Research Notes

European Commission awards old broadband projects that today would violate EU subsidy rules. Sweden’s Stokab is a case in point. The investors’ nightmare.

Strand Consult has published a number of reports about broadband and notes how the European Union falls behind in the United States on many broadband measures. See the EU’s Digital Agenda Scoreboard. Last fall the European Commission created the European Broadband award and selected five projects as winners in its competition, including Stokab, the city-owned fibre-to-the-home (FTTH) project in Stockholm. The Commission reports that it selected Stokab in the category of “future proof and quality of service” and produced this glowing video.

It is also a fact that the Commission has rules to ensure that “State aid does not crowd out market initiative in the broadband sector.” Given the Commission’s focus on increasing next generation broadband deployment, it is noteworthy that the EU Commission and Stokab have not responded to repeated requests from Strand Consult to share more background on how the winners are selected.

In 2009 the European Commission established rules that make it impossible to establish companies such as Stokab, prohibiting public funds to be deployed against private actors that have invested in infrastructure. The rules were further clarified in 2013 and are available at EU Guidelines for the application of State aid rules in relation to the rapid deployment of broadband networks. It is therefore suspect that the Commission would highlight a municipal broadband provider that operates with a model which is now illegal by the Commission’s own rules, not to mention uneconomic.

Official facts about Stokab

1. Stokab is a dark fiber company established in 1994 in Stockholm, Sweden’s largest city and capital (216 square km) where population density is high and deployment costs relatively scalable. The city’s population is 840,000, and of 450,000 households, 400,000 can get FTTH.

2. Stokab covers 90% of the capital, and through regulation, the city prohibits competing infrastructure in a number locations where Stokab already exists. Additionally the municipality eliminates competition with a series of restrictive measures to protect its investment.

3. Stokab received municipality guarantees that the city can tax the city residents to cover losses.

4. Stokab operates in the region with the highest concentration of knowledge-intensive jobs in Europe, and where the service sector predominates.

5. Some 3.3 billion SEK was invested in the project from 1996-2008; from 2009-2012, 1.526 billion SEK. In the 16 year period, a total of 4.426 billion SEK was invested, about 5 billion SEK in present value. In the same period, Stokab earned returns of 997 million SEK, an average of 51 million SEK annually.

Conclusions for broadband providers and investors
To the extent that the European Commission considers Stokab a success reflects the fact that the city of Stockholm could give itself a sweetheart deal when going into the broadband business. It operates with a set of conditions that private broadband providers could only dream of. Moreover the residents of the city are willing to support a project that effectively loses money every year. In practice, Stokab`s profit is below the rate of inflation, and it has a poor return on invested capital. It is a financial result that a private actor would never accept, especially a pensioner who expects that his investments will at make a return that at least exceeds the rate of inflation.

Is municipal broadband a good idea or a waste of taxpayers’ money?
Around the world there are examples of broadband projects in urban areas with government financing – a support that can be compared to offering the richest people an income tax exemption. European governments spend considerable resources to compile reports to estimate the cost of next generation networks, and subsequently some government actors lobby for these projects as an antidote to the lingering financial crisis, regardless of whether there is a business case for the investment.

Too few governments have examined whether they could reach the same broadband goals without state subsidies. For example a Norwegian report concluded that the Norwegian state should invest between 7 and 14 billion NOK to bring broadband to remote Norway. Even in a rich country such as Norway, 7 to 14 billion NOK is a lot of money. It is worth considering whether precious public funds are more prudently invested in an industry that already earns a profit, or better yet, in the country’s own sovereign wealth fund which owns 1 percent of the world’s equities.

They don’t need the money!
The world’s telecom industry is a mix of established players (Telefonica, Telenor, KPN, Orange, BT etc.) and newcomers. In a number of countries the newcomers are energy companies – companies whose core business is selling energy and which are trying to make money on telco services by investing in fibre to the home.

When we examine the telecom industry’s EBITDA revenue level, it is today probably one of the world’s industries with the largest profit margins – margins that are often between 25% and 50%. Likewise the European energy sector is not exactly an industry that is battling against a lack of cash flow or revenue from its core business. Many energy companies today have a large and healthy business based on their original monopoly and continually announce high cash flow and revenue figures. At the end of the day, very few other industries can match the revenue and cash flow generated by the telcos and energy companies.

It is no secret that many countries want to encourage regional policy for political reasons, even if people increasingly want to live in cities. But that is still not a justification to subsidize a profitable industry.

The future telecom market – what does it look like?
The telecom market develops at a fast pace. The staggering advances in wireless technologies in recent years is just one example. Both FTTH and wireless service providers use the same backbone but the CAPEX per subscriber is very different. When the end user is connected either by fibre, carrier Wi-FI, or 4G/LTE, the mobile technologies are the most cost efficient method to get people online.

Given the cost effectiveness and popularity of wireless technologies, this increases competition in wireline technologies (copper, coax, LAN and fibre). Landline providers of all kinds compete with a multitude of solutions at different prices via different technologies. Customers experience a wide selection of offerings and continually decreasing prices, making the business case for new FTTH builds more difficult.

That the EU pronounces FTTH a “future proof” technology demonstrates tremendous hubris. It flies in the face of data in which competing broadband technologies are increasingly competitive and desirable. To be sure, there are some regulators and their activist friends who believe that they should make the decisions about broadband, which kind of technology, which speed and which price. But the market has a clever way of revealing the truth. As such, the development on the telecom market has been driven not by politicians, but by technological developments and consumers – who have been able to choose freely between products and the many market players.

Carrot & stick is the path forward
Around the world there are a number of companies within both the telecom and energy sector that have enough customers and revenue to cover the costs to provide quality telecom services in remote areas. Strand Consult supports a “Carrot & Stick” model in which government actors and industry have a conversation about what the industry can do for the state and what the state can do for the industry. There is a lot that government actors can do which can result in billions of euros of savings, the same amount of money that some politicians want to use on subsidies to market players that already has a high cash flow and high revenue.

A key area to focus is the digital dividend. There are possibilities that emerge with mobile frequencies related to “7-800 MHz” as well as the refarming of the 900 MHz area and the frequencies to be offered regarding e.g. 2600 MHz. There are similar buttons that governments can adjust for the energy sector – that is, after all, subject to considerable regulation and taxation.

Giving government subsidies to telecom and energy companies is the same giving the richest people a tax exemption
The world needs viable models for broadband deployment. Stokab is not a role model. Moreover Stokab isn’t even a legal option for the cities of Europe. Stokab is a 22 year old case dating from a period when European countries had just started to liberalize their telecommunications market. That Sweden decided to transition from one form of monopoly to another suggests that the government failed in its goal. The very purpose of a telecom regulator is to transition the market from one of full monopoly to one of full competition.

It is unfortunate that the European Commission grants a broadband award without due diligence to the applicants and without respect to its own rules. It is also unfortunate that neither the Commission nor Stokab would share the material with Strand Consult which could help taxpayers gain insight into what actually happened when Stokab got EU´s broadband price.

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