commentary The Federal Government's preferred National Broadband Network partner is due to be nominated shortly. As that moment looms, and Stephen Conroy's language becomes more aggressive, Telstra's share price has been imploding.
It would take several years, perhaps many years, before the NBN had a material impact on Telstra's revenues and earnings
But Telstra, at least, believes the market's fears grossly exaggerate the risks.
The telco's chief financial officer, John Stanhope, devoted most of an address to a Credit Suisse Asian investment conference last week to trying to put the impact of an NBN and the associated measures the government could impose into perspective.
At or about $3 a share — which is where Telstra's share price had fallen in recent weeks — he says the market was pricing in a 33 per cent discount to analysts' consensus valuation (about $4.50 a share), a 30 per cent price-to-earnings discount to its peers with similar earnings per share growth expectations and, on a discounted cash flow valuation, a minus 5 per cent terminal growth rate.
The valuation relative to Telstra's peers, he says, implies a $5 billion hole in consensus 2011 revenues, or a 4 per cent decline in revenues in this year and the same in 2010 and 2011. At $3 a share the discounted cash flow numbers would imply a halving in free cash flow over the next nine years.
Stanhope referred to "Armageddon" scenarios, in which the worst-case impact for Telstra of a competitor build of an NBN had been estimated at up to $1.75 a share. Within that, the impact of operational separation has been variously estimated at between 4 cents a share and 93 cents or, as Stanhope said, a $10 billion range.
Telstra's own forecasts say that if a network were given a statutory monopoly with a prohibition on competing infrastructure it might lose up to 69 cents a share of value. Functional separation could cost it 14 cents a share. Low-cost sub-loop access could cost 42 cents a share. Forced migration of retail traffic might cost 13 cents a share. The impacts can't be added together to produce a total impact because some revenue effects would be double counted.
The key point Stanhope was making is that even if the worst came to the worst and there was a fully funded and perfectly executed NBN build by a competitor, one that was well-protected by legislation, not only is the risk of revenue loss for Telstra far less than the market is pricing in but it would take far longer for the impact to be fully felt than Telstra's share price implies.
Telstra has said previously that it believes it has between $1 billion and $2 billion of its lower-than-average-margin revenues at potential risk from a perfectly executed NBN build. Stanhope identified potential losses of $500 million of revenue in its wholesale business, $620 million in its retail business and $165 million in enterprise and government, which adds to about $1.3 billion.
With the NBN bidders indicating they would start any roll-out of fibre in the rural and regional areas, leaving the urban areas until last, and with Telstra having the ability to migrate its high-value customers in the cities onto its cable and ADSL2+ platforms — or buy wholesale access to the NBN if that were economically more attractive — it would take several years, perhaps many years, before the NBN had a material impact on Telstra's revenues and earnings.
Its recent decisions to invest $300 million in upgrading its cable broadband network in Melbourne, an upgrade it could repeat in the capital cities, to provide minimum speeds of between 70Mbps to 100Mbps, is an example of aggressive pre-emptive action to both protect its customer base and undermine the NBN's economics. The NBN builder will need to win a large share of Telstra's traffic — or have it forcibly transferred — to make sense of the investment.
The message Telstra is trying to convey, that the NBN will have no meaningful impact in the near term and manageable impacts in the medium term, is quite rational and reasonable. In the meantime Telstra's cash flows will swell — it is maintaining its target of free cash flows of $6 billion to $7 billion in 2010 — and its financial flexibility and ability to respond to the NBN build will increase.
However draconian the measures Conroy announces to support the NBN — and whether or not Telstra is successful in its inevitable legal challenges and demands for compensation — if Stanhope's judgement of the scale of the risks is right, the market is grossly over-estimating the potential damage Conroy and the NBN can do.
This article by Business Spectator's Stephen Bartholomeusz is reproduced on ZDNet.com.au courtesy of a reciprocal publishing agreement.
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