Stephen Bartholomeusz
The NBN number crunch
Now that the board of the new National Broadband Network company, NBN Co, has been assembled, the moment of truth is nearing. There is little prospect that NBN Co can be financially sustainable on a standalone basis, which means the original concept of a giant public/private partnership will founder without massive and ongoing government subsidies.
The telecommunications team at Goldman Sachs JB Were has just released a major (92-page) report on the NBN. They estimate it will cost $37 billion to build – $41 billion if Telstra isn’t prepared to sell the ducts, pits and pipe that constitute the most strategic element of its ‘last mile’ network to NBN at a 33 per cent discount to the analysts’ $12 billion valuation – but be worth negative $9 billion in net present value terms.
As they conclude, ‘’it is difficult to see the market ascribing any value to an equity investment in a company such as this.’’
On their forecasts NBN Co won’t be free cash flow positive until 2025.
They argue that Telstra will be prepared to sell its passive infrastructure to NBN Co for $8 billion – a $4 billion discount to its assessed value – to demonstrate that it is a good corporate citizen (and presumably to try to avoid regulatory punishment for non-cooperation).
Telstra would also significantly reduce its maintenance capital expenditures and selling its assets to NBN Co would avert the threat that the NBN would ’go aerial’ and, in the longer term, leave Telstra’s existing network intact but eventually obsolete.
However, the Goldman analysts don’t believe Telstra will accept equity in NBN Co as consideration, given their view of its equity value. They believe it will be politically unpalatable for the government to pay cash for the assets, saying the most likely outcome was a mixture of cash, the transfer of some Telstra debt, and some kind of annuity stream.
The most interesting/controversial aspect of the research is the team’s modelling of NBN Co. They say it will be 2017 before 50 per cent of Australian homes are passed by the network, and 2025 before the network passes 90 per cent of Australian homes. By 2020 40 per cent of the homes would be connected and it would take until 2028 for 85 per cent of homes to be plugged into the NBN.
That means the NBN Co would be burning a lot of cash for a long time – more than $2 billion in 2012, with negative cash flows continuing until about 2025. At an earnings before interest and tax level, it would take until 2019 for the network to break even before moving into positive territory, with Goldman estimating EBIT of $425 million in 2020.
While the team retains doubt that the NBN will be built, that will ultimately be a matter of the government’s resolve and preparedness to write a blank cheque in the form of funding and funding guarantees. If it is right, however, it will be very difficult for existing telcos to vend in their own assets in exchange for equity, a key concept of the original proposal, if there is no equity value in NBN Co.
The analysts believe that Telstra will retain its copper network, selling and leasing back access to its ducts and pits, which would mean the NBN’s fibre-to-the-home network would face competition from the cheaper copper network and the take-up will be slower than if the copper were also acquired and shut down.
Goldman believes the government would be reluctant to pay for the copper network, which will ultimately be obsolete, and would also be wary of a backlash from consumers if they are forcibly migrated onto a higher cost platform. Acquiring the copper and continuing to operate services on it would increase the cost of acquiring Telstra’s infrastructure to $20 billion.
Acquiring the ducts, pits and pipes at a material discount would not only reduce the overall build costs but would, the analysts say, cut the cost to pass/connect in metro areas from $3500 per home to $2500 – about $12 billion in total – and reduce the time-frame for the roll-out by three or four years.
There could also, the teams says, be a prospect of the government having to pay compensation to internet service providers for their redundant digital subscriber line access multiplexers if a forced migration were pursued.
They also argue that it is probable NBN Co is unlikely to simply provide dark fibre services (the last sophisticated and cheapest model) or to provide a full suite of wholesale services (the most sophisticated and expensive model). Instead it was probable NBN Co would provide bitstream services, selling data services to wholesale service providers that would then develop and on-sell products and services to retail service providers.
The ‘’two-layer’’ nature of that model would, they argue, mute the competitive impact of the NBN on Telstra in the short term because there would need to be significant investment at the wholesale level before there could be significant competition at the retail level. Telstra could also compete with other wholesale service providers to win the business of the retail service providers.
It is clear that the new NBN board is going to be faced with a myriad of different choices, in terms of the nature of the network, the services it provides, the way it is rolled out and funded and how Telstra and other telcos and the new network interact and cooperate.
The Goldman report reinforces the market’s conclusion that, whatever the NBN looks like, it is going to have to be taxpayer funded and the cheques will be massive.
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