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HomeMy WebLinkAboutStaff Report 319-05DISCUSSION FTTH Trial Staff recommends that the FTTH trial be ended by the earlier of December 2005 when existing contracts with the switch equipment supplier expires or when the existing FTTH equipment fails. The reasons for closing the trial are as follows: 1. The trial has served its purpose as a pilot project that has demonstrated its functionality. 2. The trial was never meant to be a commercial operation and has: a. no dedicated support staff b. no service contract with the equipment supplier c. no equipment replacement fund (current subscriber revenues just cover operating costs) Given this reasoning, staff believes it best to plan an orderly "winding down" of the demonstration project that has minimal impact on trial participants. Staff will work with trial members to transition to alternative providers. FTTH Financing in Other California Jurisdictions In accordance with Council direction, staff continues to follow FTTH financing activity in other jurisdictions. While there has not been significant progress on financing methods, the experience in other localities is informative. Truckee-Donner Public Utility District Truckee-Donner still has not implemented its FTTH system. The agency responsible for allowing Truckee-Donner to build FTTH, the Local Agency Formation Commission (LAFCO), did not grant permission to move ahead with the project on a technicality. Once this is resolved, it appears that the District will proceed with its original financing plan that first uses bridge financing and then Revenue Certificates of Participation. The District is legally forbidden to use electric funds to finance non-electric projects or services. Alameda Power and Telecom To finance its fiber/coaxial broadband system, Alameda has gone through three financings (2000,2002 and 2004) with a fourth planned in 2009. These financings included a $10.0 million loan from the Electric Utility and a $2.2 million loan from the City'S Redevelopment Agency. Financing vehicles included Certificates of Participation issued in 2000 and 2002 and Bond Anticipation Notes issued in 2004. During early financings, private funding was utilized by Alameda. As a consequence of past financings, the use of a BAN in 2004 (which utilizes capitalized interest) and· an anticipated refinancing in 2009, the FTTH operation will have incurred significant obligations to repay from its revenue streams. CMR: 319:05 Page 2 of5 f' '\ Lompoc Electric Utility The City of Lompoc's telecommunications program involves two phases, the first to build broadcasting antennas for a wireless system and the second to build an FTTH system. Completion is expected in four months. The City's FTTH effort has not begun in earnest. Lompoc has used loans from their Electric Fund to finance the wireless operation. It is noteworthy that a local write-in campaign against the wireless and FTTH enterprises has been initiated. The Howard Jarvis, California, and Santa Barbara Taxpayers Associations have written letters to Lompoc's Council opposing the use of City resources for telecommunications and opposing City competition with the private sector. The ostensible rationale for the opposition was that City resources should be used for basic services such as public safety. City officials recently discovered that major local service providers provided financial backing for the taxpayer campaign against the City. While there is strong opposition from incumbent providers and taxpayer associations, Lompoc's Council and residents intend to move forward with FTTH. Private Sector Since last July, staff met several times with a consulting firm, Dynamic Cities (DC), which worked with the Utopia Network in Utah to build and operate an FTTH system. DC is a firm interested in long-term partnerships with cities. While its chief goal is to manage FTTH programs, the firm has expertise in business modding, financing, and designing FTTH systems. These discussions were informative and touched on financing vehicles used by other cities as well as evolving financing concepts. DC has been active in interacting with Palo Alto residents who are interested in developing an FTTH program. While DC has an interesting and flexible approach to financing, its ideas have yet to take root in . California. More importantly, and as emphasized in last year's FTTH report, there continues to be sufficient legal, financial, and other concerns that militate against proceeding with FTTH efforts at this time. . These concerns include: • The inability of the City to use Utility Revenue Bonds backed by the Electric Fund based on analyses of evolving California law (statutes and cases). Based on voter-approved statewide propositions, it is clear that· ratepayers, fee payers, and assessment payers should not be required to pay more than the cost of services received. • Potential protracted and costly legal opposition from incumbent providers. • Investor and rating agency unfamiliarity with public FTTH projects injects considerable uncertainty and risk/reward considerations into the financing process. Whereas Palo Alto traditionally seeks capital funds by competitively selling bonds based on anticipated revenue streams and reserves, in this case it would have to consider alternative funding such as a private placement or a mixture of private placement and equity investment. Staff analysis indicated (see Attachment A) that, based on potential private placement financing costs, there would not be sufficient financial resources to move forward with the FTTH project. • Potential for failure of current FTTH trial equipment that would be costly to repair. CMR: 319:05 Page 3 of5 • . Limited staff resources due to budget reductions and demands of other projects. Based on these issues, staff recommends halting the monitoring of financing methods used by other jurisdictions. Dark Fiber Operation The City will continue its dark fiber operations. Staff will return to Council before fiscal year 2006-07 with a report on dark fiber finances and a business plan. RESOURCE IMPACT Ending the FTTH trial will result in a reduction to expenses and revenues. Contract expenditures to support trial participants will be reduced by $39,600 annually, while revenues from monthly charges to users will decline by $63,240 annually. The FTTH trial has been in operation for approximately three years. It is important to note that the costs cited above do not include: • Repayment of loans to the Electric Fund for initial capital and start-up costs • The cost of equipment and equipment maintenance costs necessary to deliver services (equipment was on loan from Motorola at no cost to City) • City staff support which includes direct and indirect costs The one-time cost of removing equipment from participant homes is estimated at $12,400 and this cost will be borne within the existing budget. Adjustments to the 2005-06 budget are expected at midyear with amounts depending upon the timing of the trial's end and removal of participant equipment. POLICY IMPLICATIONS Recommendations in this report are consistent with prior Council direction. TIMELINE If Council adopts staffs recommendations, the FTTH trial will terminate by December 2005. ENVIRONMENTAL ASSESSMENT The action recommended is not a project for the purposes of the California Environmental Quality Act. PREPARED BY: Joe Saccio, Deputy Director, Administrative Services Blake Heitzman, Manager of Telecommunications, Utilities CMR: 319:05 Page 4 of5 and asked if all objectives had been met. In addition, one Commissioner queried as to whether staff had a time frame or milestones for finalizing the trial. Staff responded that . while many objectives had been met, there was still more to learn about the evolving technology. Moreover, staff stated that cash flow from annual operations of the project was positive and that when it turned negative, staff would return with a recommendation to cease the project. It is important to note that fiber operations as a whole (dark fiber and FTTH) is cash positive only when depreciation and allocated charges are excluded. After hearing from staff that there were consulting finns eager to partner with "Palo Alto on FTTH, one Commissioner wondered whether the City could pursue a relationship. Staff replied that it would keep an open mind and would consider a viable financing option when it emerged. Another Commissioner asked whether staff had talked with investment bankers who had the expertise and creativity to find financial solutions. DISCUSSION The principal differences between the UAC's and staffs recommendation is that the UAC recOlmnended not proceeding with an advisory vote (staff had no recOlmnendation on this point) and that staff, over the next six months, actively "seek guidance from the investment banking community about possible financing options" for FTTH. Staff respectfully disagrees with the recommendation to actively seek guidance from the investment banking community over the next six months. While staff has not had many direct contacts with the investment banking community, it has gathered sufficient information to indicate that such contacts may not be fruitful. As stated in the attached report, a bond placement whh a private investor will cost more than a traditional public offering. After using a "low-end" rate of return of 7.5 percent to a private investor for a three-year investment and holding the penetration rates in the FTTH business model constant, staff and the City's Financial Advisor found that only $20.2 million of the anticipated $32.0 million in capital needs could be funded. Ivforeover, an additional $8.0 million is needed for start-up operating costs and that funding has not been identified. Preliminary information from Truckee indicates that a potential investor is seeking a rate of return closer to 13 percent and this deal has not closed. Staff has been advised by a professional in the financing arena that it will be exceedingly difficult to find private investors for the FTTH venture envisioned in the business plan. It is staff s recommendation to. monitor the efforts of other California cities in seeking viable financing. One FTTH consultant has informed staff that a city in California is about to receive private financing for an FTTH venture. It appears prudent to await the outcome of this financing and then use its results to test potential outcomes in Palo Alto's FTTH business model. CMR:360:04' Page 2 of3 " ATTACHMENT A l\1EMORA~TDUM [1]' ..... . . : .' . . . ·:2·:.·.····: .. . . . , .. :: " . . .... . ....... ,- TO: UTILITIES ADVISORY COMfVilISSION fROM: UTILITIES DEPARTMENT SUBJECT: FIBE'R TO THE HOME DATE: JULY 7,2004 REQUEST Staff requests that the UAC review the staffrecOlID11endation below on Fiber to the Home and provide advice for Council consideration on July 19,2004. Staff recommends: 1. Halt consideration of the financing options discussed to date and, instead, monitor the financing methods and results of other California jUlisdictions until such time as a viable financing option emerges. 2. Continuing with the FTTH trial for one year with an evaluation on whether to continue the trial at that time. BACKGROUND On April 19, 2004, staff presented Fiber to the Home (FTTH) financing options to the City Council. After discussion, Council refened the issue to the Utilities Advisory Commission (UAC) for its review and recommendations. On May 5, 2004, staff discussed potential financing vehicles with the UACas well as a new alternative, propeliy related fees. These options are summarized in Attachment 1. During the Council and UAC meetings, staff explained that significant legal issues sunounded and prevented use of Option A, a Utility Revenue Bond backed primarily by FTTH revenues and secondarily by the Electric Fui1d, which was used in the FTtH business model. These issues centered on whether utility ratepayers should subsidize or ultimately be held accountable for FTTH operating and debt service costs. The UAC raised numerous questions about staff s legal position on Option A. UAC 07/07/04 Fiber to the Home Page ·1 of 11 The UAC discussed the following options which involved placing an assessment, fee or potential tax on residents or property owners that would not use FTTH services: FTTH enterprise debt backed by a· special tax requiring two-thirds voter approval (Option D); assessment district(s) requiring simple majority propeliy owner approval (Option E); and propeliy related fees requiling simple majority propeliy owner approval (Option F). In addition to indicating support for the FTTH program, a favorable vote for a new credit or revenue source otlier than FTTH net revenues wOlJld enhance investor confidence and reduce FTTH project financing costs. The UAC declined to' recommend any of these options. The UAC also requested additional information on using Certificates of Pariicipation (COPs) to fund FTTH (Option C). A traditional COP financing does not require a vote by the public, pledges an essential asset as collateral for the celiificates or bonds, and generally relies on existing revenue streams to pay lease or debt payments. The City has issued COPs in the past, specifically for General Fund improvements and' as financial conditions penl1it"ted. COPs were used to fund seismic improvements in the Civic Center. After lively discussion, the UAC recommendation was as follows: "The UAC returns the FTTH project to Council with its original recommendation intact and requests that staff conduct a more thorough review of financing options A and C along with assessing altenlative financing which may be based on utility related uses and fmihermore research potential palinerships." More specifically, the UAC urged 'staff to explore the use of short-term private investment (Option B) such as that used in the City of Alameda and proposed in Truckee until such time as FTTH project revenues were sufficient to "buy-out" the private investment with long-term revenue bonds. The Truckee deal calls for "Revenue Certificates of Pariicipation" which will be piaced with private investors. Staff has interpreted Option C to reflect this approach as opposed to relying on General Fund assets. The UAC recommended running such a scenario through the FTTH business model to analyze its viability. In addition~ Commissioners were interested in financing methods used by other public jurisdictions inside and outside of California to fund FTTH enterprises. DISCUSSION Staff believes that after extensive internal and extemal legal analyses of evolving California law (statutes and cases), Utility Revenue Bonds backed by the Electric Fund are not viable. Based on voter approved Statewide propositions, it is clear that ratepayers, fee payers, and assessment payers should not be required t6 pay more than the .. ~~ .. ~! ...... ~ .. ~~._.~~~~ .. ~Q! __ .~~_.~~E.~~~~ .. ~_~~~ .. ~iY..~~.:~_ ........ ~~_ ..... ~~~~:~~2.._!12~E~~~~~.~ ... _?~ ..... _i~ .. ~EP.E?E!,i~~~ ..... _!~_.J2.~:::~. UAC 07/07/04 Fiber to the Home Page 2 of 11 e Truckee-Donner Public Utility District is legally forbidden to use its electric or water utility as a credit pledge or as a financing source (electric & water) of revenues or reserves for unrelated activities such FTTH services. f! ConmlUnity exploring ~lse of Revenue Certificates of Pmiicipation backed wholly by the revenues of the FTTH system. This is not an asset-backed COP at this time. e Potential investors have been identified, but a final deal has not been consummated. One investor is requesting a rating on the COPs which may be conducted by a Canadian rating agency. Cl Consultants working on Tl1lckee project are Aggregate Networks· (Financial Advisor) and Eagle Broadband (Service Provider). Alameda Power and Telecom 8l Alameda apparently has the longest and most complex history in finm1cing a fiber/coaxial system in Calif o 111ia. After buying the assets of a small, private telecommunications company, it has gone throu,gh three financings '(2000, 2002 and 2004) with a f01.nih planned in 2009. These financings were supplemented by $12.2 million in advances from available utility reserves and by the City's Redevelopment Agency. II Alameda has used private financing to fund construction of its hybrid system tlu'ough Celiificates of Participation issued in 2000 and 2002 and in its 2004 Bond Anticipation Notes (BAN). e With each financing, Alameda has taken on additional debt and obligations to repay private investors. Of the $33 million 2004 BAN issue, $16 million will be used to repay a prior year debt obligation; $11.3 million will be used for capitalized interest (interest payment to private purchaser of BAN); and $.9 . million for costs of issuance. @> Using loans with capitalized interest may be useful on a one-time basis to jump~ stali an untried enterprise seeking capital, but it does place considerable burden on the telecommunications enterprise to meet its. future obligations. In 2009, Alameda is intending to issue new, 10ng-tem1 bonds to finance the capitalized interest and other costs inculTedin the 2004 financing. Lompoc Electric Utmty " Lompoc's telecommunications program has 1\vo phases: the first is to bui1d broadcasting anteimas for a wireless system and the second is to build an .FTTH system. e Preliminary plans are to build a $25-26 million fiber system. E!l Lompoc has n·ot had an opportunity to investigate the legal and financial relationship between its utilities and proposed fiber enterprise. It has not deten11ined what, if any, utility funding will be used for FTTH at this time. UAC 07/07/04 Fiber to the Home Page 4 of 11 II ',Iv11ile Lompoc will investigate its financing options, the initial idea is to undertake a traditional negotiated financing whereby an underwriter will be hired to sell Utility Revenue Bonds to investors. Utopia Network, Utah ~ Funding is being provided by a IOta 11 city consortium for 30-40 percent of funding needs with the balance being provided by private investors. The financing is backed primarily by project revenues and secondarily with existing sales tax revenues .. III A construction loan from a bank is expected and, to mitigate lisk, loans will be . made in installments or to coincide with the build-out of system. Utopia's strategy is to build out .sections of system to determine each stage's financial viability before moving ahead with proj ect. Half of the cons Oliiulll 's cities will be built out and evaluated before the next stage. Three to four small, additional cities have expressed interest in being pali of consOliium in future. & In pmi, as a result of Comcast's and Qwest'.s effOlis to prevent municipal involvement in providing broadband services, the Utah legislature has established requirements for cities to provide FTTH retail services. Utopia has chosen to be a wholesale operation with the goal·of promoting retail con1petition. AT&T is the anchor tenant at this time. e Consulting fi1111, Dynamic Cities, expected to manage FTTH system for Utopia. • Utopia is mix of rural and urban communities and had some private fiber build-out prior to fiber initiative. Provo, Utah e TeleconU11Unications/FTTH operation is paIi 01 City's utility operation; FTTH was piggybacked 011 top of a fiber system built for SCADA and to connect substations. " Bonds to build out FTTH are backed by the full faith and credit of the City of Provo. It appears that City is willing to use the utility rate structure, utility reserves, and City sales taxes as pledges for its bonds. El Provo chose traditional municipal financing methods and did not utilize the private financing option. This decision was made in Ol:der to minimize interest costs and ensure financial viability of the program. Interest rate on bonds was in 5 percent range. ~ Provo utilized a poll rather than a general vote to assess resident FTTH suppOli. (Il Provo has signed a small, full-service provider for its network. Uptown Services developed its business mode1. Tacoma, VVashington Ql Initial Tacoma system included fiber backbone between electric utility facilities; a Supervisory Control and Data Acquisition (SCADA) system; and a broadband UAC 07/07/04 Fibedo the Home Page 5 of 11 conIDmnication network between city offices, educational facilities and other public sites. £I Initial estimate for build-out was approximately $60 million and was funded by utility revenues .. €l Tacoma Power had to fill the "hole" in services that were not available to all residents. ,Expansion included additional infrastructure purchases,· service enhancements and connecting the fiber backbone to residences via coaxial cable. Expansion required an additional $36 million in funding. The above "infol1nation sheds light on a number of issues the City of Palo Alto is facing. It Clarifies that PTTH financing is a new field for cities, public utilities, rating agencies, and the investment community. Jurisdictions· looking for financing are caught between the need to find politically and legally acceptable revenue pledges to lower interest costs and a capital market unfamiliar with PTTH enterprises that will seek higher retUl11S to coverits potentially higher-risk investments. The Utah enterprises have pledged existing revenue sources to enhance credit for PTTH bon·owing. Truckee, which is legally prohibited from using non-telecommunication utility revenues as a pledge, has been seeking private investment and has not .signed mY investor as of this writing. Preliminary . financing information from Truckee indicates steep financing costs to implement a deal. Alameda's experience, paliicularly with its 2004 financing, also reveals significant financing costs. It is important to note that Alameda and Truckee have pledged or proposed pledging only projeCt net revenues. As far as staff ·can determine from discussiol1s and public documents, assets of the system have not been pledged toward debt obligations. As UAC members and residents have indicated, once the PTTH system has been built and a sustaining customer base has been established, there may be value for investors t6 seek in the case of default. This value, however, will be dependent on the number of customers Palo Alto attracts, the desire of a finn to compete with other incumbent providers, and market conditions at the time of a possible asset sale. According to Provo's Telecommunications I\1anager, incumbent providers such as Comcast and Qwest, with significant investments in their existing assets located within a proposed public PTTH service area, were active in opposing public PTTH enteI}Jrises. Comcast, for example, was influential in· passing legislation in Utah that created numerous hurdles for pubiic entities to. deliver telecommunication services. It is instructive that in a more rural community such as Truckee there appears to be no concelied opposition. Provo's experience is more indicative of expected incumbent opposition to the proposed PTTH system in cities such as Palo Alto. UAC 07/07/04 Fiber to the Home Page 6 of 11 As stated, whhout a proven revenue source or asset pledge (e.g. strong existing revenue streams, a special tax, or an essential physical asset), the financing costs of initiating the FTTH project are likely to be high. The impact of these costs as well as val1iations of other key variables in the business 'model are explored' in staffs sensitivity analysis below. It should also be noted that although a private investor is aware that its principal is at risk when it invests with an expectation of a higher rate of return, it is likely to claim the jurisdiction has a "moral obligation" to fulfill its responsibilities and not let the project remain at-risk in the event of a default. Staff understands that Truckee's potential investor fully expects that the district will meet its "moral obligation" and not let the project go into financial default despite the lack of an explicit commitment of other assets in itspre1iminary statements. Not meeting a debt obligation could have a negative impact on future bond issues in Palo Alto. Analysis of FTTH Business Model Based on Varying Assumptions The UAC raised the question of running several interest nite scenarios through the CUlTent busiiless model to 'detenlline potential financial outcomes. Staff also has spoken with a number of consultants involved in private placement FTTH financing proposals to obtain a sense of the true costs of such deals. The range of information varies considerably and, ultimately, until the City develops tenll sheets or negotiates a deal, interest costs are speculative. . The City's financial advisor and staff have run several private placement scenanos through the current FTTH model. The scenarios, which vary the penetration rate assllmed in the model as well as the long-teml bond rate, assume a private investors will invest in the form of a three-year bond anticipation note (BAN) at a 7.5 percent rate with fully capitalized interest. In 2007, the BAN would be refinanced with a long-term bond at 6.0 percent or 7.0 percent. The effect of using a BAN and the higher rates that can be expected from private placement >is expressed in terms of net proceed dollars that can be- secured for capital needs. Investors will take a careful look at the FTTH business plan and revenue and expense projections and pay paliicular attention to the ability of the project to generate sufficient net revenues to cover debt obligations. An investor will also look at the model's assumption on penetration rates and may choose to adopt a more conservative approach. Hence, this analysis focuses on what bOlTowing levels the City can expect based on variations in interest and penetration rates. \Vbereas the FTTH project requires $32 million in capital funds, the use of a BAN, which capitalizes interest and rewards a plivate investor with a higher rate of retum, significantly lowers the proceeds for the project. As shown in Scenario 1 below, a 7.5 percent BAN rate and a 6 percent long-teml bond rate lowers capital proceeds from the required amount" of $32 million to $20.2 million. Moreover, .as the penetration rate assumed in the model decreases, proceeds for the project decrease as 'Yell. It is important .~~_E.~~~_~J.!_~~ __ i.~~ __ ~~.~_~:.:~~i_?~~~ __ ~~!~~. ___ ~?_l:'.~~~~~~l?:!.~J.. __ !!!_~E~_ .. i~_.""~?.12~.~~~~~~.~_ .. !I~~.~ .. !he~.~L~_~J?.~E~~!2!_ UAC 07/07/04 Fiber to the Home Page 7 of 1.1 penetration rate used in Palo Alto's model is a reasonable assumption. The 2007 take-out financing bond interest rate incorporated above is based on cun-ent market plus 100-200 basis points. Given the above infonnation, financial scenarios are presented as follows: Sceliario 1: Penetration rates are achieved at 100% of Uptown's base model projections: e Assuming 6.0% 10ng-telTI1 bond·rate in 2007, $20.2 million could be secured for the project (net of issuance and capitalized interest costs). €> Assuming 7.0% long-term bond rate, $18.2 million could be secured for the project. Scenario 2: Penetration rates are achieved at 75% of Uptown's base l1wdel projections: II Assuming 6.0% long-term bond rate, $15.0 million conld be secured for the' project. Cl Assuming '7.0% long-tenn bond rate, $13.5 111illion could be secured for the project. Scenario 3: Penetration rates at 60% of Uptown's projections: e With a 6.0% bond rate, $11.9 million could be secured from investor(s) for the project. ., With a 7.0% bond rate, $10.7 million could be secured from investor(s) for the project. The above analysis clearly shows, based on the assumptions above, that Palo Alto would be required to secure additional funds to meet the capital needs of the PTTH project. Additionally, the City has yet to identify an appropriate source of funding for the approximately $8 mi1l:ion needed for stmi-up operating costs. By running the expected costs of a private placement financing through the PTTH business model and holdillg penetration rates in the cun-ent model constant (Scenario 1), staff concludes that there are not sufficient financial resources to move fOl"'vvard with the PTTH project. Emendnr::: Relationships on FTTH . Since meetings with Council and the UAC on PTTH, staff has contacted jurisdictions pursuing PTTH projects as well as consultants helping with their business models, financing, product development, and operations. Staff has found considerable variation in the expeliise, knowledge, and financing approach of the consultants. Some consultants UAC 07/07/04· Fiber to the Home Page 8 of 11 offer business model and financing expeliise while others want to pursue long-tel111 relationships with revenue sharing. and becoming the City's service provider. Exploring these relationships and their value to the City will involve additional appraisal and a possible change to the .cUlTent business model if the City should choose not to run the system intel11 ally. One consultant indicated that some corporations providing telephony or broadband services might be interested in pmineling with Palo Alto. All of these consultants are eager to establish a relationship with the City of Palo Alto. A brief descliption of the expeliise the consultants provide and the role they played in FTTH effOlis may be helpful. l. Aggregate Networks (AN) is serving a key role in developing Truckee- Donner's business plan and f0l111ulating a still tentative financilig proposal. AN has introduced an interested investor to Truckee, but the deal has not been finalized. AN is a small fil111, somewhat similar to Uptown, and compares municipal FTTH projects to start-up finns requiring private financing. AN . does .not appear to be interested in a revenue sharing partnership or providing management for the FTTH system. i 2. Eagle Broadband (EB) is the fun service provider for Truckee'S FTTH project. At Truckee's request, EB has played a secondary role in the overall financing effOli, given Aggregate Netwol'ks suppOli. EB, however, indicated to staff that it has financing expertise as well·as access to potential investors. EB is also arelative1y small fim1, eager to develop a market for its product and services. It indicated that it is close to closing a deal with a Southem Califomia city (not identified) where it has acted as a facilitator for financing as well as becoming the service provider .. Naturally, theplice of Eagle's assistance is that it be permitted to sell its services on the system. In the case of Truckee, EB is seeking assurance that it will be the wholesaler of video, phone, Intemet and security services on the Truckee system. 3. Dynamic Cities (DC). offers consultant and project management services to institutions interested in the broadband business. It has staff experienced in business case deve] opment, partner development, construction managemel1t and alTangement of financing. Currently, DC is responsible for project management of the Utopia project in Utah (includes Salt Lake City). This involves development of the b1-1siness case, procurement of equipment, negotiation of pminerships (including landing AT&T as the anchor tenant on the system). It is intetested in providing a subset of these services to Palo Alto and believes it could develop a financing plan and match the City with investors. UAC 07/07/04 Fibei to the Home Page 9 of 11 Cit" of Palo Alto Utilities Usa!!e of FTTH Finally, staff has investigated the ability of jts existing Utilities to use the FTTH system and pay for their appropriate share. Potential uses such as remote meter reading, electric load control, refined real time system monitoring (SCADA) and time of use metering ( electric) have been investigated. Each of these systems is more expensive and requires more equipment than the CUlTent FTTH commercial business model includes. Costs were calculated for two base cases: deployment to 100% of the premises and deployment to 50% of the premise in Palo Alto. These costs were calculated using an internal staff model and by modifying the Uptown FTTH Business Model and the results from each analysis were similar. Staff has found it difficult to determine the monetary value of each Utility's use of the FTTH system. Many benefits are qualitative rather than quantitative or lead to a reallocation of costs among ratepayers. Load management, for exalI~.ple, is .dependent on forecasts of future demand costs. Cun-ent forecasts indicate that a marginal amount of savings can be associated with load control. Time-of-use rates will not increase existing revenue streams, but will allow a more equitable distribution of costs of expensive power to those who use it. Real time monitoring could provide better dispatch practices dUling regional emergencies and better allocate resources to protect life and property, but the . value of this needs to be researched, and should include input from public safety staff. Automatic meter· reading of gas, water, and electricity through a FTTH system is cun-ently the most likely value to Utilities. It should be one of the options studied in the . Automatic Meter Reading study currently being done by Utilities. Given the need for additional research, that would involve coordination with other depmiments of the City, staffs best estimate at this time is that FTTH would not pTOvide more than $500,000 per year of value to the Utility. These savings wbuld not be realized until the tenth year in the model and assumes a full implementation of automatic metering tlll"ough FTTH plus Utility efficiencies through real time monitoring. These numbers are very preliminary, and a more rigorous study would have to be completed to establish a solid value. CONCLUSIONS AND COMMENTS Staff s research reaffin11s that implementing a public FTTH system will be a complex task. There are numerous factors and risks to take into consideration in moving forward: legal issues; opposition and competition from the private sector; teclmological changes; financing sources and obligations in the event of default; the City's and community's appetite for risk taking; public service priorities in a challenging economic eilVironment; and many others. There also are many potential benefits from a City FTTH system such as local control, keeping consumer spending local, the promise of state of the ali teclmology, developing a citywide inforn1ation and telecommunications network, the potential for new revenues, and other public benefits. UAC 07/07/04 Fiber to the Home Page 10 of 11 ATTACHlVIENT B DRAFT EXCERPT UTILITIES ADVISORY COM~1ISSION MEETING MINUTES July 7s 2004 "" I. ROLL CALL Commissioner Rosenbaum called the meeting to order at 7:05 p.m. in the Chambers, 250 Hamilton Avenue, Palo Alto, California. Present: Dick Rosenbaum, Elizabeth Dahlen, George Bechtel, Dexter Dawes, Mayor Beecham and John Melton II. ORAL COMMUNICATIONS None III. APPROVAL OF MINUTES Motion: Comniissioner Bechtel moved that the minutes from June 2,2004 with the correction made that the reference on page one to the "New Dawn Pedro Dam" should be Don and not Dawn. John Melton seconded. Motion Passed: 4-0 Dawes Abstained as he was not present at June meeting. Dawes asked about beginning sense minutes and mentioned that this may be on a future agenda. IV. AGENDA REViEW AND REVISIONS No changes to agenda. V. REPORTS FROM COMMISSIONER MEETINGS/EVENTS None. VI. DIRECTOR OF UTILITIES REPORT City Council approved the budget including rate increases in gas, water and electric. The overall effect to the average customer is about 8.4% including the refuse cost that went up. Normal $200 bill will go up to around $15-$17 increases to each customer. Council approved electric to be effective January 1st• Execution of Council approval of energy block purchases. As of June 30th, staff 360 giga watt hrs at $51.76 megawatt hour. Will give update at quarterly meeting. Tariff bill for services from PG&E, we've been protesting. 1998 April-Aug 2002 -we lost decision at FERC -now obligated to pay $8.5 million fot" past services. We will be paying about $700,000 a month next 12 month period. We will be depositing money into an escrow account and will be parceled out after we've completed further litigation. This is currently being discussed with our external auditors. Council approved the feasibility study for local alternatives. Interdepartmental training is being developed to have a good understanding of legal and environmental requirements before we look at sites. We're also developing public outreach pian. " C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7,2004 Page 1 of8 DRAFT EXCERPT Dawes asked about PG&E, FERC decision. Free to discuss any appeals or is it confidential? Ulrich explained the escrow account; expect to have appeal through NCPA through FERC, which may result in court. VII. UNFINISHED BUSINESS None. VIII. NEW BUSINESS 1. UAC Elections Motion: George Bechtel made the nomination of the Vice Chair, Dexter Dawes as Chairman for this upcoming year. Seconded by Elizabeth Dahlen. Motion Approved: Unanimously. Motion: Chairman Dawes asked for nominations for Vice Chairman for the Commission. Rosenbaum nominated George Bechtel, seconded by Dawes . . Motion Approved: Unanimously. 2. Fiber To The Home Ulrich introduced Joe Saccio who as the leader of looking into financing options. Blake Heitzman was also at the table to answer any questions. John stated it is important to come back with the latest news on financing options .. Utilities has attempted to answer questions the UAC had and also sent questions some City 'Council members asked at the last Council meeting and through emails we've received. Joe Saccio explained highlights of information to summarize additional information we did on finance options. Looking at other communities. State staff recommendations on what to do from here. Option A: don't have a lot of information to compliment what we had last time, legal constraints prohibit us from pursuing revenue bond backed by Utility. Couldn't use rate payer assistance to back subsidies. Option B is discussed in the CMR which appears too costly. Option C appears to be not viable and revenue certificates of participation with private placement would be too costly. Financing (Option A) through Utility Revenue Bonds backed by the Electric Fund is not viable since ratepayers would be paying for a benefit they may not receive. Private Placement (Option B) is too costly and does not provide required funding. Certificates of Participation (Option C) backing of General Fund is not viable and Revenue Certificates of Participation with private placement is too costly. . FTIH Financing in other jurisdictions -number of municipal jurisdictions have implemented or are currently implementing FTIH project financing. These include Truckee-Donner PUD, Alameda, Lompoc, Utopia Consortium, Provo, and Tacoma. Approaches for these projects are summarized here. We've been looking at how to come up with a viable financing method. There are no cookie cutter approaches. We've heard that there is a city on the verge of getting help but we don't know what city that is and there is no track record there. . We came to the conclusion that doing a bond financing would not yield the $32 million in capital costs or provide for $8 million initial operating costs. BAN's could range anywhere between 7 and 15 percent. Will be based on different variables on what their interest rate would actually be. Conservative approach to financing, we believe that some of the assumptions we've used are very reasonable. Palo Alto has always taken a very prudent approach to financil')g. We take conservative approaches when we do Capital Projects. City has a low debt ratio. Looking at more conservative numbers where we do have more questions, we are not recommending moving forward at this time. We recommend sitting back for a while and monitoring other jurisdictions and continue FTIH trial for 12 more months with Council review. . Commissioner Dawes stated questions from Commissioners would be addressed. C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 2 of8 DRAFT EXCERPT Melton asked why continue FTTH for an additional 12 months? He thought we had achieved everything we needed to know which were mostly technical not finanGial. Wnat more would we learn by continuing for another 12 months? Heitzman said we are in the position of council having approved indefinitely until we decide if we are going to go through with FTTH citywide, so moving to a one year time line is more conservative. On an annual operating cost basis, the trial is paying for itself. This does not include the initial construction costs, trial fees will never pay that back. There is much value in additional information we can learn (i.e. testing and incorporating different types of eqUipment) and there are other bits of information to learn about, test, try. There is value in the research. Dahlen asked if the' trial had met the objectives that it was intended to meet? Heitzman stated that one objective is to learn technique for setting equipment which is constantly changing so we've met that objective, but we' are constantly increasing our knowledge base by having the installation to work with. Rosenbaum wanted to know if participation is continuing at the original level or if we've lost any from the original trial members. Heitzman responded that this has to be cash flow positive to continue operating. If at any time we do not have enough subscribers we would have to go to Council, with a decommission plan. We've lost a few but we haven't hooked anyone else up not knowing if the trial will go forward. He also stated that our annual operating expenses must be lower than our annual income. Bechtel asked Joe if staff or Council has ever received a legal written statement about the options .... Ulrich answered 'yes'. Bechtel stated the Commission has asked for that information over the last year, can it be shared with the Commission and the public so everyone can understand the legal basis of' the staff recommendation. Ulrich explained that we have been trying to embed this information into the report. The legal review is a confidential document and has been reviewed with Council as appropriate. Bechtel noticed emerging relationships on FTTH -conSUltants met with -interviewed, so on. Some people seem eager to work with us. So eager they came and pleaded on bended knees to work with us. If we held off, would CPAU talk with these people? Heitzman had deferred a lot of financial issues to Finance. He noted that many people were eager to work with us but all had strings attached. Some had actual financial rates there were pretty high and would be prohibitive. Until we see something better in reality, these are prohibitive rates. As you close one parameter you. narrow the others. Higher interest rates mean you will need higher penetrations, and have less room to lower prices. The plan becomes more risky with a higher interest rate. Saccio commented Eagle Broadband and Dynamic were eager to partner with the City. That would be a deviation from the basic business model as you'd have partners hoping to profit in the long term. We need to be serious about moving forward with the project. When you enter into those discussions, your understanding about interest rates and discounts may be different. Joe's sense was some conSUltants w.ere interested in being part of the marketing process in the community. There may be investors out there but no one could be certain and we don't know what the interest rates would be from the private section. If we wait, we may gain knowledge from other cities. C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of.Tuly 7, 2004 Page 3 of8 DRAFT E XC E R PT' Bechtel asked about continuing talking with them. Staff's recommendat'ion says halt consideration about what we've talked about to date. How could we move forward? Ulrich assured him that we would be glad to sit down and listen if a deal looked very financially viable. We believe this is what we've found ... if someone else is going to come in with a better plan it would pencil out our plan but we still think the business model is sound. We think it is prudent at this point to make our recommendation on what we've found, constraints given. If.you want to give different constraints we will be glad to take to the public. No longer able to continue taking money from the public enterprise funds. Can't keep spending more money and staff time. Dahlen stated that she expected more clarity on when we would be moving forward. What time frame are we looking at? How will we know when to open up the discussion again? Ulrich said "when we see it, we'll know it'. We are interested in seeing Truckee/Donner financing plan. We'd have a real number, see revenues, costs they have.. Something to look at. Every month APPA report says over 600 public entities that have gone into some form of telecommunications, we know it can be done but for California, all points have not come together. Dahlen questioned if there are few cities in California you want to keep monitoring? We're looking for a clear path to move forward or not move forward. Ulrich is willing to listen to any ideas the Commission has. Closure of this project is a different set of recommendations. We are trying to leave the door open, it's premature to say let's not look at it any more. If we see a viable solution, we'd be the first ones back to discuss. Heitzman says once we get a real model we'll have real numbers to put in instead of the estirna'tes we now have. Dahlen asked when will we terminate the FTTH build out? What stepping stones are involved in that process? Trial tied to city-wide build out is .still on the table. What information do we need to say we are going to terminate the city-wide build-out? . Ulrich said if we see Truckee comes out, we plug the numbers in, don't see anything better coming along, that would be the point to say enough is enough. He asked Elizabeth to explain what is the driving force she is looking for to say no? Dawes stated when we make a motion it should have open-ended clause or when to end. Dahlen questioned if DonnerfTruckee 'would be a critical decision point for us. Ulrich said it would be one of them, it's not exactly like Palo Alto so you would have to go in and put in other factors. It would be important point but not the one and only. Dawes observed investment bankers are very intelligent when filling customers needs, as Santa Clara is trying to finance a project right now for a symphony hall. Have we ever -get a DO in place, these people are willing to spend a fair amount of time -have we thought of inviting in teams or a team of investment bankers saying here's our need, find a way to fill it and come back. "We're not giving you retainer fees, we're not hiring you but we will hire if you come back with a way to accomplish this?" Saccio stated they only have been told there may be investors out there willing to finance. They probably do have access to bond councils. We'd exercise discretion in choosing bond councils. Such talks could occurin this situation. We'd use great scrutiny in looking at what would be offered. We .find figures increase as the talks go along. We have not really gone to the point that Dawes mentioned. C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of.Tuly 7, 2004 Page 4 of8 DRAFT EXCERPT Dawes thinks it is a very fertile resource to find out how to accomplish our needs by listing what our requirements are. Slide 6 says 'not been pledged only by revenues'. Is that by law? Is this illegal under Muni-finance? Saccio says it is legal but we found nothing in the official language or illusion to that in the consultant report in the early Truckee report or Alameda report. Dawes asked if we can pledge revenues and assets itself, we'll give title to it? Who ever succeeds to ownership of the assets. Value is in the eye of the beholder. We financed our municipal garages with that process. The revenues of them are no greater assurity than municipal communication system. That's his observation and belief, any other assets pledged? Saccio replied that you're pledging full faith and credit of the City. City Hall could be leased. General Fund pledging resources to pay for that. Rosenbaum -garages was funded by assessment districts. Saccio stated that assessments are the revenue stream for which we pay for the garages. Dawes recommends to staff and ASD to get creative types in to see if they rise to the bait to see if they come up with a plan we can live with. Commissioner Dawes asked for comments from the Public. Art Kraemer expressed his belief that there is no doubt services on fiber optics will be part of most homes. Palo Alto has an important piece as the City owns right of ways and can control who uses it. City can deny other power or telephone companies to compete. Comcast needs city approval to replace (assume) Palo Alto could use it's. ownership of the right of way to gain some control. Part ownership in the company, Palo Alto could follow similar model for fiber optics. For a piece of the action, some degree of control and a share of the ·profits. To invest in busin~ss to provide income to the city without gambling. He hopes we can find a reasonable way. Robert Smith stated that the staff report is very reasonable but conclusive enough. He stated that there are sigr1ificant events that foreshadow greater competition and greater complexity. Will be a different world if we wait 12 months. He is not recommending go forward or stop but if we believe in it go with it or shut it down. Tremendous competition brewing -no one quite knows what is going to happen. It will be a very different place in a year from noyv. His recommendation: do it whole hog find a way to do it or shut it down. . . Bob Moss spoke. Palo Alto should show everyone else the way. He's heard that we can't bond because 100% of the people won't be having fiber to the home. DWn't matter with the other utiiiiies. Electric utilities used bonds and it took more than 20 years before everyone had the service. That doesn't automatically disqualify us from using revenue bonds. There is a prevalence of fiber: no lack of fiber .in the right-of-ways. Fiber to the home to the final user is what we're lacking. SBC is planning on investing money but not one cent to existing homes, just new homes. Muni utilities are the only entity putting fiber to the home. The only way we'll get it is if we do it. Mr. Moss agreed that Commissioner Dawes is correct, when you borrow money you pledge the assets. They gave money back to the community, to MCMC. There is money out there to be made. The business plan kisses off VIOP. Mr. Moss predicts within 10 years it will have entire market for phone service. If we do the job right, we can finance and pay it off. Would like to see us go forward, not go back. Find a way to finance it and build it. Stanford Forte spoke. Business model are much too taunt -things will get more complex but the City can leverage complexity to their advantage. Leverage an asset, it's a good idea but if we're talking about municipal assets it's not a good idea. If the FTTH trial continues, we will have necessary time to discover specific usage goals community want's to have. Once all the goals are C:\Documents and Settings\dzichow\Deslctop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes ofJuly 7, 2004 Pagc50f8 DRAFT EXCERPT discovered they should be embedded in fhe strategy. Gain consensus that results will be understood in a way that creates immunity. He spoke of the private capital in the community. Local investor opportunities could be introduced. Private placement options are too institutionally driven. Find a way to include institutional goals. Payback scenarios should be instituted. How can additional services be incorporated into the big three. VIOP will be given away free in the next . year or two. Look at the social return on investment modeling showing real revenue gain and real opportunity loss. CPAU should not employ outside consultants. We have enough knowledge and resources to here to accomplish our goals. Looking for community goals -ubiquitous all kinds of choices that would be complimentary -wireless hot spots all over town, everyone understands the goals making it more supported. Herb Borak had two suggestions for the UAC to take to the City Council. First, recommend council release legal opinion that is the basis for staff's conclusion that you can't use revenue bonds. Council should release that report. Second suggestion is that any equity invested should be a public entity. Most states that are prohibited hire the same type saying you can be a wholesale provider. We need to do retail services to be successful. Mike Le Bright said the analysis looks very difficult so it has to look further to give the City more options if something comes in. He stated that he is not one of the trial people, but wishes he were. Allow other people that could be added, be allowed to join. He likes the concept "I'm in control," through the City, "of my own content." The benefits are not that it's cheaper but that we can get content, support and service we need City-wide. Dawes asked for a motion. Discussion was held on several revisions to the former recommendation. Dahlen was concerned that the motions were more open that what staff is asking for. She as the other Commissioners if that what they had in mind. And what is the time frame these activities should take place, what steps necessary to initiate discussions? Rosenbaum said he has no time frame in mind, if Council directs, staff will do. There is the feeling that the investment banking community has not b'een consulted with enough up to this point. There should be no time horizon in mind. Dahlen -staff will continue with efforts that they have been doing and we're not giving them any other direction other than looking at investment banking. Melton wanted clarification' of motion. Ulrich drew attention back to the staff recommendation. Halt consideration means we're not going to go out and actively pound on doors. The key word is monitor what is happening in other locations. Halt means we are not going tomorrow to actively spend money to look for people to come forward. We feel we've done enough of that. Bechtel asked to speak to comments. He expressed his concern that we have not educated the Councilor the public enough about what is going on. We have a long way to go. He strongly urged the proponents of this project to get out and talk it up ... they will have to do the work, city will not do your work, get busy! Dahlen mentioned again that the proposed motion doesn't address ending the FTIH trial. Will vote for that motion. Dawes: second part of recommendation .. ,,, Dahlen wanted a motion that the FTIH trial met objective intended for, looking to cease or slow down. Recommend ceasing operation of the trial.' C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 6 of8 DRAFT EXCERPT Melton seconded. Rosenbaum said that given the consideration of all effort put in by so many people it would be too final to just cut it off. Depending on staffs assurance that the trail is meeting expenses he said he is happy to see the trial continue for a year and would oppose any motion to end the trial. Bechtel expressed his opposition to a motion to end the trial. Dick is on track. The system has paid for itself now. It's an asset and by continuing the trial we would provide further support for any further financing that might occur. We would loose the opportunity to demonstrate it is a viable business. He thinks proponents of system need this as a demonstration of what can be done. By demonstrating with 70 homes we have, we could demonstrate benefits we haven't had before . . Ulrich intercepted with the comment that before the Commission votes, he is very surprised in any interest in shutting down since we've made the recommendation to continue and we are making more revenue. We've invested more than $600,000. If we end the trial, are you expecting we will keep this in benign neglect or go out and remove and pay· for the cost of doing that? Benefits of taking· it down verses just turning if off. John stated that he'd appreciate the opportunity to allow us to continue doing this.' . Dawes asked for a motion. Rosenbaum revised the previous UAC motion as follows: Motion: 1. Do not place advisory vote on the November ballot.· 2. Halt consideration on further action on FTTH until a viable financial option emerges. Direct staff, over the next 6 months, to seek guidance from the investment banking community about possible financing options and continue to monitor the progress of other California cities in securing financing. Motion Approved 3-2, Dahlen and Melton opposed. Bechtel moved to add the Motion: Motion: Continuing with the FTTH trial for one year with an evaluation on whether to continue the trial at that time. Seconded by Rosenbaum. Motion approved 3-2, Dahlen and Melton opposed. Dahlen asked how much it will cost to shut down the trial. Ulrich said once it is turned off decisions will need to be made regarding facilities on poles. or on ground, equipment, and cost of labor to remove. Dahlen stated that the intention of a trail is to demonstrate certain objectives, they were met. Since she was not on the Commission when this project began she asked for an explanation of what they had in mind when you started trial with end point and closure. Bechtel'was not on the Commission when Council authorized it.. Heitzman said the trial was approved by Council on November 13, 2000. Objectives are in that report. He offered to make the report available to the Commission. He sa"id it listed various objectives and to the extent we foresaw saw what we could really do , those have been met. Some of the marketing objectives were un-fulfillable. C:\Documents and Settings\dzichow\Deskiop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 7 of8 DRAFT EXCERPT Dawes was on commission. He stated the objectives were a demonstration of feasibility and customer satisfaction. Still is a project that could come to life. Absolutely very highly desirable to have continuing users who can attest to it's viability while it's cash positive and it serves as a successful endeavor if a full implementation does come to pass. Melton asked about Ulrich's earlier statement that some of our equipment used in the trail is on loan. Email from the public that indicated that under the loan arrangement we are approaching a time we had to purchase that equipment. Is that accurate? Heitzman replied that the agreement is open ended. If the company feels we are continuing to lend they can continue to lend to us. It is possible that they could pull it out in September. Or find alternative equipment. Installed for free by their technicians. It is highly unlikely they would ask us to do that at this point. C:\Documents and Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes ofJuly 7, 2004 Page 80f8