When the idea of municipally-owned state-of-the-art fiber-optic networks -- UTOPIA and iProvo -- was first pitched to Utah cities and residents about six years ago, it created a hailstorm of debate.

Critics however argued that governments, whom they perceive as lacking industry expertise, shouldn't be dabbling in the high-risk telecommunications market, or even worse, gambling with Utah's tax revenues.

But fiber-to-the-home advocates won the first round, as elected bodies were wowed by impressive projections of Utah's market potential and the lure of economic opportunity.

In 2003, when an 18-city consortium began organizing UTOPIA's build-out, the $400 million network was glowingly seen as serving nearly 249,000 residences and 34,580 businesses. Eventually, the projections were cut roughly in half. Eleven cities in Utah, including Orem, Lindon and Payson, committed to the bonds, pledging $202 million in sales tax revenues over 20 years to pay them back.

Now, unexpectedly low subscriber counts and revenue shortfalls are threatening UTOPIA's ability to continue to make its bond payments. Tax revenues haven't been tapped yet, but if UTOPIA fails, the 11 cities could be on the hook for up to the full $202 million, the Utah Taxpayers Association warns.

To avoid that, UTOPIA wants to refinance. It is asking the cities this week to increase their sales tax pledges and extend their guarantees to 33 years.

The question facing city councils this week is whether UTOPIA's track record gives them enough confidence of future success to commit taxpayers for three decades.

UTOPIA had projected it would bring fiber connections to as many as 70,000 households and businesses in its six member cities, and achieve a subscription rate of around 40 percent by 2008. To date, it has passed fiber connections to about 42,000 households and businesses, with only about 7,200 paying customers. On top of weak customer response, the network's construction costs are above what it had projected.

In iProvo's case, Provo officials had projected that 75 percent of customers would sign up for its top-end "triple-play" -- meaning TV, telephone and Internet services in a single package. They also expected the network, which was built on $39.5 million in sales-tax revenue bonds, to break even when it reached 10,000 subscribers.

Instead, the iProvo triple-play take rate was closer to 17 percent, not 75. And while the network passed the 10,000 subscriber mark late last year, city officials now say they may need as many as 15,000 subscribers to break even because of revenue shortfalls.

Now the city's fiber-optic network is $10 million in the hole, and critics are calling for the struggling venture to be sold.

Fish or cut bait?

Both Provo officials and UTOPIA city councils are faced with a difficult decision this week. Do they continue to extend themselves further or cut bait and run?

Royce Van Tassell, vice president of the Utah Taxpayers Association, believes the cities should cut their losses now rather than take a bigger hit down the road.

"Even if they get their refinancing now, they're just deferring the day of reckoning by another few years and with a higher bill, unless they turn the situation around," he said.

But iProvo and UTOPIA officials are loath to consider the possibility of selling their networks.

Today, Provo officials will be discussing ways to stanch the flow of iProvo's red ink. Possible solutions include having the city pay full freight for its own use of the system, bringing on additional service providers and improving its marketing plan. It may also mean higher power bills for Provo residents, Provo Councilman George Stewart warns. Because of a slower economy and declining city revenues, the city may not now have the money to pay the going rate for the iProvo services it uses.

On Tuesday, several city councils in the 11 UTOPIA member communities will cast their votes on whether they should pony up more sales tax revenues and extend their guarantees to 33 years. Orem, Lindon, Payson, Centerville, West Valley, Tremonton and Midvale will vote on Tuesday, while Perry, Brigham City and Layton will cast their votes on Thursday. Murray's city council will make its decision on April 28.

"The refinancing is meant to get us to a point where we don't have to call on the pledges," said Paul Recanzone, UTOPIA's project manager. "We're only asking to extend the risk period even though it seems like we're asking for more money."

One Payson city official voiced the dilemma that all the UTOPIA cities now face:

"If Payson votes in favor of increasing the tax pledge, we'll be paying more for longer. And if UTOPIA's financing is down again, when will it back asking for more money?" asked Brad Daley, a member of the Payson city council. "Payson is a small player. But if it votes against increasing the tax pledge, and enough cities do so likewise, then the odds are greater that UTOPIA will fail."

Steven Titch, a policy analyst with Los Angeles-based Reason Foundation, believes cities should be looking to liquidate iProvo and UTOPIA's assets while there's still "a degree of value."

"Of the two, iProvo has more value because it is smaller, localized and there's potential for a company that really wants to finish the job and use them as a springboard for growth. UTOPIA is a tougher sell even though it's larger because it has deeper problems in terms of having to develop a market for the network. It does however, reach into a number of communities. But it will require a large investment to be resuscitated," Titch said.

Recanzone disagreed: "Even if we don't get the cities' refinancing approval, we still have other options before it turns into an asset sale. UTOPIA's board is made up of council members and employees of the member cities who believe in the principles of the project. If our assets are sold to a private company, UTOPIA will become just another monopoly network."

What went wrong?

From the beginning, UTOPIA and iProvo either chose, or were saddled with, a business model that has proved least successful in fiber rollouts, analysts say.

In 2001, the state Legislature passed the Utah Municipal Cable Television and Public Telecommunications Services Act, which allows cities to construct telecommunication infrastructure but not become the retail service provider for those systems. Instead, they have to use a wholesale model in which they build the digital pipe and then lease the lines to retail service providers such as Mstar.

That leads to underselling of the system and friction between the municipality, which needs to see a return on its multi-million dollar investment, and the service providers, which haven't risked as much, says Michael Render, president of RVA, a market research company that focuses on private and public fiber systems.

"They don't have skin in the game," he said. "The more difficult ones have been the wholesale systems such as iProvo and UTOPIA."

A consultant's report released last week found examples of that in iProvo.

"I found a lot of problems in the relationship between the two parties. Almost universally the telcom employees dislike or distrust the retailers, and this is then manifested in the working relationship between the two parties," wrote Doug Dawson of CCG Consulting. He said that Provo's contracts needed to be renegotiated to clearly delineate each party's tasks and responsibilities.

Critics gloat

Critics say that the problems now facing both of the networks only prove that cities shouldn't have used taxpayers dollars to fund what Qwest officials now call "flawed" business plans. Van Tassell agreed. "It's not the taxpayers' job to subsidize businesses using UTOPIA or iProvo," he said.

Plenty of people think that infrastructure should be provided exclusively by private enterprise, including Jerry Fenn, president of Qwest, which is currently in fierce competition with Comcast for electronic hearts and households.

"Qwest's strategy is to build where we think we have market share and the revenue to generate payback," said Fenn. "And we have a more cost-effective way to deliver what the market demands."

Qwest will soon unveil a $300 million company-wide initiative to upgrade its broadband speeds by bringing fiber-optic lines as close to homes and businesses as possible, including more than 200,000 in Utah by the end of the year. The company, which is spending a significant chunk of its investment in Utah, has not announced where the new service will be available.

They call it "fiber-to-the-node" technology, which means high-speed fiber-optic cables to junction boxes near neighborhoods and businesses. Unlike fiber-to-the-home networks that bring fiber-optics all the way, copper wire under the Qwest model would connect to a home. But because the distances of copper would be shorter, copper-wire performance would improve.

Fenn said this approach will provide customers with Internet speeds of up to 20 megabytes per second, and eventually 40 Mb/s.

"We will be using our existing copper-wire infrastructure to connect fiber-optic lines from the neighborhood node to the individual homes and businesses, and the speeds will vary depending on the distance the home or business is from the node," Fenn said. "Our fiber-copper hybrid is less capital-intensive than fiber-to-the-home networks because we're using existing copper wire in the ground. That way we avoid charging our customers the connection fee to bring fiber-to-the-home."

UTOPIA's Recanzone downplayed Qwest's concept as "additional competition but not compelling competition."

"UTOPIA's strength is its ability to close that last mile to the home entirely with fiber-optics. That gives you up to 100 Mb/s. Plus we offer multiple service providers. Qwest, on the other hand, will have a shared neighborhood loop that will never be able to provide the bandwidth that UTOPIA provides."

Bad estimates?

Critics say that city-run network operators have grossly underestimated competition from the incumbent telecoms, as well as the marketing resources they need to establish their brand and build their customer base. They flat-out missed the boat on the financial resources it takes to build their networks, they say.

But there's always an answer -- or what to some seems like an excuse.

"We couldn't meet our take rate projections because of a lack of business customers. We had expected a take rate of 17 percent in the business community, but in reality it was only 2 to 3 percent," Recanzone said. "The average revenue per business user is 10 times that of a residential user, because they tend to buy a higher class and quality of service, and better customer service guarantees."

Going in with an optimistic projection of 70,000 households and businesses served by a fiber-optic network, and a hoped for 40 percent subscription rate, the low returns were discouraging.

UTOPIA blames an unexpected 18-month delay in securing a $67 million loan from the U.S. Department of Agriculture's Rural Utilities Services. That delay brought building and marketing to a halt for several months, and the service providers couldn't connect as many new customers because many of the areas weren't built yet.

More discouraging, when the federal loan was finally approved in July 2006, it was for only $21.3 million instead of $67 million. The agency rejected the rest reportedly because UTOPIA wasn't meeting its projections.

Complicating matters, lower-than-expected subscriber counts and subsequent revenue shortfalls are now threatening UTOPIA's ability to continue to make payments on $115 million in bond financing from Bank of America. An ongoing cash crunch means it may not make a monthly payment that's due on June 2, for example -- and if UTOPIA defaults, bond investors may call to redeem the bonds.

To avoid that, UTOPIA is now asking for the cities to increase their tax pledges so it can obtain $189 million in new bonds to retire $135 million in existing debt with Bank of America and the federal government. The term of the new debt will also extend the cities' risk from the current 20 years to 33 years.

"We're proposing that the cities raise their annual tax pledges by about 15 percent in the first year, and by a subsequent 1 to 2 percent increase each year for 33 years," said Kirt Sudweeks, UTOPIA's chief financial officer. "The remaining $54 million will go off to pay two years of capitalized interest on the $189 million loan, pay off our vendors and continue the build-out of the network."

KeyBank will provide the $189 million in bond financing if all 11 cities agree to increase their tax pledges. If UTOPIA doesn't get the support of 11 cities, it may have to ask for less money from KeyBank, Sudweeks said.

"If any city drops out, the amount that Utopia can legally bond will have to be removed from the refinancing. That puts UTOPIA in a very difficult situation," Recanzone said.

"We don't know how many cities have to drop out before we have to call on the pledges. We haven't done those numbers," he said. "But even if we don't get the cities' support, we have other options including rearranging payments with the creditors. UTOPIA owes $11 million to the lead contractor and engineering firms. But the contractors have held off on collecting payment so far."

And there may be a silver lining -- for the first two years of the restructured bonds, bond investors can't call on the bonds. That means UTOPIA has another two years to turn itself around.

The service challenge

Compounding iProvo's financial problems has been the struggles of its service providers. The first provider, HomeNet went bankrupt and current providers Mstar and Nuvont have reportedly been unable to keep up with their payments to the city.

On the UTOPIA side, officials say, network sales were hurt by insufficient marketing by its service providers and issues with pricing and product availability.

"Veracity and XMission, two of UTOPIA's service providers, have very strong business products. But the door-knocking campaign by Veracity doesn't really work. XMission's word of mouth marketing campaign gives them very steady but slow growth. Mstar recently implemented some good business products, but their services were almost entirely residential in the beginning," Recanzone said.

"Mstar, Nuvont and Veracity are the same providers that iProvo has, which is why they are having the same problems UTOPIA is having with a lack of business customers," he said.

But Mstar executive Kirk Tanner countered, citing a lack of control over the types of products it can sell to compete effectively.

"We don't have the flexibility to develop products for different market segments. That's why we don't focus on a lot of businesses. We don't have control to slice up the pie and be competitive," he said. "The networks are owned by UTOPIA and iProvo, so they determine the types of products we can sell and they set the wholesale price for us to lease the networks."

Size and cost matter too, he said.

"The larger the business customer, the easier it is to sell them our product. The problem is most of our business customers are small and their cash flow is tight. If they have to pay $80 for our product, and also pay between $300 and $10,000 to install fiber to the business, they can't," Tanner said.

"We would love to sell something that can compete with dial-up connections, which typically cost between $9.95 and $15," he said. "Right now, we have a 15 Mb/s product that costs $40 on iProvo and UTOPIA, and we also offer speeds of 30 Mb/s, and 50 Mb/s on UTOPIA. We've talked about doing a 2 to 5 Mb/s product so we can sell at a lower price point. But the cities say they can't do it at that price point to justify the installation and hardware costs of delivering fiber-to-the-home."

Unlike an incumbent like Comcast that owns its own network infrastructure and is also a retail provider, Tanner said the UTOPIA and iProvo service providers haven't got the flexibility to "take on losses associated with doing promotions."

Tanner also alluded to a mismatch between the price point of Utopia's product offering and the income demographics within the six cities where services have begun.

"There are lots of areas that desperately want the service but it hasn't been built out yet. And in areas that have been built out, like West Valley, the household incomes are lower, making it harder for them to buy the service," Tanner said. "Some parts of Lindon saw take rates as high as 40 percent because household incomes were substantially higher."

New marketing plans

Recanzone said UTOPIA is now planning to create a business-class product that would give dial-up services a run for their money, and is working on adding more service providers to the network by year-end.

UTOPIA is looking to develop a channel marketing program to distribute its services as part of a suite of products to businesses. "Channel partners can help multiply your sales force, and this model is used by lots of businesses to procure their telecommunications needs. For instance, XMission sells phone service but not voice switches. If you subscribe to XMission's phone service, how do you break it up so it's available to multiple workers within the company? That's where a channel partner comes in."

On the residential side, not only is Mstar not getting enough high-revenue "triple-play" customers, it also faces competition for those customers from Comcast and satellite television providers, Dish Network and DirecTV.

"We have a lot of apartment unit customers on iProvo, and most of them don't subscribe to triple-play services," Tanner said. "And when Comcast comes out with a promotion where you can get triple-play for $65, we can't compete. After factoring in charges to access the network and hardware costs, our margins aren't big enough for us to drop prices that low. And so our customers will cancel our service to switch over to Comcast."

Co-op membership fee

To continue funding its build-out, UTOPIA hopes that many of its existing 7,200 customers will agree to pay a one-time fee -- a cooperative membership fee -- that has been estimated at between $1,100 and $3,500. To sweeten the deal, UTOPIA officials say the proposed fee, which goes to paying the costs of installing fiber to the home, will result in lower monthly rates for the customers.

Currently, the cost of connecting fiber-optics from the street to the home is being absorbed by UTOPIA.

"If subscribers pay the membership fee, they are creating revenues for the building of the next neighborhood," Recanzone said. "The initial model was 'build it and they will come.' The new model is to let the market tell you where the demand is before building out."

"You have to understand the services, pricing and value of the connection before you balk at the installation fee," said Jim Reams, interim executive director. "The data link and the high bandwidth is the real value to the network. We can drive revenues through niche services like real-time application hosting and security monitoring with high bandwidth speeds. In other words, we can create new business models for companies."

Recanzone agreed. "If you run a small business with three employees. It's unrealistic to get a Microsoft exchange server for your staff's computer needs. Fiber-to-the-home also means we can explore offering tele-medicine services. That's where nurses can do online video conferencing with a patient, and say, remotely take the blood pressure of the patient. That extends people's ability to stay in their homes instead of living in a nursing home," he said.

But Payson council member Kim Hancock worries that the high installation fee -- an average of $2,300 -- will take a toll on UTOPIA's fledgling take rates.

"One of the chokers is the amount of the installation fee. Can Payson supply the connection, install fiber to the home in lieu of part of the tax pledge increase?" he asked. "If Payson can do that, and help reduce the installation fee, that could help UTOPIA increase its take rate."

Mstar's Tanner doesn't expect the two fiber-optic networks to die out.

"You can spend more now and build the network and eventually have it pay for itself. Or you can let the networks fail and the taxpayers have to pay for it anyway. To me, it would be better to spend what you have to to get it built," he said. "Should it be a private-public venture or privatized is a debate that will go on forever, but fiber-to-the-home is ultimately an indispensable service that all residents will have access to, whether it's provided by UTOPIA, iProvo or the incumbent telecoms."