Fairpoint Communications (FRP) plans to spend $781M over the next 5 years maintaining and upgrading the network they purchased from Verizon. Drilling into the details of the network spending suggests Occam Networks (OCNW) is well positioned to materially benefit from this proposed deployment. Details provided by Fairpoint and fundamental metrics of the Broadband Loop Carrier business lead us to believe Occam will recognize up to $125M in revenue, of which $80M will come in the next 18-24 months, provided Fairpoint executes it’s current capex plan.
Fairpoint provided an in-depth picture of how they plan to manage ‘SpinCo’ during a conference call April 17th. SpinCo represents the newly acquired residential and business subscriber assets & infrastructure from Verizon (VZ) in Vermont, New Hampshire, and Maine. During this call Fairpoint provided detail on their plans and expectations for growing broadband penetration within the subscriber base including capex forecasts for network upgrades. A full copy of the presentation is available here: (Link: Fairpoint IR)
Occam Networks was the first announced access equipment supplier (Jan 08 release here), and Cisco was chosen to provide the back-end IP routing infrastructure. Pannaway was selected as the second vendor of access equipment following the close of the Fairpoint/Verizon transaction.
Fairpoint ‘SpinCo’ Demography and Finance
Fairpoint’s newly acquired New England assets (SpinCo) have the following subscriber profile:
Other key information about SpinCo:
Top Down Analysis
In Q108 VZ spent $12M to broadband enable 30k lines in Maine – $400/line (link). AT&T is spending $361/line on Project Lightspeed (see AT&T Lightspeed Gets More Expensive), which is similar to what Fairpoint is planing. But Fairpoint is dealing with a much more rural and less dense subscriber base, and therefore a larger capex/line figure is reasonable. Fairpoint also includes the costs of a new Ethernet backhaul network and Cisco routing infrastructure – something not included in the Verizon and AT&T numbers.
Using the Verizon Maine deployment as a template would put Fairpoint’s access related capex at around $400/line.The remainder is backhaul at $166/line ($566-$400), or roughly 30% (approx $235M)of the total capex, allocated to Cisco (CSCO). The other 70% (approx $550M) is access spending, allocated to Occam and Pannaway.
Fairpoint’s capex numbers account for all the capitalized costs involved in installing a network: labor, fiber, copper conditioning, and the hardware itself. A general rule of thumb in the carrier industry is equipment/hardware capex is about 20%-30% of total capex. This would result in hardware revenues to Cisco of $50-$75M and $110M-$165M for Occam and Pannaway.
Bottoms Up Analysis
Fairpoint’s demography data can be used to make estimates about the quantity and type of equipment they will purchase. They will buy access equipment for three purposes.
#1. Increased Broadband Penetration:
SpinCo, at 16%, is under-penetrated relative to the rest of Fairpoints holdings. It is reasonable to see this increase to 25% in 5 years. A 9% increase in subscribers among the 68% of the served area is 84k lines (68% * [928k Res + 449k Business] * 9%).
Assuming a per-port cost of $60, anticipated subscriber gains in areas already covered by broadband will require approximately $5M in hardware capex (84k * $60) over the next 5 years. This capex will flow to the vendors of the existing broadband equipment- either legacy vendors, or as we propose in #3 – Occam/Pannaway.
#2. Increased Broadband Coverage:
Fairpoint will expand broadband availability from 68% to 90% of the served customer base, increasing the potential broadband market by 302k lines (22%*[928k Res + 449k Business]). Using the broadband penetration target of 25%, we can expect to see 75k additional broadband subscribers over the next 5 years.
It is virtually certain that this deployment will scrap existing equipment in the field and migrate all lines, including existing POTS subscribers, to new converged Ethernet/IP access hardware. This will require the deployment of 300k POTS lines with 75k broadband lines added incrementally over the next five years. This is consistent with the Occam announcement that highlighted 50k in broadband lines expected to be deployed in the near term.
Therefore, we can expect Fairpoint to purchase equipment for a greenfield installation of 300k POTS lines and eventually 75k broadband customers. This capex will be front loaded, as all POTS customers will be migrated early on, and the new access chassis must be purchased and installed. We expect it to be complete by EOY 2009.
We assign a per port value to such an installation of $150, for total capex of $45M (300k * $150).
#3. Existing Network Upgrades
The other 68% of Fairpoint’s network is already broadband enabled. There are a total of 936k lines (68%*[928k+ 449k]) that currently support broadband. We believe that the majority of this equipment will be replaced with next generation Ethernet access equipment for the following reasons:
Unlike the broadband coverage increases, upgrading the existing network will take a full 5 years. And risk exists that such an effort would be halted if Fairpoint encountered financial difficulties.
A complete upgrade of the installed broadband capable base will require 940k lines (68%[928k+ 449k]), of which 250k must support broadband in addition to POTS. At $100/port, a number applicable to installation in an existing CO, this is $94M. This includes the 10GbE ring deployment that appears to be underway. The timing of this revenue should mirror the capex percentages shared by Fairpoint, with 26% being spent in 2008 and 21% in 2009.
However, it is clear that some of this network was recently upgraded by Adtran, and is unlikely to see new hardware immediately. Verizon spent the bare minimum given their long term plans to dispose of the asset. We assume 80% of the existing network will be upgraded in the next 5 years – or $75M
Note: The top down figure based on industry ratios yielded a range of $110-$165M.
Market Share – Occam vs. Pannaway
It is difficult to provide a quantitative estimate of how this business will be shared by Occam and Pannaway. However, the following facts are known:
The demography here is clear, and demography is destiny. Fairpoint has regulatory obligations and the business motivation to spend nearly $800M over the next five years upgrading their network. They have announced partner vendors and indications are that work has already begun.
Our biggest concern is why Fairpoint would bet their entire company on Occam and Pannaway. This is a significant piece of business that major equipment vendors would want. Perhaps tier 2/3 carriers simply “Think Different” and see equal risk in being a small customer fish in the big pond of Alcatel as they do working with critical vendors that are small companies.
Still, Fairpoint must have a risk plan in place, perhaps similar to the deal brokered by AT&T that put World Wide Packets into the hands of Ciena, or the deal brokered by British Telecom that partnered Covaro networks and ADVA AG. The logical acquirers of Occam/Pannaway would be Cisco or Ciena, as both lack Telco DLC solutions, and would be complemented by the addition of Occam’s products.
Author holds positions in OCNW and ADTN.