Understanding UTOPIA, Macquarie, and the options open to cities

UTOPIAUTOPIA has been a hot topic ever since it was formed over a decade ago. For supporters (like me), it’s a necessary step to break up a government-granted monopoly in telecommunications services that have become vital to modern life. For opponents, it’s an overreach by local governments into the private sector and wastes taxpayer dollars. Whatever your philosophical take, it’s important to understand what it is, what it has tried, and where it is going since 11 Utah cities are on the hook for over $200M in bonds.

History Lessons

As long as it will be, I don’t think you can understand UTOPIA without an overview of its history. There’s a lot of more in-depth reading out there, so I’ll stick to brief-ish summaries.

Why it got started (and immediate challenges)

To understand where we are, you have to understand how it got started. UTOPIA was initially formed because cities were frustrated at their broadband options and felt they needed something better in order to remain economically competitive. Brigham City has cited the loss of Flying J over inadequate telecommunications services as their primary impetus. Lindon had even gone so far as to offer incumbent providers TCI and US West (remember them?) payment to improve their existing infrastructure (they both declined).

As cities were discussing their options for a modern telecommunications system, the legislature took notice and amended state code to prohibit them from offering retail services and restrict any bonds for such a system to no more than 50% of the total cost of construction. The existing Spanish Fork Community Network (SFCN) was unaffected as it had begun operations prior to this restriction and was grandfathered in. This left UTOPIA cities with a challenge: they would have to share the revenues from service with private providers and use system revenues to complete over half of the network.

The first plan (and how it failed)

UTOPIA cities decided that despite the large handicap placed upon them by HB149, they needed to move forward with the plan to build a fully fiber optic system to every address. The goal was to build as much of the network as possible with a combination of bonds backed by sales tax revenues and loans backed by system revenues. Revenues from the network in excess of operational expenses and bond costs would be used to gradually complete the rest of the network.

As we all know, that plan failed, and for a variety of reasons. As soon as they were ready to build, US West/Qwest sued UTOPIA and halted construction for 18 months. UTOPIA prevailed in the suit, but they had to make bond payments during that time. They then followed up not by building the network to where the demand was, but rather building where the network was cheapest to roll out. While they briefly covered operational expenses, the network soon ran into the red as the construction money ran dry and loans from the USDA’s Rural Utility Service went sour.

At this point, UTOPIA was stuck with outstanding liabilities for construction that was approved by RUS and not reimbursed, a network that could not meet operating expenses, no money to continue building, and no way to legally bond for more. Most of the staff was let go, the few that were left worked for free for six months, and the death of the network appeared to be imminent.

Re-bonding for breathing room

With bills due and no money, UTOPIA changed up their management team and went back to the cities to extend the existing bonds to a 33-year commitment. This included pulling money out to pay off contractors, finish some incomplete network portions, and cover bond payments for a couple of years. Unfortunately, UTOPIA’s poor financial condition led them to use a bond structure that was complex and unstable. This lead to an unexpected (and to that point unprecedented) rise in the interest rate on the bond that cut short the breathing room money. Not exactly the best choice, but ten of the eleven pledging cities opted to move forward with this. Payson did not.

The SAA, the UIA, and cooperative style models

Around 2009, UTOPIA came up with a new plan to replace the old one. This would make use of a voluntary special assessment area (SAA) to sign up subscribers before building the network. Any costs associated with building the network would be assessed only on subscribers, so the burden on taxpayers as a whole would be reduced. The downside was the cost: you either had to come up with $2750 up-front or pay $20/mo for 20 years to get the connection. Even with this high cost, about 28% of Brigham City chose to connect to the network, the city switched their offices over to UTOPIA connections, and the Box Elder School District switched about half of its buildings over.

The SAA in Brigham City was a moderate success, just barely covering the operating costs associated with the build-out. Still, the rest of the network still suffered from operational shortfalls and other cities had patchwork builds that made it tough to fill in the cracks. It would also be more challenging to get users hooked up with a large install fee where they had previously had none.

This is where the Utah Infrastructure Agency (UIA) was born from. Ten of the eleven pledging cities (with Payson again the lone holdout) agreed to cover five years of the operational shortfall and back SAA bonds in their cities to repeat what had been done in Brigham City. Areas with high interest would be blanketed with door-to-door sales staff as had been done in Brigham. Once sufficient interest was registered, those neighborhoods would be built out.

And so residents waited. And waited. And waited some more.

UTOPIA didn’t end up building much of anything under the UIA plan. About two years ago, the cities directed UTOPIA to pursue high-margin business accounts instead of focusing on residential service. While the margins were better, there was only so much business to chase and nowhere near enough to make up operational shortfalls. Most of the UIA bond money lay fallow, and several cities stopped allocating promised money to cover operational shortfalls.

Where is UTOPIA now?

Right now, UTOPIA still can’t cover operational expenses, much less any of the bond payments. There’s no money to build out the network and new city councils and mayors have been elected on anti-UTOPIA platforms in several cities. There’s no confidence in current management with previous executive director Todd Marriott having resigned several months ago. It’s broke, mismanaged, and not getting better.

It’s not all bad, though. Almost 12,000 homes and businesses are getting world-class service at very competitive prices. UTOPIA is one of the largest gigabit networks in the nation. And there’s still a lot of demand for the service even if it hasn’t been built to chase it. I hear from people on a monthly basis who are looking to buy a house with UTOPIA service and consider it to be a non-negotiable item. As an economic development tool, it has attracted or retained businesses in many member cities including Midvale, Lindon, and Murray. It’s hard to quantify these benefits against the financial issues.

The options for member cities

There’s not a lot of options on the table for UTOPIA cities right now, and many of them are not very good financially. City councils are currently evaluating their options to see which way to go. Here’s what’s been put on the table.

Shut down the network

This has been proposed many times as a “cut bait” option. The advantage of this option is that it ends the operational shortfall immediately. The huge disadvantage, however, is that the bond may be called and a large penalty assessed against the cities. It would also end all intangible benefits to the cities and cut off multiple local and state government agencies that use the network in additional to regular users. Cities largely consider this to be a non-option since it comes with so many downsides.

Sell the network

This has many of the same features as shutting down the network, but it may bring in some money from a sale. Unfortunately, the sale price wouldn’t put much of a dent in the bond debt. Provo gave away their network and AFCNet sold theirs at a large loss. With an estimated asset value of $86M, it’s conceivable that a sale could fetch $30M or less, especially in an uncompleted state. A bigger problem would be getting all of the cities to agree on selling. If a city with a lot of fiber chose not to sell, it puts cities with less fiber at a serious disadvantage. There’s also the question of how to split shared assets in the event of a sale. It could get very ugly, very quickly as the lawyers get involved and cities all start suing each other. That could easily eat up any money from a potential sale and scare away potential buyers.

Maintain the status quo

Cities also have the option to keep on doing what’s been done. This means funding the operational shortfall, paying for network refreshes (with one due soon), and possibly issuing bonds to continue the UIA plan of having subscribers pay for the connection to the network. This would require a lot of active involvement from the cities and a lot of financial commitment to see it through.

Find a private partner to work with

The last option (which will require some more detailed breakout) is to find a private company willing to partner with the cities to operate the network. Provo did this with Google Fiber, effectively leasing the network to the search giant for $1 plus $18.7M in required network upgrades. The city still carries the entire debt load and would be responsible for figuring out what to do with the network should Google withdraw at the end of the seven year contract. Given that the network was covering at least some of the debt load before, it’s not really a great deal financially. There’s also a limited number of companies with the know-how and resources to take on a large project covering 163K addresses. Since each proposal is unique, it’s hard to say if partnering is a good thing or not.

Meet the suitors

UTOPIA (or at least some of its cities) have had some offers being presented by private companies to build, maintain, and operate the network. Here’s at least three proposals I’m aware of.

Vivint Wireless

Vivint has been working on a wireless mesh product that they want to beta test in Utah before rolling it out nationally. They’re looking at doing 50Mbps service for around $45. In a recent presentation in Orem, they presented their plan as an alternative to building out UTOPIA, but they don’t have any plan for the current assets beyond shutting them down, and they would charge more for a slower tier of service. Lindon is also reportedly in their crosshairs. It’s the least viable private option since it doesn’t do anything for the network itself.

FirstDigital

FirstDigital has been providing phone, TV, and Internet access to business parks for over a decade. Unfortunately, they also don’t have any experience with residential service and reportedly have an annual income of barely over 1% of the UTOPIA network’s assets. There’s also some very spotty reviews of the services they do provide. It’s hard to see how city councils would accept this offer on the table.

Macquarie Capital

Macquarie is a very large investment bank from Australia that wants to dip its toes into the US broadband market. They’ve made a proposal to UTOPIA to invest $300M to build the network to every address while maintaining and operating it for 30 years. They have also committed to offer a basic level of service to everyone of 3Mbps/3Mbps with a 20GB cap. In exchange, they will charge the cities $18-20 per month per address for the next 30 years.

While this is one of the more expensive options, it does come with a large potential upside. Macquarie shows income to the cities between $17.04 per month per address and $25.56 per month per address depending on how many people sign up for services. At the midrange, it would cover the utility fee and provide some relief on the bond payments. UTOPIA currently generates revenues of $6.50 per month per address, but that’s with a lower participation rate than under Macquarie’s models and only 27% of the network able to provide services. The question is if Macquarie’s revenue estimates are accurate and if they can hit a take rate high enough to not cost more than the other options.

This is the main proposal that is before city councils right now. Only five (maybe six, if Perry voted yes) of the eleven UTOPIA cities have opted to move forward with formulating a more detailed plan that nails down exact costs and responsibilities. Each of them will still have the option to reject the proposal as not right for their city.

There are no easy answers

Despite the rhetoric, there is no easy answer to UTOPIA. A citizen’s review committee in Centerville exhaustively evaluated all of the options and could not unanimously agree on a course of action when presenting their findings to the council. With a track record of amazing technology hampered by poor management, it’s hard to take any new set of promises without a grain of salt.

Only one thing is certain: city councils need to come up with a good plan. Fast.

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