Consolidated Communications (NASDAQ: CNSL) entered into an agreement with Searchlight Capital Partners, who will make a strategic investment of $425m into the company, which is expected to close in mid-2021.
Searchlight’s investment provides a significant capital infusion, which enables Consolidated to upgrade more than 1 million homes with fiber passings to consumer and small business customers. This investment further expands Consolidated’s fiber network and accelerates its growth plans.
Consolidated also announced a refinancing, which will result in an improved capital structure. The refinancing, provides the company with extended debt maturities, financial flexibility, and liquidity.
Investment Overview – Consolidated Communications and Searchlight
Searchlight Capital Partners is a highly experienced broadband and digital infrastructure investor. Searchlight has committed to a $425m investment in Consolidated Communications.
Debt Refinancing – Consolidated Communications
Upon closing of Searchlight’s initial investment, Consolidated raised $2.25bn in new secured debt, including a new revolving credit facility. With debt raise, Consolidated was able to retire all $2.0bn of its previously outstanding debt. Consolidated’s new debt consists of a 5-year $250m revolving credit facility and a 7-year $1.25bn term loan, with a maturity date in 2027, priced at L+4.75%. Consolidated also raised $750m of senior secured notes, with a maturity date in 2028, which priced at 6.50%.
As a result of the refinancing, Consolidated reduced its net debt by $325m. In turn, the company’s net leverage ratio declined from 4.1x EBITDA to 3.5x EBITDA, pro forma for the proceeds of Searchlight’s $425m investment. Consolidated will have a $155m pro forma cash balance, leaving the company well capitalized to accelerate its fiber deployment.
Board of Directors – Consolidated Communications and Searchlight
In connection with Searchlight’s investment in the company, Searchlight will receive two board seats on Consolidated’s Board of Directors. On October 2nd, Consolidated’s Board appointed one new independent director, David Fuller, as part of closing Searchlight’s initial investment.
David Fuller is an advisor of Searchlight Capital Partners and brings significant experience in broadband infrastructure transformation:
- Fuller is currently the chair of the board of directors at Mitel Networks. Additionally, he is a member of the board of directors of Great-West Lifeco
- Fuller is also a Senior Advisor to the Boston Consulting Group, for their Technology, Media and Telecom practice globally
Following Searchlight’s second investment closing, it will be entitled to appoint a second director to the Consolidated board.
Transaction Advisors – Consolidated Communications and Searchlight
Morgan Stanley and Wells Fargo served as financial advisors to Consolidated Communications and Schiff Hardin LLP served as legal counsel to Consolidated Communications. J.P. Morgan served as lead financial advisor to Searchlight, with Goldman Sachs, Deutsche Bank and TD Securities also providing financial advisory services to Searchlight and Wachtell, Lipton, Rosen & Katz served as legal counsel to Searchlight.
Investment Terms and Stages
Stage 1: Investment
Under the terms of the agreement, Searchlight is committed to a $425m investment. Initially, Searchlight will invest $350m and receive common stock representing an 8% ownership interest in Consolidated Communications.
From the initial $350m investment, Searchlight will:
- Receive an unsecured note, with a principal amount of $395.5m
- Be issued a Contingent Payment Right (known as a CPR), convertible into common stock in Consolidated Communications. This Contingent Payment Right (CPR) represents an additional 17% ownership interest in the company, for an aggregate 25% ownership interest
Stage 2: Investment
Upon receipt of Federal Communications Commission (FCC) and antitrust approvals, Searchlight will invest an additional $75m. In return, Searchlight will receive additional Contingent Payment Rights (CPRs), convertible into common stock in Consolidated Communications. These Contingent Payment Rights (CPRs) represent another 10% ownership interest in Consolidated Communications.
Searchlight’s $395.5m unsecured note will convert into perpetual preferred stock with a 9.0% coupon, with a payment-in-kind (PIK) option for five years. The value of the preferred stock was derived by mirroring the economics of a $425m (Searchlight’s total investment) perpetual preferred stock with a coupon of 7.5% for the first five years. The difference between earning a 9.0% coupon and 7.5% coupon was done for Searchlight’s private equity tax management purposes.
Stage 3: Conversion of Contingent Payment Rights (CPRs)
Following all applicable regulatory approvals (including Public Utility Commission or PUC approval) as well as stockholder approval, Searchlight’s Contingent Payment Rights (CPRs) will convert to common equity. Post-conversion, Searchlight will hold an aggregate pro forma ownership interest in Consolidated Communications of 35%. This is in addition to the $395.5m of perpetual preferred stock with a 9.0% coupon.
Consolidated Communications Overview
Consolidated Communications is a top 10 United States fiber provider, operating 46k fiber route miles and over 2 million fiber strand miles across 23 states. The company serves three main customer groups, including carriers, commercial, and consumer.
Consolidated’s addressable market includes 2.8 million homes passed, and its network connects to 12.9k on-net buildings. Notably, the majority of the markets Consolidated serves have only 1 wireline broadband competitor. Further, 11% of the markets have no existing competition. In terms of specific competition, Consolidated’s key competitors are AT&T, Comcast, Mediacom, Armstrong, Suddenlink and NewWave Communications.
Consolidated Communications and Searchlight Vision
Consolidated Communications will use this deal to position the company as a leading fiber-to-the-home, business, and wholesale provider. Capital from Searchlight will enable Consolidated to significantly enhance its fiber infrastructure and accelerate investments in high-growth broadband areas of its business.
Consolidated’s accelerated build plan leverages its fiber network to significantly increase consumer speeds to 1 gigabit per second (Gbps), in more than 50% of its addressable market. In addition, Consolidated will leverage the fiber it is building for these consumer initiatives, to target select areas of opportunity for enterprise and carrier (i.e., wholesale) business growth.
Future Build Plan for Consolidated Communications and Searchlight
Consolidated Communications Overall Build Plan
Overall, Consolidated plans to allocate $2.0bn in aggregate capital, over an 8-year period, to support its fiber build. This will enable the company to have 1.4 million fiber-to-the-home passings. Overall, this will increase Consolidated’s penetration from 11% currently, to greater than 50% of its homes passed, over the build period.
However, Consolidated will be using the $425m strategic investment from Searchlight Capital Partners to specifically accelerate its Northern New England fiber network build plan (as seen in the middle of the above page).
Northern New England Build Plan with Searchlight
Consolidated’s investment in the Northern New England market, is a subset of Consolidated’s overall build plan. The company’s Northern New England build represents 30% of the company’s total capital expenditures. Over a 5-year period, Consolidated will invest $450m to upgrade 1 million homes with a fiber offering of 1 gigabit per second (Gbps). Moreover, these investments will be made at a highly-efficient cost, of less than $450 per passing.
Consolidated will make this investment in three Northern New England markets. Specifically, the company will increase its fiber passings from 6% currently to 64% across Maine, Vermont, and New Hampshire. These are markets where Consolidated already has a very dense fiber network.
Fiber-to-the-Home Costs to Pass per Household
Consolidated’s assumption of a $450 cost per Household Passed (HHP) is unprecedented for a rural or low-density footprint. Given that Consolidated’s Northern New England footprint fits the low-density categorization, it represents a unique case study.
According to the Fiber Broadband Association and fiber technical consultant Cartesian (see below), urban areas typically experience costs to build fiber of a $700 to 1,500 cost per Household Passed (HHP). Whereas rural areas typically range from a $3,000 to $6,000 cost per Household Passed (HHP), which is four times more expensive.
Additionally, Consolidated’s competitors, such as Altice, validate these industry numbers above. As competitors like Altice struggle to achieve metrics any lower than a $600 cost per Household Passed (HHP). For example, Altice is overbuilding its entire Optimum footprint at a $600 cost per Household Passed (HHP) but at the same time is benefiting from high density markets, being in the Greater New York Area and having 80%+ of its fiber deployed aerially – both of which lower fiber deployment costs.
Consolidated’s management nonetheless remains confident in its uniquely low $450 cost per Household Passed (HHP). Management notes that build-out cost data from historical precedents is too old, to make relevant comparisons from.
Furthermore, 81% of the near-net opportunity for Consolidated is in Northern New England aerial fiber. Consolidated has the ability to hang fiber aerially, as compared to having to trench it underground. This deployment method avoids permitting and construction costs, both of which drive a significant portion of Consolidated’s fiber deployment cost reductions.
Much of Consolidated’s regional fiber build-out over the past two years will also be leveraged for near-net residential deployment. Particularly, because the company owns 18k fiber miles in a compact Northern New England geography.
Financial Returns to Consolidated Communications and Searchlight
Illustrative Returns of Fiber-to-the-Home Build by Consolidated Communications (units, $s in 000s)
- Consolidated can achieve 1 million Households Passed (HHP) over 5 years, assuming 200k Households Passed (HHP) are added each year
- Penetration of 10% is achieved in Year 1, equating to 20k subscribers, by the end of Year 1. On average, 10k subscribers are achieved, over the course of Year 1
- Penetration is assumed to grow by 2.5% each year to reach 20% penetration by Year 5
- Churn of 1.0% of average subscribers is assumed from Year 2 onwards
- Average Revenue Per User (ARPU) on a monthly basis is assumed to be $60 in Year 1. Thereafter, it grows by 2.5% each year
- Revenue is calculated on the average number of subscribers during the same period
- Operating costs of 35% of revenues are assumed, resulting in a gross profit margin of 65%
- Cost per Gross Addition is assumed to be $400. This figure is comprised of customer premise equipment (CPE) & installation costs and marketing costs
- Build Cost per Household Passed (HHP) is assumed to be $450. This figure is derived from Consolidated’s disclosed underwriting for Northern New England
Based on the above assumptions, Consolidated will achieve a Return on Invested Capital (ROIC) of ~5% in Year 1. This Return on Invested Capital (ROIC) grows 3% to 4% annually, to reach 19.5% by Year 5. Overall, the Return on Invested Capital (ROIC) from this project represents an attractive investment profile, should the above assumptions prove correct.
How Consolidated Communications Can Achieve a Higher Return on Invested Capital (ROIC)?
In terms of assumptions, penetration in Year 5 could be higher than 20%, with precedents reaching up to 50%. Additionally, pricing power of greater than $60 Average Revenue Per User (ARPU), coupled with faster ARPU growth than 2.5% could drive ROIC higher. Finally, gross margins of 60% to 75% are typical for fiber-to-the-home projects. Therefore, Consolidated could achieve higher margins than the 65% assumed.
From a competitive standpoint, the market is set-up for Consolidated to potentially achieve some of these upsides to the illustrative business plan. For example, 11% of Consolidated’s Northern New England footprint does not have a wireline broadband provider.
The remainder of the Northern New England network does have a competitor, which are largely Cable companies including Comcast, Charter and Broadband Atlantic. However, Consolidated could effectively compete with a cost-efficient dedicated 1 gigabit per second (Gbps) fiber-to-the-home build.
Largest Potential Risk from Consolidated Communications and Searchlight’s Plan
In terms of risks to the illustrative returns, Consolidated’s $450 cost per Household Passed (HHP) is unproven. Thus, it represents a major challenge, particularly for a low-density footprint such as Consolidated’s Northern New England footprint.
As a result, Consolidated’s realized build costs could well exceed its underwritten $450 cost per Household Passed (HHP).
Consolidated Communications and Searchlight Capital Partners – Background
Consolidated Communications operates 46k fiber route miles serving three main customer groups. Specifically, these groups are carriers, commercial, and consumer. Consolidated‘s network connects to 12.9k on-net buildings.
Searchlight Capital Partners is a global private equity firm with over $7bn in assets under management. Searchlight focuses on buyouts, growth equity, and recapitalizations with offices in New York, London, and Toronto.