Interview |
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Comment |
Chief executive of internet service provider iiNet, Michael Malone, tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:
Alan Kohler: Michael, could you just explain to us the strategy behind the acquisition of TransACT, in particular with a view to how that fits in with your response and your working with the NBN?
Michael Malone: We start with the point of view that we’ve been doing acquisitions for quite some time now, since the mid-1990s. I do firmly believe that scale is going to be a significant factor in the ISP game regardless of the NBN. The NBN is interesting, but at the end of the day it’s network and, while I’m very interested in the network, it’s not relevant to the challenges in our game. We’ve set out the differentiating factors we think iiNet can stand for in the future, and they’re customer service, having a well recognised brand and continuing to deliver innovative products. And the network helps with that, but even if the NBN was canned, if we got the announcement from both sides of politics they’re not going to do the NBN, the roll up would be continuing, consolidation would be continuing. This is now getting to be a scale game.
AK: I suppose the thing about TransACT is that it’s a fibre business in a regional centre – obviously a large one, Canberra – but it’s a fibre business that will be over-built by the NBN. Which means that you must be buying it for its customers, its customer database, not the actual infrastructure itself?
MM: Correct. We’re certainly buying it from the point of view of its revenue. We always look at acquisitions on this basis, as in: how much revenue do they generate, how much profit do they get from that revenue, what would it mean if the network was not there, would it change the factors. But I wouldn’t start with the assumption that it will be over built by NBN. We think there are three scenarios there. The first one is the over-build. The second one is that NBN Co, as they have with Optus and Telstra, comes to us and says ‘we’d like to buy that network and get you guys to shut it down’. The third one, and I think by far the most likely, is that they say there’s already adequate service in that area, you’ve already got fibre in that area, so why would we bother over building it?
AK: Yeah, but they want to own the fibre wherever it is, so you’d have to sell it to them.
MM: Well, the legislation allows for what’s called an ‘adequate service’, so they can say, for instance, Opticom has rolled out to a whole bunch of Greenfield estates in the last year and in those estates NBN is not going to roll out there and they’re not going to own the fibre. They’re going to make a declaration that that’s adequately served already.
Stephen Bartholomeusz: Michael, as you’ve indicated, iiNet has been one of the most aggressive of the consolidators. Is there much left that’s worth consolidating? And do you have sufficient scale at where you are?
MM: Look, I don’t think we’ve got sufficient scale. I think, looking around the global markets, you need to be at around 15 to 20 per cent to be a viable number three in any market, but particularly in telecommunications which, even with NBN, is going to remain a capex-hungry industry. So no, I don’t think we’re there yet. I think we need to grow further.
AK: What percentage have you got now?
MM: We refer to ourselves as the number two in ADSL broadband – that’s largely just to poke Optus in the back I guess. Optus is larger than us in fixed line broadband when you include their cable customers. So, in DSL we’re close to 15 per cent, but in fixed line broadband we’re about 10 per cent.
SB: The second part of that question; is there anything out there that’s worth considering to improve your scale?
MM: I don’t want to push their price up, but I’ve said it publically before I’m a big admirer of both Adam and Internode in Adelaide. One of the attractions for us in TransACT is that, iiNet has very much got a ‘Fortress WA’, which is one of the strategies we refer to. About a third of our revenue still comes from Western Australia and it’s a parochial market. We’re proud of that in all industries, not just in telco. So, WA is a great place for us to continue to cement our position. I see a lot of similarities there with TransACT and TransACT is very deeply entrenched into the Canberra market. Ivan and his team, but Ivan in particular, has built a very strong personal brand in Canberra. So, I guess we see a bit of a Fortress ACT with TransACT as well. Adam in particular, but also Internode, are both strongly entrenched into Adelaide market. They’d be great transactions at the right price.
SB: One can assume you’ve spoken to them both?
MM: Yes. And they’re both privately owned and in no hurry to sell.
AK: Simon Hackett’s got to cash out at some point, doesn’t he, Michael?
MM: I’ve said this before, I think he should have cashed out about a year and a half ago. I don’t think the business will ever be worth more than it was a year and a half ago when the sector was still very much in land grab mode. But, Simon loves what he’s doing and I could draw parallels here with my own role in that I think the next 10 years is going to be extremely challenging, but very exciting. My first 10 years was just about getting people connected to the Internet and telling everyone how wonderful the Internet was. The last 10 years has been about getting everyone to move from narrow band to broadband. Every trick that we learned over the last 20 years is now irrelevant. The next 10 years is about how people use their broadband. And the roll up is nearly over. It’s going to be over in the next two years. So, it’s going to be a very different and very challenging environment. I spoke with Simon a couple of weeks ago – we’re all a bit confronted by this, but we’re all pretty excited about it too.
Robert Gottliebsen: Michael, do you think the NBN will transform Australia as the government says it will?
MM: I guess I want to downplay the NBN in some ways, in that I think people have this view that national broadband comes out and that we all become resellers on it. I think it’s important to note that the NBN only deals with the piece from your house to your exchange, so from your house to the nearest point of interconnect, which is just like the copper is now. So, firstly it doesn’t really change the market dynamics as much as the media seems to assume. I think there’s this view that Joe’s Deli is going to open up as a retail service provider on the NBN. And it’s a scale game. To be a national player in NBN you’re starting with about $20 million a year of operating expenses just for the network before you connect one customer, so it is a scale game and it’s going to remain a scale game. And I’m not sure that that’s well understood. The thing that excites me about NBN is that copper has been twisted and distorted and crowbarred into becoming broadband. It was never designed for this. It was designed for analog voice and the fact that we can get broadband working over copper is a miracle in the first place. And when it faults, it’s very difficult to diagnose and fix and there are lots of arguments. We have big confrontations with Telstra and a lot of that comes down to us arguing with Telstra where the fault exists. Is it in the home? Or is it on the line? NBN for over 80 per cent of homes is going to deliver to the socket in your lounge room, so they’re going to own all the in-house cabling for each customer that they connect. That’s going to change the dynamics more than I think we can understand at the moment. If the socket doesn’t work, it’s NBN’s problem. No arguments with whether it’s NBN or iiNet or your internal wiring or your equipment or anything like that. If the socket doesn’t work, NBN has to fix it.
RG: So, how will it change my home and my business? From the point of view of your customers, how is going to change it?
MM: Most people’s focus is on the speed and I think that’s important. But the most important part about NBN is ubiquity. Everybody will have that socket in their house if this thing continues to completion. The most important thing is application providers – people that are delivering services – can start with the assumption that everyone’s got it and I think that’s what really changes things. If I’m developing an application at the moment, some of my customers could be on dial up, some could be on slow broadband, some could be on high-speed broadband or fibre. So, you’ve got to try and take all of that into account. If the NBN was allowed to go all the way to completion, you can go beyond that; you can say ‘every single household in Australia has got high speed broadband and it just works by plugging in’. That’s what I think will really change things.
SB: Michael, to be a national player in a post-NBN environment you’re going to have to connect to those hundred and twenty POIs that you referred to previously.
MM: Yes.
SB: How financially challenging is that for anyone other than Telstra and Optus?
MM: So, say you want to write a 121 backhaul network to each of those locations, you have to have equipment in those exchanges, although the equipment becomes cheaper. Right now, we have to put in what we call DSLAMs into each exchange. In an NBN world it’s switches; so it’s cheap, relatively well understood equipment. But you’ve still got to run a national network and you’ve still got to have international capacity. So, we have to link Perth to Sydney. We’ve got to link Sydney to the rest of the world. That’s our point: The empty cost of a network is about $20 million a year before you can connect one customer to that network. Now, this is all under the stupid and unrealistic assumption that the entire NBN was switched on tomorrow and was available to all 121 POIs, which is not realistic. It’s a ten year programme. But if you start with that idea that you need $30 million of capex and $20 million a year of op-ex before you’ve put on one customer, it does become a scale game. And iiNet’s at the point where that would dramatically reduce our operating expenses to be a national player. But if you were generating, say, a $100 million a year of revenue and you wanted to be national, that becomes a substantial and confrontational amount of base cost to be a player. I mentioned Adam before that operates in South Australia, or OntheNet in Gold Coast. They’re only local players. I don’t know what Adam’s got, but let’s imagine it’s $60 or $70 million a year of revenue. They would only need to connect to the South Australian points of interconnect because that’s all they operate in. So, they’re similar. They’re like, in some ways, a mini version of iiNet in that their operating expenses proportional to their revenue would be very low. So, I think the NBN will come up with a bunch of national players. Today the top four players – Optus, Telstra, iiNet, TPG – have about 85 per cent market share. So, if the NBN was switched on tomorrow, you’d assume that wouldn’t change dramatically. We can all afford to compete. But I don’t think that means the end of the small players. It just means the small players need to be niche.
RG: What happens if we get this NBN about a third of the way down the track and then it stops because there’s a change in government? What happens to all the players in that situation?
MM: Yeah. Look, I think ‘Plan B’ is what everybody in the industry is now talking about and worrying about. With all respect to the current government, I think if you were going to go call CentreBet right now, the chances of them getting the next term is relatively low. If they did win government again and had another term, then the NBN would now be passing about 40 per cent of homes and in my opinion that would be a tipping point where it would be difficult for a future conservative government to decide to cancel it. On the other hand, if this government manages to survive for the next two years, and then gets ousted, NBN at best will be passing about 10 to 12 per cent of homes. That’s not enough for it to be locked in and committed. So, I think you’re right. That is the biggest question in the industry right now: what happens if this government gets turfed out in 2013 when the NBN is only 10 per cent of the way through? On the plus side, Malcolm Turnbull has come out and – very unusual for the Abbott opposition, very unusual for any opposition – put forward their plans and their policy two years out from an election. He [Turnbull] has laid out what he would do under that scenario and it starts with a six month study of what’s going to be required and what’s the best option, but his view – and I agree with him – is that a patchwork network of different technologies, based on demand, is the most cost effective version. In other words, where NBN currently is targeting the have nots, the people that can’t get anything else and can’t get high speed broadband, continue that and preserve it. But in areas where there’s already high speed broadband, so people have got ADSL 2+ or hybrid fibre co-ax, cable networks, continue to roll that out. Maybe expand the footprint of the proposed fixed wireless services, so instead of it only servicing 6 per cent of the population, maybe expand that up to 15 per cent. These are good questions, I’ve got to say. But, either way, at least both sides of politics are now saying that broadband is really important. We want all Australians to have it and it should be ubiquitous. It should be separated, wholesale and retail. And it should be rolled out with some government subsidy and some government support.
SB: Michael, talking about those other networks, I’m sure you would have seen Telstra has decided to upgrade its HFC networks other than Melbourne. Melbourne has already been done obviously, but they’re going to do the others. How do you interpret that? Is that a bet on the outcome of the next election?
MM: I don’t know. I don’t sit in the Telstra boardroom, but I’d start with the position that they’re really just responding to Optus. Optus has already decided to upgrade their HFC network, their cable network to DOC SIS 3.0 and has progressed on that. Telstra still has a lot of customers on cable, so I think they’re largely just responding to that. Obviously we’ve got the same issue.
RG: Where do you think the weakness is in Telstra? What’s their soft underbelly?
MM: Two answers to that one. I think their culture is toxic and it’s going to take a long time for Thodey to turn that around, but he’s doing it. Every CEO that’s come in to Telstra over the last 20 years starts off with the same rhetoric about how ‘Telstra’s customers don’t like us and we need to really tackle that, we need to turn this business around’, but those are easy words to say. Once it comes to challenging the dividend and challenging the profitability, most of the CEOs have gone back to just focusing on screwing their customers for as much money as possible. So, I’m not seeing that with Thodey. They just poached our head of customer service, who is now working over in Melbourne, and I guess a lot of the signals we’re seeing out of Telstra are that they’re going to go the distance this time. This is not going to be an easy journey for them and it’ll only last, in my opinion, for as long as David Thodey is running the show, but there seems to be a genuine long term commitment to actually saying we need to change.
AK: You say that it’s only Thodey, but surely they don’t have a choice as to what they need to do?
MM: A lot of this stuff comes down to a return on investment and the simple reality is that customers are quite complacent about their telecommunications services. I’m sure a lot of Telstra customers out there now know they could get a better deal. It’s just too hard. They just say: ‘we’ll just stay where we are right now; I could save ten or twenty bucks a month; I know I could get better service elsewhere, but who cares?; it’s good enough.’ In my industry this is all we think about – telco. For the average consumer on the street, they’re thinking about what they’re going to have for dinner tonight. They’re thinking about their family issues and how they’re going to afford next week’s bills. Telco is not high on their list of priorities. And Telstra can take advantage of that. They could sit back and the bleed may end up being far more profitable than actually dealing with it. You ask what’s Telstra’s soft underbelly? If you look at regional Australia where the NBN’s going, Telstra has about 90 per cent market share in fixed line telephony and about 72 or 73 per cent market share in broadband. These are the areas that the NBN is coming to first. In metropolitan Australia, Telstra has only got about 34 per cent market share. Where there’s genuine competition, Telstra has had to fight hard for it. So, if you look at what Telstra’s soft underbelly is from a financial point of view, it’s that as NBN rolls out they’re going to have to fight really hard to retain their market share and we’re going to be there trying to take as much of that as we can, as will Optus and TPG and the others.
SB: Thodey has thrown a lot of money at the market, both in terms of pricing and service – over a billion dollars and rising.
MM: Yes.
SB: Has that impacted you at all?
MM: Again, it has in regional Australia. If you look at our profile over the last two years, it’s largely been a story of continuing to grow in the areas where we have our infrastructure, but in the areas where we’re using Telstra infrastructure to compete with Telstra, we’re bleeding in those areas. Telstra is charging more for wholesale services in some cases than they charge in retail themselves.
AK: Hey Michael, if Optus for some reason came on the market for sale, would you consider buying it?
MM: We’re a wholesale customer of Optus, so we’re what’s called an MVNO, a mobile virtual network operator – in my mindset Optus is largely a mobile company. iiNet’s fixed line revenues, inclusive of TransACT, are over $750 million. Optus’ fixed line revenues are not much more than $1 billion. If their fixed line business came up for sale, I’d be very interested, but Optus – they’re a $7 billion company. You know, I’d love to own my own mobile network. Telstra is not ever going to be available for sale. Vodafone has gone through some interesting issues in the last twelve months. Optus is the one we’ve chosen because it’s got that balance of quality and commitment to wholesale. Look, I think it’s an interesting question if Optus came up for sale, but the realistic answer is that they’re out of our reach.
SB: Michael, I think you’ve said that the Optus fixed line business are the ones that in fact you think you can target in a more competitive environment, rather than Telstra. Is that the case? And why?
MM: In regional Australia yes. I think Telstra is a bigger target for us because Telstra’s regional customers – and this is nearly half of the population of Australia – haven’t really had any viable alternative. In metropolitan areas I think Optus has been a bit lazy about their fixed line business. They’ve focused on their mobile customers, but in fixed line I think they’ve largely just done barely enough to keep the customers and so it’s an area that we’re interested in. Telstra has done a lot of work in trying to take care of and improve their fixed line products. I don’t see that Optus has done that yet. Now, if the best we can do out of this is force Optus to spruik up their fixed line products, that’s still a good outcome for customers.
SB: Thank you very much indeed, Michael. We appreciate your time and your thoughts.
MM: Thanks very much, gentlemen.
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