Should electric co-ops sell their broadband networks?

Jake Tarr: First of all, I just want to say that these cooperatives have done a remarkable job, both building high-quality networks and gaining significant penetration on their networks. I think now, what we’re seeing is that power is at least a hotter topic, maybe hotter topic than broadband is today. For them, power and broadband are both capital-intensive businesses.

As they see their power opportunity growing, they may be asking the question, “Do we need to focus our attention there, and can we really ask management to really run two very different businesses simultaneously?” Maybe it’s better for the broadband business, which is now mature, to stand on its own two feet.

Jeff Johnston: That was Jake Tarr, managing director at Kinetic Ventures, about some of the strategic broadband decisions electric co-op boards and management teams are exploring.

Hi, I’m Jeff Johnston, and welcome to the All Day Digital podcast, where we talk to industry executives and thought leaders to get their perspective on a wide range of factors shaping the digital infrastructure market. This podcast is brought to you by CoBank’s knowledge exchange group.

Electric co-ops have done a remarkable job building broadband networks in their communities when no one else would. But with surging energy demand, many electric co-ops are trying to decide if now is the time to sell their broadband business and refocus their efforts on the energy side of the house.

At Kinetic Ventures, Jake is actively involved in funding and advising rural broadband companies. I can’t think of a better person to talk to about how the electric coop broadband market might evolve over the coming years.

So, without any further ado, pitter patter, let’s see what Jake has to say.

Jake, it’s great to see you. Welcome to the podcast, and thanks for making some time for us today. How have you been?

Tarr: I’ve been great, Jeff, and thank you for having me. I’m delighted to be here.

Johnston: Well, wonderful. Electric cooperatives and broadband is what we’re going to talk about right now. I think there’s been some recent developments as these networks have matured, maybe some different ways of thinking about the future of these assets from a cooperative perspective. But before we get into all that fun stuff, Jake, maybe you can just give our listeners a high-level overview of why did electric cooperatives get into the broadband business years ago?

Tarr: Yes, I think there’s a few answers to that question. I think the biggest reason is that they understood early on, well before the nation did, how vital broadband was to their members, and no one else was providing it. No one was building into these rural markets. They took it upon themselves to build these networks. They took advantage of skills they had. They took advantage of the capital availability they had. By and large, they’ve done a terrific job.

I think in some cases, they were looking to diversify revenue because their power business growth hadn’t been that great for several years. I think those two factors, member needs and the opportunity to diversify revenues, were key drivers.

Johnston: Yes, they really stepped in at a critical time, especially with the post-COVID timeframe when those who didn’t have access to a reliable broadband connection. COVID really, I think, showed how vulnerable those communities are, so it was great that these electric cooperatives stepped in and did what they did.

Now, it’s my understanding, Jake, most of these networks are fiber, right? I don’t think they did a lot of wireless, did they?

Tarr: I think early on some did try wireless, but by and large, even those who did have moved away from that, and they’re fiber. Yes, pretty much everyone’s fiber.

Johnston: So, let’s move on; we’re several years into this, a lot of these networks have been built out. I think they’ve done a great job with market penetration and growing subscribers and generating cash flow. Maybe you could just talk a little bit about, generally speaking, how do you think boards and managers of these cooperatives are thinking longer-term about these broadband assets?

Tarr: First of all, I just want to say that these cooperatives have done a remarkable job, both building high-quality networks and gaining significant penetration on their networks. They can, in some ways, declare victory for creating such a benefit to their membership and to the local economy and everything. I think now, what we’re seeing, is that power is at least a hotter topic, maybe hotter topic than broadband is today. For them, power and broadband are both capital-intensive businesses.

As they see their power opportunity growing, they may be asking the question, “Do we need to focus our attention there, and can we really ask management to really run two very different businesses simultaneously?” Maybe it’s better for the broadband business, which is now mature, to stand on its own two feet.

Johnston: You’re probably referring to AI and the demands from that and other things too, right?

Tarr: Yes.

Johnston: More onshore manufacturing, all that kind of stuff. Maybe it’s time, or maybe they’re thinking, “we need to focus on our core competencies here.”

Tarr: That’s exactly right. That’s exactly right.

Johnston: You said they’ve done a great job, and I would agree, I think it’s a real success story. Do you think a lot of these networks are-- again, a very general comment because it’s all market-specific, as far as market penetration goes, is there much room for growth in these networks? Do you think that’s still a possibility? Is there room to edge out and continue to grow these networks?

Tarr: I think there is the opportunity to edge out and grow the networks if that’s within the appetite of the cooperative. Some may feel like we don’t really want to be spending our capital outside of our membership footprint, and that’s where some of the growth opportunity may be. We’ve talked to a number of cooperatives, and I‘d say many of them are at 50% and even 60% penetration. That’s really outstanding penetration in those markets.

They may also feel like, “Hey, this is turning away from our network build skills, network management skills, to much more of a customer acquisition marketing game,” which is not something that the cooperative typically needs to do in the power business.

Johnston: Yes, that’s a good point. Just to put a finer point on it, it’s not so much that the cooperatives are necessarily looking at this broadband business and saying, “Oh, this is not a great business to be in. We don’t like it.” It’s more of, it’s still a good business. It’s a vital service, but it’s time that maybe some of these folks, in light of the demands on the grid and their energy complex, really go back and double down on that core business.

Tarr: Yes, and I don‘t think this is universally felt, but I think there is a group. We know these conversations are occurring at the board level right now.

Johnston: Yes, that’s a good point. We’re not talking about the industry as a whole. There are some of these conversations going on. Then let’s take it one step further, Jake. How do you think these folks view the idea of selling their network? If, in fact, that’s what some of them are contemplating, what sort of factors are they considering? Are they focused on valuations? Are they focused on, “I want to make sure I sell this network to a company that’s going to continue to support the community the way the electric cooperative has supported the community?” Is that more important?

How would you rank order some of their biggest concerns as they evaluate potentially selling some of these assets?

Tarr: I would say, again, it is across the board, for sure. I do think many of the cooperatives feel about their broadband business the same way they do about their power business. That is, this is a vital service they’re bringing to their members. It’s a community-oriented approach, and it’s a community-led approach. Everyone’s local to delivering the service. When cooperatives think about the idea of selling, one, for some who’ve built pretty substantial businesses, they’re looking, “Do we have a team that wants to go forward with this business?” One.

Two, I think when they think about their long-term legacy, I think they would be thrilled to say that we built this power cooperative and we built this broadband business, and they’re both important employers in the local community. Maybe this sounds funny to say, but today at the cooperative, if you call for customer service, you might know the person answering the phone. For sure, they’re speaking the same local accent that you speak. People take a lot of comfort in that.

If they choose to sell to a national provider, one, jobs may move out of the area. And two, it may not have that local feel or commitment. Customer service could be around the world, not in the county. I think those are important things that they’re thinking about. There are some who may say, “Hey, our job is just to maximize the return on investment.” I don’t think many think that way because I think they are so member and community driven. Those who do, there’s plenty of capital out there who would be happy to participate in that.

Johnston: It makes a lot of sense to me because I know these folks are laser-focused on customer service and supporting their community. That’s very important, and they’ve got great brand equity. Most of these electric cooperatives have very high brand equity in their markets and want to make sure they keep that. That makes a lot of sense.

When we think about valuations in that context, if that was a big consideration, they might be forced to take a lower valuation potentially than a higher valuation. If they’re just looking at maximizing valuation, then maybe it might make sense to sell to a much larger operator that would take jobs out of the community and realize all these synergies, and they could pay a higher valuation. Am I thinking about that the right way?

Tarr: I think you’re definitely thinking about the right way because it all threads with their culture and intent. Just as an example, we’re talking to one cooperative who’s got their average revenue per user, their ARPU, is in the low $90s. We’re talking to another one that’s, of scale, their ARPU is in the low $60s. That’s a decision the cooperative made, to deliver affordable broadband to the community. That difference of $30 million of monthly revenue is certainly going to have an impact on valuation.

If the one at $60 sells, are they going to be happy if the buyer takes the price up to $90, like the neighbor? I think, yes, if they want to maintain some of those cooperative cultural elements of the business, they may need to talk about a lower valuation than the highest bidder, per se. I think also, they should be seeking a commitment from the capital provider that’s genuine to keep this business local.

I think that there are capital providers out there who are looking for not a five-year return, but a 20-year return. What’s attractive about these businesses, it’s unlikely that they’re going to see a fiber competitor immediately, or even in the long term, because these networks have been built with grant dollars, et cetera. They’re likely to produce very steady cash flow, very steady earnings. We think there’s capital that would respond well to that, and would also embrace the idea of keeping these companies local, supporting the local community, because it creates so much more economic vitality long-term.

Johnston: Let’s take that a little further, Jake. What types of institutions or what types of capital have that time horizon? That sounds very attractive, I would think, to cooperatives who think in long-term time horizons. You hear private equity, a lot of it’s five years or so, and they want to turn over the portfolio and move on. What sort of institutions or capital do you have in mind when you think about that 20-year time horizon?

Tarr: There’s several sources. There are pension funds who think this way. There are insurance companies who think this way. There are family offices who think this way. Just as an example, we’re one of the founding investors in Highline, which is doing a big RDOF build in Michigan and also big builds in Texas. All of our investors, but particularly the family office investors, these insurance company investors, they’re asking the question, “Why would we sell this at the end of the build? Because we’ve done all the hard work, and now we’re going to have this protected business.”

It’s unlikely that there’s going to be another fiber provider. We’ve heard our investors express this desire to be long-term. There would have to be some current return, but I just think it’s all built around this idea of maintaining the integrity of what the cooperative has already created.

Johnston: What advice would you give boards? You’re talking to a lot of these boards, I know. You’re talking to a lot of these management teams across the country. I’m sure you’re hearing a lot of things, concerns, and thoughts around this whole topic. With all that, what advice would you give boards or leaders of electric cooperatives who are considering a sale or just trying to think through what the next step might be for their broadband business?

Tarr: I think you’ve asked a lot of questions that they would ask already. I would say, if I were on the board or they were asking for my advice, first thing I’d ask myself is, has our broadband business reached sufficient scale? Have we delivered our highest value already? We know they know how to build networks. They’ve demonstrated they can add customers, but do they want to be in that extending beyond their footprint? Do they want to be into competing for customers business? That would be the first question. Is it at scale? Have you done what you can do?

The second, is it competing for capital? We talked about this already. Both the power and the broadband business, they take a lot of capital. Does the cooperative see more need for capital than they have resource for? Do they want to orient that capital towards their core business? Then what’s remarkable is that many of these cooperatives, it’s the CEO of the cooperative who has simultaneously been the CEO of the broadband business. They’ve done a remarkable job. The question is, is management focused on the right business going forward? Can they do both?

I would also ask, and we’ve touched on this, who is the best long-term steward of the business? Is it the highest bidder, or is it capital that is aligned with how the cooperative would like to see this business go forward? Is it supportive of the local community? Is it supportive of the level of customer service that these customers have learned to appreciate?

Then I think, lastly, it’s this long-term legacy question. All of these directors are temporary stewards of a very long-term business. They all want to leave it better than how they found it. They’re all doing that. That extends, I think, also to the broadband business.

I think many of them would like their members to remember the broadband business fondly for what the cooperative did, but also like it in the present moment. Not say, “Oh my God, why did they sell to X? Why couldn’t this company stay local?” I think those are the questions they need to be exploring.

Johnston: That’s great advice. Thank you for sharing that. As I think about it, too, if you look at the energy complex right now, I don’t think energy demand grew at all from the mid-‘90s to like 2022, in terms of just incremental demand on the complex. And all of a sudden, ChatGPT launches in November of 2022, and everything changes. Now energy demand is growing, I don’t know, pick a number, 5%, 6%, 8% a year. Who knows, right? Hard to say.

It’s growing at rates that no one has ever experienced before. It makes a lot of sense that these electric cooperatives are rethinking their capital strategy and their core competency because they’re dealing with an environment that’s foreign to them, I would think.

All right, Jake, this has been great. Thanks for coming on. What I like to do with my guests to wrap it up is just to give them an opportunity to share anything we haven’t talked about or any final comments. The stage is yours.

Tarr: Thank you, Jeff. It’s been a pleasure to be with you today.

This is an issue that’s dear to my heart. I grew up in rural America myself, and I understand the issues. Kinetic is very committed to this issue as well. As you know, through our Rural Broadband Opportunity Fund, we have two missions, and that is, one, to support the proliferation of broadband in rural America, and two, to support the vitality of these rural economies. We’re excited to have the opportunity to have these conversations with cooperatives to help them meet those two key issues.

Johnston: Thank you so much for making time today. Really appreciate it.

Tarr: You bet. Be well.

Johnston A special thanks goes out to Jake for being on the podcast today. Preserving the relationship between the broadband operator and the community is clearly a big consideration for any co-op who is looking to sell their broadband business. This may result in a lower valuation, but if it means no lost jobs and a continued commitment to the community, it’s probably a price many co-ops are willing to pay.

Hey thanks for joining me today and a special thanks to goes out to my CoBank associates Christina Pope and Tyler Herron because without them there wouldn’t be an All Day Digital podcast. Watch out for our next episode.