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.

The Oldest Government-Owned Telecom Network Wants to Privatize

At the same time that FCC Chairman Julius Genachowski is once again advocating that local governments consider building their own telecom networks, the well-established Iowa government network has just announced that it wants to sell itself off. The Iowa state government released a detailed request for proposals (RFP) this month for the sale or lease of thousands of miles of the Iowa Communications Network (ICN).

The Iowa network is one of the oldest government telecom networks in existence, but it now seems that the debt it has accrued over its history has rendered the system unsustainable. The ICN was created more than 25 years ago, in 1989, and currently includes an estimated 3,400 miles of state-owned fiber and 5,261 miles of leased fiber connections. The network offers video, voice, data, and Internet services to approximately 1,200 customers.

Despite the many advantages the network has enjoyed through government subsidies, investment, and special allowances, the ICN has operated at a loss for years. As a government entity, the network currently pays no income or property taxes, and it received a $16.2 million broadband stimulus grant through NTIA’s Broadband Technology Opportunities Program in 2010 to build out 1Gbps service. Still, the network ran at a deficit from 2007 to 2012. In fiscal year 2012, the network’s revenue was $31.66 million and operating expenses were $41.49 million. 

Given these failures, the RFP offers the ICN for sale or lease to the private sector. Notably, the RFP conditions any sale or lease on the ability of a buyer or lessee to provide services to customers at a lower, overall long-term cost than the state could offer. This indicates that the Iowa state government acknowledges that the private sector could, and likely will, provide service more efficiently to consumers than the government system can.  

The RFP states that if the Iowa state government is able to lease or sell its network (in whole or in part) “the ICN has additional potential . . . as a privatized entity.” Some benefits of privatizing the network include allowing the ICN to offer a greater variety of new services to existing customers and to generate new subscribers.

Although a few government telecom networks have had some limited success, overall these systems increase the financial burden on taxpayers without providing commensurate benefits. As Free State Foundation scholars have observed in the context of Utah’s UTOPIA network, the Mooresville and Davidson, NC MI-Connection, and the Chattanooga, TN EPB network, most government-owned and operated communications networks fall short of the benefits local governments promise. (For a full audit of the UTOPIA network’s financial failings, see “Report to the Utah Legislature”).

For example, as of December 2012, Chattanooga’s municipal smart grid and broadband initiatives run by EPB’s Fiber Optic Division had reportedly cost approximately $390 million, funded by $229 million in local revenue bonds, $111 million from federal stimulus grants, and $50 million in loans from EPB’s municipality electric division (to establish the fiber optic division). In other words, EPB’s electric customers have been responsible for financing a $160 million loan to the EPB telecom wing, and federal taxpayers provided the $111 million in “stimulus” funds. The final $29 million will be borne by EPB’s new Internet and cable television customers.

In addition to the inefficient use of stimulus funds, the financial structure of the Chattanooga system possibly violates state law. One report found that EPB issued bonds for $219.8 million to finance the construction of a fiber optic broadband network; however, only $48 million of that debt was allocated to the communications business unit. According to University of Denver professor Ronald Rizzuto, this violates the Tennessee law that says: “A municipal electric system providing any of the services authorized by this part shall establish and charge rates that cover all costs related to the provision of such services.” Tenn. Code Ann. § 7-52-603 (2013). The allocation of capital costs to the electric utility to foot the bill for the communications business is likely not uncommon among municipal networks nationwide. Running a telecom network is a complicated, capital-intensive, and risk-laden venture that should be left to the private sector.

Municipal or state governments should consider undertaking the construction and operation of a telecom network only if customers are not adequately served by the private sector. Allowing the marketplace to drive private sector innovation and build-out of broadband networks will avoid the unnecessary loss of taxpayer dollars, and it will better enable local governments to better perform their traditional, core public services. Government-run telecom networks should be considered only if local providers do not currently offer service to, or have the intention of offering service to, the same customer base the government system would serve.

Broadband investment has overwhelmingly come from the private sector, and it will continue to do so if the proper policies are promoted. It is vital to continue to focus on policies to incentivize private investment and remove barriers to broadband build-out, as Chairman Genachowski properly acknowledged. Government-operated networks are not the solution, as the widespread failure of these ventures nationwide shows.

A Dystopian UTOPIA

With many local governments confronting severe fiscal difficulties, you'd think they would be content to just focus their attention on trying to deliver essential public services in an efficient, economically sound manner.

You might think so.

But some cities and counties, and in some instances states, can't resist the temptation to get into running businesses that are much better left to the private sector – like building and operating telecom and broadband networks.

These government telecom ventures rarely turn out well.

Take, for example, the Utah Telecommunication Open Infrastructure Agency, with the once touted, but now unfortunate, acronym "UTOPIA".  UTOPIA is a decade-old government-run fiber optic project that is supposed to provide broadband services to eleven Utah cities.

In truth, UTOPIA ought to renamed DYSTOPIA.

Like most municipal communications networks, from the outset UTOPIA's promised benefits have fallen far short. On the other hand, UTOPIA's burdens on the public fisc – and the taxpayers – have far exceeded government projections, even as these burdens have been revised upwards on an ongoing basis.

Utah's Office of Legislative Auditor General recently prepared a lengthy report for the Utah State Legislature concerning UTOPIA's performance to date. Here are some of the key findings:

"[S]ince 2003, UTOPIA has had nine consecutive years of operating losses. These annual deficits have caused serious damage to the agency’s financial position. At the end of fiscal year 2011, UTOPIA had total net assets of negative $120 million."

"UTOPIA originally planned to build a broadband network in three years and to achieve a positive cash flow in five years. However, it has not met that schedule. Instead, the cost of financing and operating the network increased before UTOPIA could provide a substantial number of customers with service. As a result, revenues have not been sufficient to cover its costs. Year after year, as operating deficits have accrued, the agency has developed a large negative asset balance."

"Most of the bond proceeds have been invested in poorly utilized and partially completed sections of network. As a result, the network is not generating sufficient revenue for the agency to cover its annual debt service and operating costs."

"The use of debt to cover the cost of operations and debt service is symptomatic of an organization facing serious financial challenges."

"In addition to UTOPIA’s problems with poor planning, mismanagement, and unreliable business partner performance, a lack of sufficient customers is also a cause for the agency’s slow progress."

The Auditor General's Report is filled with facts and figures, almost of them dismal – or dystopian – if you will. You can read through the report and draw your own conclusions.

Here is what Utah's leading newspaper, the Deseret News, concluded in an August 3 editorial following the release of the legislative audit:

"Early projections presumed that UTOPIA's massive broadband network would be profitable within its first five years and have a subscriber base of 49,000 by 2007. Yet as of April 2012, it has a paltry 9,300 subscribers, and profitability is nowhere in sight."

"This is causing an impossible strain on the local municipalities that pooled their resources to make UTOPIA possible. The participating member cities have to scrounge up $13 million a year in sales tax revenues to keep UTOPIA going. Adverse economic conditions make that money a lot harder to come by than it was when the project was on the drawing board. Clearly, there are far more important civic priorities that ought to take precedence over the UTOPIA boondoggle. This constitutes an inexcusable waste of valuable public resources."

"UTOPIA's network duplicates more innovative projects taking place in the private sector. The free market recognizes the need for a robust communications infrastructure, and it has been able to provide customers with these services in a timely and cost-effective manner. Private enterprise doesn't have the ability to dip into public monies when their operations don't produce enough cash — they either sink or swim on their own merits. That's why the state should sell UTOPIA assets to the companies that would be in a position to use them profitably."

I have never taken an absolutist position that there might not be exceptional circumstances under which it may be appropriate for municipal governments to build and operate telecom networks. But UTOPIA's unfortunate experience, along with that of other government-run networks, provides a cautionary tale that such instances should be extremely rare. And a precondition for considering government ownership must be that no private providers are offering service in the area and none have indicated an intention to do so. Even then, of course, governments should proceed with the utmost caution. For there likely are good reasons, from an economical and practical point of view, why private operators are not yet offering service.

The cities that comprise the UTOPIA venture could do their citizens – and perforce their taxpayers – a favor by getting out of the telecom business. Indeed, they have an obligation to do so. History has shown that running a telecom network is a highly capital-intensive and complicated business much better left to private enterprise.