Navigating the shifting tides of the German FiberCo market

For many years, the German fiber market has experienced dynamic growth, driven by high expectations, political agenda (e.g., the government’s “Gigabitstrategie”), billions in financing at low interest rates, and an ever-increasing number of new market entrants. However, this enthusiasm has given way to a sobering reality: Despite record-setting investments in 2023, the German fiber market is currently facing a multitude of financial and operational challenges.

Economic headwinds for German FiberCos

Although the market continues to offer potential – the roll-out of Homes Passed[1] and financing rounds continue to take place – the market environment has changed fundamentally. The key challenges are: 

• Sustained high levels of inflation, leading to significant increases in material and labor costs while, plus constrained consumer spending.
• Increasing interest rates, making access to capital significantly more costly and restrictive.
• Revenue developments that are significantly behind plan, as private households opt not to reallocate their budgets for comparatively expensive fiber optic connections (“cost of living crisis”).

Additionally, FiberCos are confronted with operational challenges. For many, the fiber rollout and in particular the conversion of Homes Passed into Homes Connected[2] (and, ultimately, paying customers), is proving to be much more costly and time-consuming than often assumed in business cases. 

This is also reflected in the number of fiber connections. According to projections from the Association of Telecommunications and Value-Added Services Providers e.V. (VATM), by the end of 2023 of around 42 million households and 4 million companies in Germany, only around 16 million homes should have been passed and only 8 million should have been actually connected to the network. The share of activated connections, and thus of paying customers, is lower still, at around 4 million homes (an increase of c.800,000 homes since last year). The reasons for these dramatic facts include a lack of qualified labor, persistently high regulatory requirements during construction, and restrained demand from customers.

While households become more restricted in their spending, operators on the business side continue to struggle with a lack of qualified workers, regulatory requirements (acknowledging recent improvements, e.g., DIN 18220), and approval processes during expansion. Growing competition, aggressive rollout strategies from established companies, and (potential) overbuild all increase the pressure.

Many of the original business plans now need adjustment and company valuations based on them – which for a long time were built on the number of homes passed as a key indicator – must be tuned accordingly. We observe valuation discounts of 30% and more.

Further insolvencies and potential consolidation on the horizon

As a result of these developments, more and more fiber players are experiencing financial difficulties. The first upheavals have already been observed with the insolvencies of HeLiNet (February 2022), HelloFiber (January 2023) and Glasfaser Direkt (February 2023). In light of the increasingly challenging market, this trend is likely to continue and possibly even accelerate. Our experience from similar situations shows that companies can go from a “solid state” into financial distress in a matter of months – often to the surprise of investors and lenders.

Insights into the British fiber market, which is similar to the German market in many aspects but appears to be further advanced, underline our expectations. A wave of consolidation appears to be emerging. While some operators have already filed for insolvency, such as Broadway Partners in May 2023, others have been taken over by competitors (e.g., People's Fiber by Swish Fiber in January 2022) or by infrastructure-focused private equity players (e.g., Trooli by Vauban Infrastructure in April 2023). With targeted acquisitions of distressed companies, buyers aim to benefit from a rapid expansion of their network infrastructure at a low cost, as the actual rollout activity is avoided. However, the flip side of the coin is often a massive valuation discount on the sellers' side.

Lenders must prepare

Given the delicately balanced dynamics in the German market, lenders must be vigilant and prepare themselves. For their existing financing, lenders must be on the lookout for early warning signs, closely monitoring portfolio risks, and taking mitigating actions early on. Such measures may include:

• Periodic critical reviews and, where necessary, adjustments of portfolio companies´ business plans (e.g., every 3-6 months).
• Adjustment of key metrics for a more realistic performance evaluation (e.g., moving from Homes Passed to Homes Connected). 
• Tightening of covenant rules (e.g., equity requirements and credit limits) in line with the evolved economic situation of portfolio companies, and, if they occur, using covenant breaches to exert stronger influence to drive necessary changes.
• Assessment of strategic options regarding further investments, exits, or consolidation scenarios, etc.

In the case of new financings, lenders are recommended to further enhance the quality of their due diligence to ensure the feasibility of business plans and safeguard the corresponding operational capabilities of target companies. This is key to warrant that the financed portfolio companies will be on the winning side of the impending wave of market consolidation.

_{[1] The KPI Homes Passed refers to the number of premises that could potentially be connected to the fiber infrastructure. This also includes premises that are not connected to the fiber network but are within range (e.g., if fiber lines are only installed along the street but are not connected to the premises)}

_{[2] The KPI Homes Connected refers to the number of premises that are actually technically connected to the fiber network. The KPI however does not correspond with actually paying customers.}