets. 

I understand that government-owned electric power providers and government-owned telecom providers differ in some respects and operate in somewhat different contexts. I understand too that it is probably safe to say that no two government-owned telecom providers are identical or operate in the very same contexts. Nevertheless, there are certain fundamental principles of political economy that remain applicable in any event. 

Governments should not enter the telecom marketplace with government-owned systems when private sector providers, with their own capital at risk, are willing to provide service. 

With the government systems' financial backing and subsidies from taxpayers – even if such backing and subsidies often are extracted unwittingly – along with various special privileges and benefits, it is exceedingly difficult for private sector companies to compete on an equitable basis with government providers. While I have never taken the absolutist position that it is improper under all circumstances for municipal governments to provide telecom services, such entry should be limited to areas in which no private sector provider is offering service and no private operator has shown a willingness to provide service. 

Amidst all the fiscal difficulties that governments at all levels are experiencing, difficulties which sometimes call into question their ability to deliver basic government services, they should not be entering the telecom business in competition with private sector companies able and willing to provide the services that consumers demand. 

There is more than enough evidence available for observing to reverse the trend – I might say the fad – of ill-conceived government forays into the communications business.