Broadband Considerations and Opportunities ForwardThinking Professionals Helping Clients

Broadband Considerations and Opportunities Forward-Thinking Professionals Helping Clients and Colleagues ACHIEVE Their Goals. www. powersystem. org Tom Asp April 2020

About PSE Forward-Thinking SOLUTIONS Serving utilities, private industry, government entities, and associations across North America § Established in 1974 § Employee-Owned § Independent Service Areas Include: § Broadband Planning § Communications Infrastructure § Energy Resources § Industrial Facilities § Utility and Data Analytics § Rates and Finance § Transmission and Distribution § Utility Automation © 2020 Power System Engineering, Inc. 2

Broadband Progression Regardless of where you are on the spectrum of investigating and deploying broadband, it can be helpful to understand lessons others have learned. On Radar Hearing member, board & industry talk and wondering if it’s right for you. © 2020 Power System Engineering, Inc. Planning Initial Deployment Up & Running financial analysis and looking at costs, take-rates, assumptions, and plans. Deploying fiber in test areas to see if the plans were appropriate and learn lessons. Running fiber business for several years and analyzing profit/loss. 3

PSE’s Approach PSE has been supporting our clients for 45 years in critical infrastructure. Distribution Design We understand: • How important your members and customers are to you. • Your dedication to reliable and cost-effective electric service. Operations Support • The cost of maintaining and operating long-term infrastructure. Financial Planning We look out for the best long-term interest of your utility and members so we can work with you for years to come. © 2020 Power System Engineering, Inc. 4

Discussion Overview • Many electric cooperatives are intrigued by the idea of offering broadband services to their members. • Some are jumping into decisions that may not be fully vetted. • Decisions can have substantial impact on the viability of the electric utility long-term. • Entering the broadband market might be the correct choice for your cooperative and your consumers. • Or, it may be a high-risk venture that is best left to other entities. © 2020 Power System Engineering, Inc. 5

Discussion Overview Conducting a broadband feasibility study Key financial, market assessment, and design considerations “Off-the-balance sheet” drivers © 2020 Power System Engineering, Inc. 6

Example Broadband Efforts • Norwood Light Department (Norwood, MA) – First to market with broadband (2002) – Offers cable television, telephone (resell), and broadband services – Maintaining cash flow (debt service and operational experience) – Market share eroded over time due to competition • Tacoma Power (Tacoma, WA) – Early entry into market (2000) – Offers retail cable television and wholesale broadband – Paid cash for network – Unable to cover operational expenses, used electric allocations to cover cash shortages – Court ordered to cease electric department subsidy © 2020 Power System Engineering, Inc. 7

Example Broadband Efforts • Huntsville Utilities (Huntsville, AL) – Fiber infrastructure used for utility applications when practical – Excess strands and other assets offered under “dark FTTP” lease – Google first tenant • Offer retail broadband services • Tipmont REMC (Linden, IN) – Strategic deployment of FTTP (balance cost, demand, and competition) – Acquired CLEC (Wintek) for expertise and cash flow – Partnered with a telephone cooperative (Mulberry Telephone) for retail cable and telephone services – Revised cooperative mission – began an “Essential Service” provider – Approached opportunity methodically using 10 key considerations © 2020 Power System Engineering, Inc. 8

10 Key Considerations 1. Understand Consumers have Choices: Broadband is a competitive business – consumer choices are expanding. 2. Ensure Electric Operations Preparedness: Get your house in order (operations and finance). 3. Do a Thorough Feasibility Study: Thoroughness matters - be cautious of advisors or consultants that promote no risk deals or offers. 4. Own the Details: Know and understand every assumption and number in the financial analysis. 5. Facilitate Team Learning: Give your team ample time to learn—they are going to run the new business day-to -day. © 2020 Power System Engineering, Inc. 9

10 Key Considerations 6. Invest Time with Your Board: Work closely with your Board. You’re going to own the new business for years to come. 7. Start Slow - Don’t Bet the Bank: Build, sell, and work to positive cash flow in an area, then build again. 8. Consider Facilitation of Partnerships: Look at the potential for partnerships to avoid risks and reduce capital costs. 9. Learn from Others: Know where the failures and successes have occurred and why. 10. Understand its More Than a Spreadsheet: Understand the financial model and business structure, its assumptions and how well it accounts for changes. © 2020 Power System Engineering, Inc. 10

1. Understand Consumers Have Choices • No competitors? – Not acquiring a service is a choice. – Do not ignore substitute products. – Do not dismiss 4 G, 5 G, and Satellite (LEO and GEO). • Be cautious of estimating broadband demand on unsolicited comments from consumers. – Vocal minority is a self-selected sample. • Broadband has become an essential service, but it is not a utility. – Utilities are regulated and have monopoly service area. – Acting as a utility without associated regulations could be a financial disaster. © 2020 Power System Engineering, Inc. 11

1. Understand Consumers Have Choices • Ensure that your staff, management, and board are culturally ready to operate in a competitive business. – The top three activities in the broadband business. • Sales & marketing, sales & marketing, and sales & marketing. • Foreign to most electric utilities. – Customer service requires different skill sets. • Do your electric customers call you when their toaster does not work? – Service pricing is different than rate setting. © 2020 Power System Engineering, Inc. 12

2. Ensure Electric Operations Preparedness • Define and understand your mission. – Are you in the electric utility business, or are you an essential service provider? • In a rural area? – Speed to market is not a pressing concern. • Staffing - you only have room for top players. – In a competitive business, top performers are a requirement. • Make sure your core electric operation is humming along – Financial and operational health. © 2020 Power System Engineering, Inc. 13

2. Ensure Electric Operations Preparedness • Review all your policies - think defense. – You’re about to get more attention than you may have had in decades. – Don’t get derailed by possible events you could have prepared for. • Have a strategic planning and performance management system in place. – Have all your instruments working before you start. • Set your cash flow objectives and goals. – In the mid-term, at best, this is a break-even operation. – Cover early losses. © 2020 Power System Engineering, Inc. 14

3. Do a Thorough Feasibility Study – Thoroughness Matters • Be cautious of shortcuts. – You are about to make a multi-million-dollar decision. – Generalized assumptions give you generalized results. • Questions to ask your consultant: – In how many of your studies did you find the venture to not be feasible? • If they can’t identify one, don’t hire them. – Will you benefit financially if we enter into the broadband business? • If they do, can they give unbiased independent advice? • Do not underestimate staffing need. • Leverage grants when possible, and don’t overlook operational expenses. © 2020 Power System Engineering, Inc. 15

3. Do a Thorough Feasibility Study – Thoroughness Matters • Outputs from your feasibility analysis should be tailored to your utility. – Use utility-specific data – Not boilerplate estimates based on national or regional averages: • Capital construction cost estimates. • Make-ready. • Easement perfection. • Operating cost estimates. • Demand-side market analysis, possibly detailed market survey of residents. • Vocal minority is a minority. • Maybe deferred to the business planning or other stage (to avoid raising expectations too early). • Demand-side market analysis requires segmentation. © 2020 Power System Engineering, Inc. 16

Understand the Full Range of Costs © 2020 Power System Engineering, Inc. 17

Cost of FTTP is Highly Dependent on Density Cost per Passing (Fiber Plant) $ 8 000 $ 7 580 $ 7 000 $ 6 000 $ 5 000 $ 4 040 $ 3 900 $ 4 000 $ 3 000 $ 2 000 $ 1 620 $ 880 $ 1 310 $ 1 120 $ 1 020 $ 1 180 $ 860 $East Coast - East Coast Medium City Rural City © 2020 Power System Engineering, Inc. East Coast Suburban Midwest County Midwest Medium City Midwest Rural City Midwest Township West Coast - West Coast Suburban Urban & Suburban Mix 18

Cost of FTTP is Highly Dependent on Density $350 000 300 $300 000 250 $250 000 $200 000 150 $150 000 Passings per Mile Cost Per Mile 200 100 $100 000 50 $50 000 $0 0 East Coast Medium City East Coast - Rural City East Coast Suburban Midwest - County Midwest Medium City Cost per Mile © 2020 Power System Engineering, Inc. Midwest - Rural City Midwest Township West Coast Suburban West Coast Urban & Suburban Mix Passings per Mile 19

Avoid Historic Survey Blunders • Literary Digest 1936 – Predicted Alf Landon would beat Franklin Delanor Roosevelt – Sample was not representative of voters. • Used lists of phone numbers, drivers' registrations, and country club memberships. • Chicago Tribune 1948 – In the 1948 presidential election, three major polls predicted Dewey would win. He did not. What happened? • Stopped polling too soon, and Truman was notably successful at energizing people in the last days before the election. • Used telephone polls - in 1948 telephones were generally limited to more well-to-do households. © 2020 Power System Engineering, Inc. 20

Understand Business Diversity Substantial differences in use of and demand for broadband based on: • Number of employees • Type of business • Ownership structure • Activities performed at a specific location • Others © 2020 Power System Engineering, Inc. 21

Understand Business Diversity Norwich CT Business Segmentation Example © 2020 Power System Engineering, Inc. 22

3. Do a Thorough Feasibility Study –Thoroughness Matters • A feasibility study is NOT a business plan. – Feasibility study gives you a senses of risks and opportunity – Business plan gives you direction on execution – Staff needs to direct both • Your competition has better economies of scale. – Offer competitive prices- but don’t initiate a price war. – Your competitors can bury you in a price war. • Don’t turn over core operations to a management firm © 2020 Power System Engineering, Inc. 23

4. Own the Details - Know and Understand Every Assumption • Crucial step of the evaluation process. • Understand the bases for the assumption. • Understand how the model works. – Get a working copy of the model. • Challenge the consultant’s assumptions. – Understand how the assumption is used and the impact to the model. © 2020 Power System Engineering, Inc. 24

4. Own the Details - Know and Understand Every Assumption • Understand any projected cost allocations to the electric utility – Are they reasonable? – Are they defendable? – Are they affordable? – Are they legal? • The model does not correct, modify, or shape assumptions made. • Assumptions drive the projections. © 2020 Power System Engineering, Inc. 25

5. Facilitate Team Learning • Give staff the time to learn. • Your staff is going to run the new business day-to-day. • Your staff needs to “own” every assumption used in the model. • Find a place where everyone on your senior staff can participate. © 2020 Power System Engineering, Inc. 26

6. Invest Time with Your Board • The board must ultimately make the decision. • Work to create as many learning/sharing opportunities as possible. – It’s their collective value system that will ultimately define your direction. • Make sure that you, your governing body, and your staff are comfortable. – You will own all decisions and strategies after the vendors and consultants have moved on. © 2020 Power System Engineering, Inc. 27

7. Start Slow - Don’t Bet the Bank • Consider phases. – Build, sell, work to positive cash flow, and then build again. • Go after market where there is demand, limited choices, and a “reasonable” build cost. – Many utilities choose to built all at once to everybody – a politically-driven decision, but a disastrous business decision. © 2020 Power System Engineering, Inc. 28

7. Start Slow - Don’t Bet the Bank • You may be enamored with broadband – but not all households are. – Many are happy with a 10 Mbps or less data connection. – Many just use a smartphone for their data connection (about 20 percent nationwide today). – Some will choose not to acquire any service. © 2020 Power System Engineering, Inc. 29

8. Consider Potential for Partnerships • Partnerships can help to avoid risks and reduce capital costs. • Beware of the sharks that offer one-sided offers. – Take the initiative to define the rules yourself. • Partnerships can bring you scale and expertise that is hard to develop on your own. © 2020 Power System Engineering, Inc. 30

9. Learn from Others Common mistakes: Under-estimated build costs Overlooking make ready. Overestimated take rates. Under-estimated cost of sales and marketing. Underestimated staffing - maintenance to customer service. Tried to be all to all. Forgot about equipment replenishments, replacements, and vendor maintenance contracts. Bad debt is real – need to cut off bad payers. Don’t let your governance board make operating decisions. Added same inflation factor to revenues and expenses - makes a bad model look good. © 2020 Power System Engineering, Inc. 31

Example - Use Caution with Inflation Assumptions • Applying inflation can create substantial net revenues in out years. – The top table uses the same inflation percentage on expenses and revenues. – The bottom table uses a lower inflation percentage on revenues, which results in flat net revenues. – All other assumptions are the same. • Net revenues historically with broadband have remained relativity flat. © 2020 Power System Engineering, Inc. 32

10. Understand its More Than a Spreadsheet • Projections are only as good as the assumptions. • Be cautious of adding “inflation” on revenues and expenses (earlier example). – Over a 20 -year analysis, adding same inflation factor on revenues and expenses can make a bad business look good. • With broadband, you will be lucky to have revenue increases tracking $ for $ with expenses. – Many advisors will claim that the industry pricing is rising fast – then cite cable television increases. • Yes, cable television revenues are increasing (on a per subscriber basis), but expenses (content fees) are rising quicker- resulting in eroding net margins. – There are small to negative margins in cable • Internet service revenues (on a per-sub basis) are declining. © 2020 Power System Engineering, Inc. 33

10. Understand its More Than a Spreadsheet • Year-by-year income statement, cash flow statement, capital addition summary. • Look at cash flow. Not just a Net Present Value (NPV) or Internal Rate of Return (IRR) calculation. – A projection can show a high 20 -year IRR and have negative cash flows for the first 10 years – especially if inflation factors are misstated or misused. • Clearly understand any allocations to electric utility capital or operations. • A spreadsheet does not correct, modify, or shape assumptions made. The assumptions drive the projections. © 2020 Power System Engineering, Inc. 34

Summary • Take a methodical and cautious approach. • Broadband is a for-choice business. • Staff, management, and board must be ready to operate competitively – strong emphasis on sales, marketing, and customer service. • Perform an independent and thorough feasibility study tailored to your situation. • Be cautious of advisors or consultants who promote no-risk deals or offers. • Common mistakes include underestimating build costs, overlooking make-ready costs, overestimating take rates, and underestimating staffing levels for maintenance and customer service. • It’s not only about the numbers. The decision is also driven by your mission and community drivers. © 2020 Power System Engineering, Inc. 35

Tipmont REMC Status • In 2015, Tipmont’s board of directors and leadership began an initiative to rethink the cooperatives’ mission and purpose. • In a time of rapid change, or even disruption in the energy business, the time was right for some soul searching. – The board concluded that Tipmont is in the security, comfort, and convenience business, not necessarily just the electric business. – Tipmont began to measure their success in terms of the community’s economic health in addition to more traditional measures. – Tipmont management concluded the exercise with a new mission statement: “Empowering our communities with state-of-the-art essential services. ” © 2020 Power System Engineering, Inc. 36

Tipmont REMC Status • The new mission encouraged Tipmont to take a leadership role beyond just the consumers they serve. – New role included making meaningful and positive change through economic development efforts, education, and outreach. – A key part of the new role was consideration of offering broadband services to their membership. • Tipmont is deploying broadband methodically – Acquisition of a CLEC – Partnership with a telephone cooperative – Phased deployment approach – Leverage fiber when possible for electric operations © 2020 Power System Engineering, Inc. 37

Broadband Progression Suggestions Regardless of where you are on the spectrum of investigating and deploying broadband, it can be helpful to understand lessons others have learned. On Radar Consider carefully how to investigate further. © 2020 Power System Engineering, Inc. Planning Initial Deployment Up & Running Understand the assumptions well and metrics to monitor. Determine how to measure applicability of pilot area to rest of territory. Honestly analyze success and determine best approach. 38

Thank You We look forward to helping you achieve your goals. Power System Engineering, Inc. Tom Asp aspt@powersystem. org Direct: 608 -268 -3509 Mobile: 847 -922 -3978 www. powersystem. org © 2020 Power System Engineering, Inc. 39