Navigating Broadband’s Financial Frontier with Asset Securitization
Episode ID S2E12
November 16, 2023
With rising interest rates and tightening credit, broadband companies are exploring alternative ways of raising capital. One option getting attention is the securitization of network assets and customer contracts. This type of financing vehicle enables companies to raise capital quickly from a wide range of investors. In this episode of All Day Digital, Jim Stanley of Frontier Communications shares how the company raised capital with a securitization offering, and what they learned.
Jim Stanley: If you look at the trajectory of other industries that have used securitization, this is the beginning of something that I think will be an important part of capital structures of companies that are deploying fiber optic networks going forward.
Jeff Johnston: That was Jim Stanley, senior vice president and treasurer for Frontier Communications, regarding how he sees asset securitization playing a role in funding fiber network builds.
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 communications industry. This podcast is brought to you by CoBank’s Knowledge Exchange group.
With the recent rise in interest rates and tightening of credit conditions from major banks, companies are exploring alternative ways of raising capital. One option that is garnering increased interest in the communications market is the securitization of network assets and customer contracts. This type of financing vehicle enables companies to raise capital quickly from a wide range of investors.
Given Jim’s extensive expertise as Frontier’s treasurer, and the fact that Frontier recently raised capital with a securitization offering, we were eager to have him on to learn more about this alternative way of sourcing capital.
So, without any further ado, pitter patter let’s see what Jim has to say.
Jim Stanley, welcome to the podcast. It is an absolute pleasure to have you with us here today.
Stanley: Hey, Jeff, thanks a lot. Thanks for inviting me and thanks for your support and CoBank support as well through everything we're doing here at Frontier.
Johnston: Oh, absolutely. I'm glad we can be a part of it. Again, super excited to have you on the podcast here today. I want to talk about, I guess I would call it, a different form of capital financing. Different in terms of borrowing money from a commercial bank, but this whole notion of-- I don't know if you call it asset-backed securities or securitization of assets, what is this form of financing? If you could just give us a high-level overview of what that structure is.
Stanley: Yes, sure, Jeff. Well, it's a structure, asset-backed securities, or securitization as it's being called, is something that is not new to the world of finance. It's been used for many years in oil and gas, rail cars, rental cars, jet leases, a number of different areas. It's become more prevalent in digital infrastructure over the last decade and most recently here in financing fiber optic networks. It's a technique that involves a legal structure where you're taking valuable assets from the company, placing those assets into a newly-formed special-purpose entity that has bankruptcy-remote characteristics, and allowing debt to be issued in that special-purpose entity based on the net operating cash flows of those assets that you've dropped into the entity. It's a way of isolating assets from the parent company. It's a way of attracting a different type of investor, which allows us to borrow costs at a higher level of leverage and a lower rate than we typical would, typical bank debt, or a high-yield debt.
Johnston: So, the notion of separating this structure from the parent company, I guess that reduces risk for investors, and then I'm guessing it also gives you a more favorable interest rate as well. Is that a fair comment?
Stanley: That's exactly right. Not only do you isolate these really valuable assets and put a focus on those assets, but the structure puts in place credit-enhancing provisions such as liquidity reserves, cash traps, cash sweeps, and other things that are triggered to retain that cash for the purpose of maintaining the principal and interest payments that lowers the risk of the cash flows around those assets. When we do that, we get it rated, and we get it rated in separate tranches. We get A, B, and C tranches with the higher numerical being subordinated to the lower numerical tranches.
That allows us to in invite in and attract investment-grade lenders where we typically haven't been able to do that. Frontier has a corporate rating of BB-. We've been able to rate the A tranche and the B tranche of our securitization as investment grades with an A rating on the A and a BBB on the B. It allows us to attract more investors, ones that will allow us to have a lower interest rate on the blended product, as well as achieve a higher-level leverage on these really valuable assets that we've put into the securitization entity.
Johnston: Okay, that's great. That's great. Look, we're all aware that interest rates have gone up a lot here in the last 18 months. There's concerns around the state of the economy and commercial banks are starting to tighten up their lending standards. It's harder to get a mortgage if you're trying to buy a home. It seems like credit's just getting tighter. Then on top of that, of course, in the communications industry, we've got this rushed to-- everyone wants to plant their fiber flag first and build fiber in underserved areas.
There's a whole lot of momentum there, but then the choking point could be access to capital. With that as a backdrop, as we think about this particular structure from a capital financing strategic perspective, maybe just help us understand. Is this so that you can raise capital quicker and cheaper than going through traditional forms, given the tightening, or how do you think companies think about that from a strategic perspective?
Stanley: From our perspective, securitization is going to be one tool in the box of all of our capital structure. We'll continue to have leverage loans, high-yield bonds, as well as securitization going forward. For an entity like ours that has a very long-lived asset that has a sticky group of customers that will continue to pay if the product is what we know it is, a high-speed, very efficient, and very reliable network, it allows us to lower the cost of our build, lower the cost of our investment overall. But it is one market that we want to have that access to. We can tap the securitization market or the high-yield market or the leveraged loan market when one or the other may have some difficulty.
In this time when rates are rising, rates are rising on all of these products. What we want to do is make sure that, over time, if one of the markets were to shut down, we've got access to the other. It's an interesting world that we're in at Frontier where we've been traditionally a high-yield and leverage loan. Getting into securitization, we need to make sure we're preserving ratings, preserving the overall credit backdrop of the company as we're bringing this new product in that leverages some of our best assets at a real low rate.
Johnston: It seems like a very prudent capital budgeting strategy to pulling on different levers that make most sense for the company, so that's great to hear. In terms of the assets that are backing up these securities, obviously, fiber is clearly one of them. Can you do customer contracts as well? Can you securitize those? Can you securitize DSL networks or HFC or is it better to do fiber and customer contracts with large corporations?
Stanley: Different industries have done different things. Securitization can be morphed into different products. When we looked at this for our application, what we wanted to do is be able to put something into that special-purpose entity that could essentially be portable if there was this distress situation. What we placed into our inaugural transaction that we closed in August was the entire network around our Dallas-Fort Worth area.
That was primarily fiber optic. It's a fiber optic network that has been in place for years. It was one that Frontier acquired from Verizon and was started being developed in 2004. It's the fiber optic network, including all of the cables, all of the network equipment, all of the facilities and infrastructure required to provide the internet and related services to customers.
But it's also in that footprint, that geographic footprint, all of the work that we do with a DSL network, which is a much smaller portion, and all of the work that we're doing, not only to residential customers but wholesale commercial customers as well. We saw that taking a footprint was the best way to segregate those assets and give comfort that those assets could be something that the investors could look to as a backstop to support the principal and interest payments over time.
Johnston: This seems like, from the outside looking in, a fairly complex thing to do. Maybe I'm mistaken with that, but I guess when you think about-- Obviously, this was the right decision for Frontier, but is this the right decision for any type of communications company, be it small or large? How do you think this would screen out for different companies whether it would or would not make sense?
Stanley: I think it's something that as we get into the fiber optic space, we'll become more and more accepted on the part of investors. I think we have good uptake in our transaction and I think investors are becoming more and more knowledgeable about the space. The complexity has to be accepted by the investment community, which is happening. The structure is complex and it is something for an operator like us to get our head around the legal aspects of it, the regulatory aspects, all of that's complicated, as well as the operational aspects of being able to segregate customer payments, to be able to segregate operations and all of that.
With all of that being said, it is something that I believe can be executed in large companies and small companies as well. There were a couple of transactions that took place in the private space before ours that were smaller in scale that I think were received very well. I think the technology, if I can call it that for this structure, is something that's applicable for fiber operators. It's applicable for Frontier specifically. It really depends on just the way the operator can put out those assets as resilient, sustainable, which they will be over time, and something that provides a good cash value given the ins and outs of the economy.
Johnston: Let's just talk a little bit about the investors who are interested in buying up these tranches. I would imagine it's a wide cast of characters, but if you can share with us what you've seen and typically who is interested in these types of products.
Stanley: Sure, so it varies by these tranches we talked about, the A, B, and C class. Within the A's, there's actually two different types of products. One is a term note that are the bonds that we sell, and one is a variable funding note, which is a floating rate instrument that is something that is drawn after closing based on the conditions of that note. In the A's, the VFN is primarily banks and banks that would lend in oftentimes to traditional revolving lines of credit. In the A notes, the A bonds are fixed rate, which are typically insurance companies, institutional money managers, and to a lesser extent, some hedge funds.
The same would be the B with a little bit less of a skew on the insurance. The C's are often hedge funds, sometimes equity investors that see this as an attractive alternative to equity and high-yield crossover in special-situation funds. What it does, it's a product that you can go out with one issue. You can cast it in real broadly with a number of investors and bring that blended average of what we're offering inside your typical leverage loan or high-yield bond issuance, which is great for a company like ours that's building fiber and building these assets that are highly marketable.
Johnston: It seems like a highly customized type of a product? Do you reach out to the market and understand what they're looking for and then build the structure around that, or do you just intuitively know different segments of the market want different things, so this is how we have to package everything up?
Stanley: We had the benefit of a number of real bright banks that are developing this structure. Goldman Sachs was our lead on the transaction. Barclays and Morgan Stanley played a role in structuring and helping us understand the marketplace. There is a whole group of people within some of these larger banks that deal in securitization and know the industry and know what the profile is of the investors and design the products for people like us to issue and for investors to consume that look like the other industries that I mentioned previously.
It's an application that's new to the space, not new to the industry, and having the advice of the banks that are helping us structure and having the banks like CoBank to come along and advise us on how it interacts with all of the other debt instruments that we have makes it something that for my role is pretty easy, get a lot of bright minds in the room, and then we select through a product that actually is the right thing for Frontier. This securitization felt like a really appropriate transaction for us and a real valuable deal for us this year.
Johnston: Well, you're certainly dealing with the who's who of investment banking in the world. You got the A-team there. If you had to look into your crystal ball, Jim, do you think we'll see more of this type of financing in digital infrastructure and communications? As you mentioned on the outset, this is not necessarily a new structure to financing in general, but maybe a little bit new to the communications or the digital infrastructure space. Thoughts on where you see this going over the next three to five years or so?
Stanley: I think it's a definite yes. If you look at the trajectory of other industries that have used securitization, this is the beginning of something that I think will be an important part of capital structures of companies that are deploying fiber optic networks going forward. There is a huge value in these type of networks. They're resilient. They are the best technology out there and they are something that a lender at an investment-grade level should be looking to participate in for good returns going forward.
The structure allows investment-grade lenders to get that priority bite at the collateral and allows us to open up the aperture on who's investing in this company. The industry is going to be seeing the same thing. I would expect to see deals this year, deals next year. Regardless of what the economic conditions are, there's a lot of development being done to upgrade the broadband services throughout the country. Smart capital will be needed to help finance that. There will be good payoffs down the long run as consumers get good value out of those networks.
Johnston: That's great. I think it's such an exciting time. There seems to be this insatiable appetite on the part of infrastructure funds and private equity sponsors to get exposure to the U.S. communications market. You hear of small properties going on in the market. It's just this incredible bidding war that everybody wants a piece of it. I would imagine the interest in these types of securitization deals on the part of those investors is pretty high. I think it's a really exciting time for operators to be able to leverage this.
Stanley: It is. It's not just the people investing in it, it's us also. This is a transformational time in our industry. This is a point where people who are traditional DSL providers over copper wires and all are upgrading their networks to accommodate the demand that's out there for data transmission and the consumption of data that's going to be happening throughout the country. You see things like AI and the use of data. You see things like the progression of 4K TVs a while ago and all.
There is more out there that will come and this technology will satisfy that demand going forward. It is a transformational time for the industry. It's a huge capital investment, it's going to be an investment that's going to pay off for decades and not only make the industry healthier but the consumers more productive and the country more valuable as we're connected together in all different parts of the world to be able to be frontline on data transmission analytics and the things that make us cutting-edge.
Johnston: Well said. We also cover and bank the energy sector. It's fascinating to see the forecast of energy demand from data centers over the next 5 to 10 years. It's nothing short of mind-blowing. That all is tied together, right? Data centers and fiber networks and all of these great applications that are going to generate a ton of data and need low-latency networks. It's, again, a super exciting time.
Well, hey, look, Jim, we've covered a lot here today, which has been fantastic. Before we wrap it up, I just want to give you an opportunity to share anything that I didn't ask that you think we should touch on. The stage is yours.
Stanley: I appreciate the support, Jeff, in your podcast and with CoBank. Nothing else in particular from my perspective other than just that a little bit of a plug for Frontier in the strategy and the timeline that we're on. It's been a great turnaround story for us at Frontier. It's something that not only do we have a good outlook for the industry, but the company itself, I think, is in the right space with the right people. We've got a vision of building fiber, selling fiber, making a better customer experience, and lowering costs.
That strategy's been something we've been following for the last two or three years here with great success. The investments in securitization that lenders are making to us, people who are investing in the company is really well-received as we're out trying to deliver on our promises. It feels like we're getting real good traction on that strategy and feel really good about the things that are going on. I appreciate CoBank's support, I appreciate your support, and I appreciate all the support of folks that are investing in Frontier and our mission going forward.
Johnston: Jim, thanks again so much for being on today. This was incredibly insightful and very much appreciated.
Stanley: Great. Thanks a lot, Jeff. I appreciate being on with you.
Johnston: A special thanks goes out to Jim for being on the podcast today. Securitizing assets to raise capital is not a new idea in the world of financing, but it is a relatively new one for the communications industry. Digital infrastructure assets, namely fiber and datacenters, have the characteristics found in typical assets backed offerings: they are resilient, future proof and offer stable cash flows. And Jim’s belief that we will see more companies using this structure makes sense given the capital-intensive nature of the business and the optionality it gives CFOs.
Hey, thanks for joining me today and watch out for the next episode of the All Day Digital podcast.
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