Rural Flush: Capital Outlook Improves for Rural Companies

p>Recent indicators are optimistic that rural local exchange carriers (RLECs) will again see improved access to capital. The caveat, however, is that the renewed access will be gained chiefly by companies with proven management teams who demonstrate a strong business case for funding.

In short, basics are back in vogue. That’s good news. What it signals is a maturity that will enable the industry to achieve growth with balance. It also indicates openness on the part of lenders and investors to again fund the proposals that direct growth. That’s a change of attitude, but one that was clearly--if not cautiously--expressed by a number of industry executives and market observers at a recent conference hosted by CoBank.

There is money available for rural carriers, but communications executives must visibly demonstrate their leadership capabilities to get it. The focus today is on sound business judgment and realistic gains, not home runs. That attitude fits in well with the manner in which rural companies have traditionally approached their business operations.

Rural communications companies vary greatly in size, but the average small, local carrier serves about 6500 access lines. This contrasts sharply with the average RBOC, which manages approximately 40 million access lines. Overall, independent telcos serve less than 5% of the nation’s telephone subscribers, but their service areas encompass more than 40% of the nation’s land mass. Their territories are thinly populated, dominated by residential versus business subscribers, and incur higher local line costs. Not much of an advantage, at first glance.

Consider these characteristics, however, that represent focus, longevity and customer loyalty. First, many of the RLECs hold near-monopoly franchises and largely have been profitable. A number have operated for more than 50 years--others for 100 years--and are privately held. They have name recognition in their markets and proven operations.

Second, many of these carriers know how to capitalize on their infrastructure strengths. They have minimized expansion costs by growing incrementally into adjacent markets. Before “edge-out” became a popular business term, these companies were growing bit-by-bit, overbuilding their existing wireline infrastructure and integrating business synergies, making them highly effective competitors in new markets.

Among lenders, there is an adage that no two companies are alike and no two business plans are alike. For managers seeking capital, the emphasis should be put on presenting the dynamics of their companies’ needs and the reasoned plans to address those needs. Lenders are simply more interested in hearing the company’s story in its projected numbers and in seeing a realistic, sustainable cash flow in the business plan. There are, obviously, additional criteria used to assess prospective borrowers, including evaluations of a company’s financial ratios (i.e., coverage, leverage and balance sheet), the quality of its management team and the market position of its product/service offerings.

In general, a sketch begins to emerge of borrower characteristics that lenders use to evaluate risk, determine access to funds and assign relative costs to obtain those funds. Capital access may appear more promising for the industry as a whole, but for individual borrowers, the critical factors remain categorical to some extent.

Through a broad array of financial structures, lenders can design solutions to meet the specific business needs of prospective borrowers over various tenures. For example, carriers seeking to obtain working capital can consider short-term loans or establish lines of credit. Companies looking to expand their network facilities can evaluate intermediate or long-term funding, as well as competitive interest rate alternatives that could include rate management or hedging tools. For companies pursuing acquisitions, other financial structures are appropriate, including senior debt, subordinated debt, leveraged leases and asset-backed securities, among others.

For small, rural carriers exploring various financial solutions, a number of funding sources are available, including industry lenders such as the Rural Utilities Service, Rural Telephone Finance Corp. and CoBank. Other sources are emerging as well, including local and regional commercial banks that have recently stepped up activity among rural carriers. Private equity investors continue to be more reluctant, generally directing their investments elsewhere. As one market observer said, the equity investors are simply market-sector agnostic. They can find faster and greater gains on their money elsewhere.

Communications executives should keep in mind that the renewed prospects for capital will not lead to robust market activity in the near future. Business and regulatory forces wield significant impact. With regard to public policy, one of the most heated debates centers on sustainability of regulated cost recovery funds, notably the Universal Service Fund (USF). In addition, the irregularity of policy enforcement from state to state, whether on USF or inter-carrier compensation, leads to confusion and outcry when, for example, eligibility definitions are applied inconsistently.

Overall, the fickle regulatory environment inhibits investment and promotes a “wait-and-see” attitude among potential capital providers, particularly those in the public markets. “It is a perfect regulatory storm of disincentives to invest,” concluded Christopher Libertelli, senior legal advisor to FCC Chairman Michael Powell.

Despite the turmoil in Washington, D.C. and on Wall Street, there is reason to expect that communications companies will again see improved access to capital. As expressed at a recent CoBank conference, the view is one of cautious optimism. There are obvious constraints for years to come, but we see hopeful signs as regulators work with carriers to resolve issues and communications executives take steps to improve their market positions.

The competition for scarce capital will remain high, but it also appears that the judicious character of rural companies will serve them well. Led by experienced management and employing strategies focused on realistic gains, we believe they are viable contenders. Through their efforts, we expect that these communications companies will continue to grow and diversify services that add value for rural America.

Rob West is the senior vice president with CoBank and manager of the bank’s Communications Division for its Communications and Energy Banking Group in Denver, Colo.

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