Loading...
HomeMy WebLinkAbout2004-07-19 City Council (10)City of Palo Alto C ty Manager’s Report TO:HONORABLE CITY COUNCIL 1 FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE SERVICES/UTILITIES DATE:JULY 19, 2004 CMR: 360:04 SUBJECT:UTILITIES ADVISORY COMMISSION RECOMMENDATION REGARDING FIBER TO THE HOME FINANCING OPTIONS RECOMMENDATION The Utilities Advisory Commission (3-2) recommends that the City Council: 1. Not place an advisory vote on the November ballot. Halt consideration of 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. 3.Continue with the FTTH trial for one year with an evaluation on whether to continue the trial at that time. Staff recolnmends: Halt consideration of the financing options discussed to date and, instead, monitor the financing methods and results of other California jurisdictions until such time as a viable financing option emerges. 2.Continue the FTTH trial for one year with an evaluation on whether to continue the trial at that time. COMMITTEE REVIEW AND RECOMMENDATIONS After providing a brief summary of the report (Attachment A) that answered questions from the May 5 Commission meeting, Commission questions and discussion focused on the rationale for continuing the FTTH trial and on additional investigation of FTTH financial options. Several Comlnissioners questioned the need for cominuing the trial CMR:360:04 ,Page 1 of 3 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 firms 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 staff’s recommendation is that the UAC recommended not proceeding with an advisory vote (staff had no recommendation 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 with 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. Moreover, 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 of 3 ATTACHMENTS Attachment A: July 7, 2004 UAC Memoranduln "Fiber to the Home" Attachment B: Minutes from July 7, 2004 UAC Meeting PREPARED BY: JOS ~ Director, Administrative Services DEPARTMENT HEAD APPROVAL: CARL YEAT Director, DEPARTMENT HEAD APPROVAL: ;ctor, Utilities CITY MANAGER APPROVAL: g HARRISON Assistant City Manager CMR:360:04 ,Page 3 of 3 ATTACHMENT A MEMORANDUM TO:UTILITIES ADVISORY COMMISSIO N FROM:UTILITIES DEPARTM ENT SUB]ECT: FIBERTO THE HOME DATE:3ULY 7, :2004 REQUEST Staff requests that the UAC review the staff recommendation below on Fiber to the Home and provide advice for Council consideration on July 19, 2004. Staff recommends" Halt consideration of the financing options discussed to date and, instead, monitor the financing methods and results of other California jurisdictions until such time as a viable financing option emerges Contimdng with the FTTH triat for one year with an evaluation on whether to continue the trial at that tilne. BACKGROUND On April 19, 2004, staff presented Fiber to the Hon-~e (FTTH) financing options to the City Council. After discussion, Council refen’ed the issue to the Utilities Advisory Colnmission (UAC) for its review and recommendations. On May 5, 2004, staff discussed potential financing vehicles with the UAC as well as a new alternative, property related fees. These options are summarized in Attachment 1. During the Council and UAC meetings, staff explained that significant legal issues surrounded and prevented use of Option A, a Utility Revenue Bond backed primarily by FTTH revenues mad secondarily by the Electric Fund, 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 property owner approval (Option E); and property related fees requiring simple majority property owner approval (Option F). In addition to indicating support for the FTTH program, a favorable, vote for a 11ew credit or revenue source other than FTTH net revenues would 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 Participation (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 certificates 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 improvelnelats and as financial conditions permitted. 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 alternative financing which may be based on utility related uses and furthermore research potential partnerships." 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 Participation" which will be placed with private investors. Staff has interpreted Option C to reflect this approach as opposed to relying on General Fund assets. The UAC recommended lq_~m~ing such a scenario through the FTTH business model to analyze its viability. In addition, Commissioners were interested in financing rnethods used by other public jurisdictions inside and ou{side of California to fund FTTH enterprises. ’ DISCUSSION Staff believes that after extensive internal and extemat 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 to pay more than the UAC 07/07/04 Fiber to the Home Page 2 of 11 someone not benefiting from an FTTH system be held accountable for its financial risks. This logic was indirectly endorsed by the UAC when it rejected pursuing an assessment or property related fee (which would require a vote) by which property owners might have to pay for a system they might not use. As mentioned at the Council and UAC meetings, FTTH proga’ams are a relatively new service for municipalities. Staff has discovered that there is no "coolde-cutter" formula for financing FTTH activities. Local jurisdictions, both in California and in other states, are struggling to find viable financing options to fund capital and start-up operating expenses. In addition to the legal and political considerations local jurisdictions face in most financings, investor and rating agency unfamiliarity with public FTTH projects injects considerable uncertainty and risk/reward considerations into the financing process. Whereas the typical route for Palo Alto in finding capital funds is to competitively sell bonds in the market based on tested revenue streams and solid collateral, in this case Palo Alto is forced to consider alternative funding strategies such as a private placement (whereby funds are raised from a private investor(s)), or a mixed financing approach using private placement and equity investment. One consulting firm working with a California city has opined to staff, "traditional municipal bond financing creates considerable challenges for municipalities/utilities and unnecessarily burdens residents/rate payers." This finn advocates the use of private financing in the early stages of an FTTH program. It appears that California jurisdictions are gravitating toward this model. At least three California jurisdictions (Alameda, Trnckee, and a city in Soutllern California) have looked to the private sector for capital. It is perhaps no accident given California law, the financial condition of jurisdictions, the resistance of voters to new taxes, and the newness of FTTH that jurisdictions are looking to the private sector. On the other hand, recent efforts to procure private financing, such as that in Truckee, have not been finalized. Moreover, private financings are expensive, with investors expecting (based on information gleaned from other cities and their consultants) returns of between 7 and 15 percent. The following summarizes salient information on jurisdictions pursuing FTTH financing: Truckee-Donner Public Utility District Community lacks a major provider of broadband services such as Inten2et and video and does not have an FTTH system. Preliminarily identified $24-25 million in financing needs of which approximately $14-18 million is identified for. operating and capital needs. Remaining $8-10 million is for capitalized interest, investor discount, repaying an internal loan, and issuance costs. Use of COPs for operating costs in Palo Alto would require bond counsel review. 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 selwices. Community exploring use of Revenue Certificates of Participation backed wholly by the revenues of the FTTH system. This is not an asset-backed COP at this time. 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. Consultants working on Truckee project are Aggregate Networks (Financial Advisor) and Eagle Broadband (Service Provider). Alameda Power and Telecom *Alameda apparently has the longest and most complex history in financing a fiber/coaxial system in California. After buying the assets of a small, private telecommunications company, it has gone through three financings (2000, 2002 and 2004) with a fourth plalmed in 2009. These financings were supplemented by $12.2 million in advances from available utility reselwes and by the City’s Redevelopmem Agency. Alameda has ~.~sed private financing to fund consn~ction of its hybrid system tln’ough Certificates of Participation issued in 2000 and 2002 and in its 2004 Bond Anticipation Notes (BAN). 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. e Using loans with capitalized interest may be useful on a one-time basis to jump- start 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, long-term bonds to finance the capitalized interest and other costs incurred in the 2004 financing. Lompoc Electric Utility Lompoc’s telecommunications program has two phases: the first is to build broadcasting antennas for a wireless system and the second is to build an FTTH system. ¯Preliminary plans are to build a $25-26 million fiber system. ¯Lompoc has not had an opportunity to investigate the legal and financial relationship between its utilities and proposed fiber enterprise. It has not determined 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 While Lompoc will investigate its financing options, the initial idea is to undertake a traditional negotiated financing whereby an undm~vriter will be hired to sell Utility Revenue Bonds to investors. Utopia Network, Utah Funding is being provided by a 10 toll city consortimn 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. A construction loan from a bank is expected and, to mitigate risk, loans wilt be mad’e 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 project. Half of the consortium’s cities will be built out and evaluated before the next stage. Tln’ee to four small, additional cities have expressed interest in being part of consortium in furore. In pal~, as a result of Comcast’s and Qwest’s efforts to prevent municipal involvement in providing broadband smwices, the Utah legislature has established requirements for cities to provide FTTH retail selwices. Utopia has chosen to be a wholesale operation with the goal ’of promoting retail competition. AT&T is the anchor tenant at this time. Consulting fi1"111, 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 Telecommunications/FTTH operation is part of City’sutility operation; FTTH was piggybacked on 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. Provo chose traditional municipal financing methods and did not utilize the private financing option. This decision was made in order 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 support. Provo has signed a small, full-smwice provider for its network. Uptown Smwices developed its business model. Tacoma, Washington Initial Tacoma system included fiber backbone between electric utility facilities; a Supervisory Control and Data Acquisition (SCADA) system; and a broadband colrmmnication network between city offices, educational facilities and other public sites. Initial estimate for build-out was approximately $60 million and was funded by utility revenues. 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 all additional $36 million in funding. The above information sheds light on a number of issues the City of Palo Alto is facing. It clarifies that FTTH 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 FTTH. enterprises that witl seek higher returns to cover its potentially higher-risk investments. The Utah enterprises have pledged existing revelme sources to enhance credit for FTTH 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 an investor as of this writing. Preliminary financing information from Truckee indicates steep financing costs to implement a deal. Alameda’s experience, particularly with its 2004 financing, also reveals significant financing costs. It is important to note that Aiameda and Tlvckee have pledged or proposed pledging only project net revenues. As far as staff can determine froln discussions and public docmnents, assets of the system have not been pledged toward debt obligations. As UAC members and residents have indicated, once the FTTH system has been built and a sustaining customer base has been established, there may be value for investors to seek in the case of default. This value, however, will be dependent on the mmaber of customers Palo Alto attracts, the desire of a firm to compete with other inculnbent prov!ders, and market conditions at the time Of a possible asset sale. According to Provo’s Telecomniunications Manager, inculnbent providers such as Comcast and Qwest, with significant investments in their existing assets located within a proposed public FTTH se~wice area, were active in opposing public FTTH ente~prises. Comcast, for example, was influential m passing legislation in Utah that created numerous hurdles for public entities to deliver telecommunication services. It is instructive that in a more rural community such as Truckee there appears to be no concerted opposition. Provo’s experience is more indicative of expected incumbent opposition to the proposed FTTH system in cities such as Palo Alto. UAC 07/07/04 Fiber to the Home Page 6 of 11 As stated, without 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 variations of other key variables in the business model are explored in staff’s 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 its preliminary 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 Varyin~ Assumptions The UAC raised the question of runlaing several interest rate scenarios through the current business model to determine potential financial outcomes. Staff also has spoken ¯ with a nmnber 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 term sheets or negotiates a deal, interest costs are speculative. The City’s financial advisor and staff have run several private placement scenarios through the current FTTH model. The scenarios, which vary the penetration rate assmned in the model as well as the long-term bond rate, assume a private investors will invest in the form of a tkree-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 particular attention to the ability of the project to generate sufficient net revem~es to cover debt obligations. An investor will also look at the mode!’s assumption on penetration rates and may choose to adopt a more conservative approach. Hence, this analysis focuses on what borrowing levels the City can expect based on variations in interest and penetration rates. Whereas the FTTH project requires $32 million in capital f~mds, the use of a BAN, which capitalizes interest and rewards a private investor with a higher rate of return, significantly lowers the proceeds for the project. As shown in Scenm’io 1 below, a 7.5 percent BAN rate and a 6 percent long-term 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 well. It is important UAC 07/07/04 Fiber to the Home Page 7 of 11 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 current market plus 100-200 basis points. Given the above information, financial scenarios are presented as follows: Scenario 1: Penetration rates are achieved at 100% of Uptown’s base model projeetions." Assuming 6.0% long-term 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 model projections: Assuming 6.0% long-term bond rate, $15.0 million could be secured for the project. Assuming 7.0% long-term bond rate, $13.5 million could be secured for the project. Scenario 3: Penetration rates at 60% of Uptown ’s projections: 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 frominvestor(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 FTTH project. Additionally, the City has yet to identify an appropriate source of funding for the approximately $8 million needed for start-up operating costs. By running the expected costs of a private placement financing through the FTTH business model and liolding penetration rates in the current model constant (Scenario 1), staff concludes that there are not sufficient financial resources to move forward with the FTTH project. Emer~in~ Relationships on FTTH Since meetings with Council and the UAC on FTTH, staff has contacted jurisdictions pursuing FTTH projects as well as consultants helping with their business models, financing, product development, and operations. Staff has found considerable variation in the expertise, kmowledge, 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 expertise while others want to pursue long-term relationships with revemte 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 current business model if the City should choose not to run the system internally. One consultant indicated that some corporations providing telephony or broadband services might be interested in partnering with Palo Alto. All of these consultants are eager to establish a relationship with the City of Palo Alto. A brief description of the expertise the consultants provide and the role they played in FTTH efforts may be helpful. Aggregate Networks (AN) is se,wing a key role in developing Truckee- Donner’s business plan and fomaulating a still tentative financing proposal. AN has introduced an interested investor to Truckee, but .the deal has not been finalized. AN is a small firm, somewhat similar to Uptown, and compares municipal FTTH projects fo start-up firms requiring private financing. AN does not appear to be interested in a revenue sharing parta~ership or providing management for the FTTH system. Eagle Broadband (EB) is the full service provider for Truckee’s FTTH project. At Truckee’s request, EB has played a secondary role in the overall financing effort, given Aggregate Networks support. EB, however, indicated to staff that it has financing expertise as well as access to potential investors. EB is also a relatively small finn, eager to develop a market -for its product and services. It indicated that it is close to closing a deal with a Southern California city (not identified) where it has acted as a facilitator for financing as well as becoming the service provider. Naturally, the price of Eagle’s ~ssistance is that it be peranitted to sell its se~ices on the system. In the case of T~qackee, EB is seeking assurance that it will be the wholesaler of video, phone, Internet and security services on the Truckee system. Dynamic Cities (DC) offers consultant and project management services to institutions interested in the broadband business. It has staff experienced in business case development, partner development, construction management and arrangement of financing. Currently, DC is responsible for, project management of the Utopia project in Utah (includes Salt Lake City). This involves development of the business case, procurement of equipment, negotiation of partnerships (including landing AT&T as the anchor tenant on the system). It is interested 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 Fiber to the Home Page 9 of 11 City of Palo Alto Utilities Usage of FTTH Finally, staff has investigated the ability of its 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 current 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 frona 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 lnanagemel~t, for example, is dependent on forecasts of future demand costs. Current forecasts indicate that a marginal amount of savings can be associated with load conta’ol~ Time-of-use rates will not increase existing revenne streams, but will allow a lnore equitable distribution of costs of expensive power to those who use it. Real time monitoring could provide better dispatch practices during regional emergencies and better allocate resom’ces 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 electa~icity through a FTTH system is currently 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 departments of the City, staff’s best estimate at this time is that FTTH would not provide more than $500,000 per year of value to the Utility. These savings would not be realized until the tenth year in the model and assumes a full implementation of automatic metering through 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 reaffirms 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 co~.npetition froln the private sector; technological changes; financing sources and obligations in the event of default; the City’s and community’s appetite for risk talcing; public se~wice priorities in a challenging economic environment; 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 art technology, developing a citywide information and telecommunications networks the potential for new revenues, and other public benefits. UAC 07/07/04 Fiber to the Home Page 10 of 11 From staff’s perspective, the jurisdic}ions of Alameda and Truckee, along with their advisors, are experimenting in what could be described as a highly.fluid environment. Staff is not aware of any California jurisdiction that has demonstrated it can develop and sustain a successful hybrid or fiber system that is financially viable over the long tel~n. While there is considerable zeal to pursue FTTH as an alternative to the of smwice gaps of incumbent providers, there is an underlying realization on the part of staff and outside consultants that public FTTH efforts represent a venture into uncharted territory. The City of Palo Alto traditionally has been a "pay-as-you-go" community with a risk- and debt-averse financing philosophy. A private placement, .with an eventual "buy-out" using traditional revenue bonds, represents a significant departure from this philosophy. It is a depam~re because of the higher interest rates associated with such a placement and the pressure those rates and subsequent boIrowing would place upon the success of the project. Moreover, the use of a private placement or Bond Anticipation Notes as discussed in Scenario 1 above only funds approximately two-thirds of capital project needs. Additional capital and operating start-up funding would still be required. Based on information gathered from other cities, discussions with advisors on financing options, and legal opinions, staff has not found a viable financing option for FTTH that is consistent with the tenor of past financing practice and is one in which staff has substantial confidence. ATTACHMENT: Fiber to the Home Financing Options PREPARED BY:Joe Saccio, Deputy Director-of Administrative Services Blake Heitzman, Manager of Telecolnnmnications Karl Van Orsdol, Risk Manager " Nancy Nagel, Senior Financial Analyst REVIEWED BY: Carl Yeats, Director Services APPROVED BY: D,rect~6r of Utilities / UAC 07/07/04 Fiber to the Home Page 11 of 11 "1- ATTACHMENT B DRAFT EXC ER PT UTILITIES ADVISORY COMMISSION MEETING MINUTES July 7, 2004 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 I]’.ORAL COMMUNICATIONS None APPROVAL OF MINUTES Motion" Commissioner 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. AGENDA REVIEW AND REVISIONS No changes to agenda. 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 ~s aboul 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 1s’. Execution of Council approval of energy block purchases. As of June 30m, 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 for past services. We will be paying about $700,000 a month next 12 month period We wi be depositing money into an escrow account and will be parceledout 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 plan. C:\Documents mad Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 1 of 8 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. UNFINISHED BUSINESS None. vzzz. NEW BUSINESS UAC Elections IVlotion: 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. 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 fora 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. FTTH Financing in other jurisdictions - number Qf municipal jurisdictions have implemented or are currently implementing FFIH 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 financing. 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 FTTH 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 of 8 D RA F T E X CE R P T 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 financial. What 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 Ibe 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 asl<ed 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 were interested in being part of the marketing process in the community. There may be investors out there but no one could be certain and w.e 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 July 7, 2004 Page 3 of 8 DRAFT EXCERPT Bechtel asked about continuing talking with them. Staff’s recommendation 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 estimates 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 Donner/Truckee 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 occur in 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 July 7, 2004 Page 4 of 8 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 on{y by revenues’. Is that by law? Is this illegal under Muni-fina~ ce? 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 eased. 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 p~ece 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.business 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 significant 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 now. His recommendation : do it whole hog find a way to do it or shut it down. Bob Moss spoke. Palo Altd should show everyone else the way. He’s heard that we can’t bond becaase 100% Of the people won’t be having fiber to the home. Didn’t matter with the other utilities. 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 uti!ities 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 VlOP. 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 F-I-IH trial continues, we will have necessary time to discover specific usage goals community wants to have. Once all the goals .are C:\Documents mad Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 5 of 8 DR A F T E X C E RP T discovered they should be embedded in the 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 option.s 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 ’Tm 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 severa 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 been 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 Council or 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 FTTH trial.Wil vote for that motion Dawes: second part of recommendation ..... Dahlen wanted a motion that the FTTH trial met objective intended for, looking to cease or slow down. Recommend ceasing operation of the trial. C:\Documents mad Settings\dzichow\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 6 of 8 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 staff’s 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: Do not place advisory vote on the November ballot. 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 thetrial. 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 said 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\Desktop\UAC Draft Minutes FTTH Excerpt 070704.doc Draft UAC Minutes of July 7, 2004 Page 7 of 8 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 ca~ 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 Utrich’s earlier statement that some of our equipment used i~ 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, s 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 of July 7, 2004 Page 8 of 8