Bringing Telstra into the NBN fold

commentary A tender for the role of lead advisor for the implementation study for the Rudd Government's proposed $43 billion National Broadband Network (NBN) closed last week.

Paul O'Sullivan had it right ... when he said that the new NBN would be a commercial failure unless there was only one network that included Telstra's fixed-line assets.

One would hope that, once appointed, the advisor tells the government that the fibre network will only be remotely feasible if it is prepared to acquire all of Telstra's existing fixed-line infrastructure.

Optus' Paul O'Sullivan had it right earlier this month when he said that the new NBN would be a commercial failure unless there was only one network that included Telstra's fixed-line assets. In fact, he was probably grossly understating the consequences of leaving Telstra's copper, fibre and cable networks outside the NBN.

When Kevin Rudd and Stephen Conroy revealed in April that their original tender for a $4.7 billion fibre-to-the-node network had been an abysmal failure, with not a single acceptable proposal, and unveiled their far more ambitious plan for a $43 billion fibre-to-the-premise network, they made a virtue of the fact that by leaving the copper network (which would have been cut over by fibre-to-the-node) intact they had avoided having to pay compensation to Telstra of more than $20 billion.

The problem with leaving the copper alone is that it means the new NBN would face competition from an inferior but fully-depreciated network offering fast-enough broadband at sufficiently affordable prices to satisfy most of the mass market demand for broadband services.

Given the copper network is in place and that it generates margins in the mid-60 per cent range, if not higher, for both Telstra and the internet service providers that have installed their own digital subscriber line access multiplexers in Telstra's exchanges, there would be no compelling incentive for the bulk of today's broadband users to be shifted onto the new fibre network.

Indeed, the incentive for Telstra and the ISPs (including Optus) would be to remain on the copper network and milk returns from their existing investments for as long as possible. Unless the new NBN service was priced at a very substantial premium to the copper services, Telstra and the ISPs would face far lower margins and returns.

In other jurisdictions like Japan, where copper services are offered alongside even government-subsidised fibre, the cheaper copper still retains very substantial market shares a decade or more after the launch of the high-speed services because of both the incentives for the established operators and the trade-offs between cost and speed made by customers.

Without Telstra's customer base, let alone the ISPs', the new NBN would almost certainly be a horrendously costly disaster, with taxpayers being forced to subsidise a state-of-the-art but grossly under-utilised network to the tune of billions of dollars a year for years to come.

Even if Telstra and the ISPs shift their customers onto the new network it will, because it will be built out into sub-economic regions and have to contain big cross-subsidies to provide equivalent prices between the dense urban regions and regional areas, probably still have to be very heavily subsidised.

O'Sullivan referred to Telstra's "rational incentive" to preserve its margins and the fiduciary obligations of its directors and management to maximise profitability and therefore the inability of even the new, conciliatory, board and management to voluntarily move their traffic onto the NBN.

That implies that Telstra and the ISPs have to be given an incentive to shift their customers and shut down the competing alternatives — or to vend them into the NBN to create a new wholesale monopoly.

It has always been the case that Telstra had to be brought into the NBN fold if it were to have any chance of being remotely feasible. The government could threaten Telstra, and did, with all sort of draconian regulatory reforms, but whether Telstra were structurally separated or not in its current form there would still be competing, cheaper, fast-enough services out there.

The "new" Telstra might have been more easily intimidated by the threats than the old, but ultimately the fiduciary obligations would prevail.

The government itself has valued Telstra's copper network at more than $20 billion. Throw in its fibre and cable assets and it would cost very serious money to nationalise Telstra's fixed-line infrastructure and remove the competition to the NBN.

A pure asset-for-equity in the NBN swap would simply replace one Telstra-dominated fixed-line network with another and probably couldn't be made economically acceptable to Telstra without hefty on-going subsidies, which suggests that the government is going to have to offer Telstra a big slab of cash and substantial but non-controlling equity in the NBN to convince it that participating in the NBN and selling its fixed-line assets was in the interests of its shareholders.

A 'capital-lite' Telstra focused purely on retailing and free of the endless and unproductive battles with governments and its regulator could be an even more formidable competitor.

It would be difficult, if not impossible, for the government to convince other infrastructure owners to vend in their fixed line assets for equity in the NBN unless they were convinced the new entity was economically viable and they were getting fair value.

That probably means someone — Telstra shareholders, which is unlikely, or the taxpayer — is going to have to absorb a big one-off hit to create a cost base for the NBN that will enable it to both offer services at prices that consumers will be prepared to pay and deliver commercial returns to the private sector participants. There would also be the on-going costs of the subsidies to achieve the government's social objectives in rural and regional areas without undermining the returns to NBN investors.

Offered a really big lump of capital that reflects the revenues and margins Telstra is extracting from its degrading copper network — and the strategic value of that network — as well as the key shareholding in the new wholesale network, Telstra directors might well see a future as the biggest wireless services operator and biggest retailer of fixed-line services (as well as the owner of Sensis and a growing portfolio of online services offshore) as an attractive option to the status quo.

A "capital-lite" Telstra focused purely on retailing and free of the endless and unproductive battles with governments and its regulator could be an even more formidable competitor.

Convincing Telstra that joining the NBN and vending in all its assets, including its copper network, would be in the interests of its shareholders would, however, be a very expensive exercise and entail the new NBN/taxpayers potentially spending billions of dollars, perhaps tens of billions, to acquire assets at inflated prices — assets that by definition won't be part of a long-term fibre-only future.

This article by Business Spectator's Stephen Bartholomeusz is reproduced on ZDNet.com.au courtesy of a reciprocal publishing agreement.