Feature Stories | May 24 2007
By Greg Peel
If you’re like me, you find it frustratingly difficult to comprehend discussions or analysis about broadband technology when experts, analysts and journalists alike insist on using unexplained acronyms as assumed knowledge within their text. It is also helpful to understand just what Telstra actually owns and thus controls. With apologies to those who are fully up to speed on such matters, I suggest that a bit of background is necessary in this discussion.
Telstra owns the system of twisted copper wires that connects the central telephone exchange to your home or business and has allowed you for decades to make a simple phone call. It also owns the infrastructure that provides the copper wire connections – overhead “telegraph pole” networks, underground ducting networks, local telephone exchanges and smaller “street furniture” exchange boxes that create a copper path to your telephone through a system of ever-diminishing junctions.
The line of twisted copper wire that reaches you individually from a local exchange is referred to variously as the “last mile” or the “local loop”. That line will also usually hit yet another junction, often a “pillar”, that then radiates lines out to individual homes or businesses.
In a country such as the US with a population 15 times that of Australia, it is commercially effective to have a number of telcos in competition providing their own infrastructure and delivery technology. In Australia it is not commercially viable for a competitor to replicate the infrastructure that Telstra (TLS) has constructed over decades in its time as a public utility. The biggest mistake the government made in privatising Telstra was to let the infrastructure be sold with the business. Thus we now have the untenable situation of a private monopoly with responsibility only to shareholders having to be regulated by the government and restricted by the Australian Competition and Consumer Commission (ACCC) so that no Australian is disadvantaged in product and price. In essence we have neither a public nor a private utility.
In the 1980/90s two companies, Telstra and (now SingTel owned) Optus (SGT), rolled out competing cable infrastructure which at that point on the technology timeline was the only way to deliver cable (pay) television (other than microwave). By insisting on competition between the then public utility (Telstra) and a private competitor (Optus) rather than instituting an arrangement where one set of infrastructure could be shared, the government ensured cable television became, and today remains, prohibitively expensive for the average household. Australia has one of the lowest rates of cable television take-up in the world.
The second big mistake the government made was to allow Telstra to be a 50% owner of the dominant cable television company, Foxtel. Cable became the initially obvious means of delivering broadband capacity until the digital software was developed to provide the same capacity over copper wire. This was ultimately developed because Margaret Thatcher privatised British Telecom but would not allow it to move into cable television. Hence BT was initially shut out of broadband, and necessity is the mother of invention. Canada is a country that mimics Australia in size and population, but because the government would also not allow a telco to operate on both platforms, competition between platforms has led to Canada having the sort of super-fast broadband that Australia is still only dreaming of.
The reason we can now deploy the old copper wire system that once could only manage telephone calls, and then dial-up internet connection, and now broadband internet connection, is due to aforementioned developments in digital technology software. These have led to the development of the Digital Subscriber Loop (DSL) which has expanded the amount of information (bits) that can pass through the infrastructure simultaneously. The technology has also allowed for existing lines to be shared, thus creating a Line Sharing Service (LSS).
If one fiddles with the 50/50 to and fro capacity of a line via the software, such that more space is given to information coming down the line than going back up, one has created an Asymmetric Digital Subscriber Loop (ADSL) that allows for faster download at the expense of upload (bearing in mind that most people spend a lot more time downloading information than uploading).
The whole system can be sped up further by the use of an Digital Subscriber Loop Access Multiplexer (DSLAM), which allows faster connections between multiple customers at the exchange point.
When delivery of telephony and subsequently dial-up internet services were opened to competition due to the privatisation of Telstra, competitors simply rented line space from Telstra and “resold” services on varying deals for their customers. With the advent of DSL broadband technology, competitors have the opportunity to deliver their own broadband capacity across Telstra’s local loop of copper wire, as long as they plug in their own machines at the local exchange and physically pull out the copper wire that travels to a specific home and reattach it to their own system. This is called “unbundling the local loop”. Before there was any talk of fibre-to-the-node (which I’ll get to shortly) Telstra had already entered into a battle with the ACCC on what price to charge competitors for Unbundled (or Unconditioned) Local Loop (ULL) access.
That battle still rages today, with Telstra insisting it needs to charge $30 and will still be losing money while the ACCC has insisted on a price of $17.70. Telstra has just (last week) lost an appeal in the Australian Competition Tribunal against the ACCC on this matter.
But while that battle was raging on, as it has done for the best part of a year now, the technology had already moved on. Last year Telstra announced it intended to spend some $4 billion building a fibre-to-the-node (FTTN) network. This technology uses fibre optic cable to replace the copper wires which emanate from the central exchanges through to local exchanges and on to a final street “cabinet” at a point not far from your business or home. That final point is called “the node”. From the node, the last stretch into the home or business will remain as existing copper wire.
The news was welcomed by all and sundry until Telstra let the ACCC know just how much it expected competitors to pay to rent space on the new technology.
FTTN is a step into the future, but what it immediately does is render ULL and DSLAM technology “stranded”. ULL is the means by which Telstra’s competitors can provide a competing broadband service to their own customers by setting up and plugging in at Telstra’s local exchanges. But FTTN will take fibre beyond the exchange and onto this new thing called “the node”. The only way other telcos can then compete is to pick up their gear and move it downstream to be reinstalled in the little street cabinet (node) that represents the end of the fibre line before copper takes over once more. Unfortunately there are all sorts of problems in doing this, not the least of which is (and don’t forget this is the age of the microchip) there is not enough room in the cabinet! To replicate the nodes, or add any sort of competing sub-infrastructure, would be simply uncommercial.
Hence we are back at the situation that the only realistic way to ensure competition is for Telstra’s competitors to rent space once more – this time on the fibre network. The amount Telstra wants to charge for this access has, to date, never been officially disclosed (it’s about $85 per month) but suffice to say Telstra was not happy when the ACCC countered with a requirement for a much lower charge.
So the telco took its bat and ball and went home. FTTN was indefinitely shelved.
There was an outcry from the business community, which implored the government to step in and assist with the cost of the FTTN infrastructure, and balance out the rental gap between Telstra and the ACCC, so that Australia would not suffer as an economy against its speedier broadband competitors. Communications Minister Helen Coonan dismissed the whole argument as irrelevant, noting that ADSL2+ technology over copper wire could be just as fast as FTTN, and that such technology was becoming more readily available. (ADSL2+ is simply a latter, more souped-up version of ADSL).
Coonan was not incorrect, however she neglected to let on about the one thing that ultimately makes fibre superior to copper – broadband speeds are maintained on fibre over distance, whereas it doesn’t take more than a kilometre or two before broadband over copper begins to slow right down. ADSL2+ may be able to provide fast broadband, but only if you’re right on top of the exchange. The further away you get, the more the speed drops off.
This doesn’t help if you’re somewhere out in Australia’s bush, but then not everyone in the country even has a local loop and thus was never going to be reached by FTTN either. Remote parts of Australia need to be serviced by wireless broadband technology such as microwave – which works fine until things like mountains get in the way – or satellite. Clearly satellite technology adds greater cost to the delivery of broadband, and therein lies another problem. Despite having sold off its telco utility, the government still insists that no Australian, however remotely located, will have to pay more for their broadband than anybody else. This is to appease the National Party, without which the Liberal Party could not win government.
And this creates big problems for Telstra. In order to maintain a consistent broadband price for all, city-dwellers have to subsidise country-dwellers. This raises the cost of broadband delivery and thus the price Telstra wants to charge for competitor access. If country folk – those who survived years without telephones or little or no television reception in earlier days – were left to ponder the tyranny of distance as having its disadvantages, circumspectly, then Australian cities would no doubt have had an FTTN fast broadband system already. (Indeed, there are already smaller networks being built by state governments.)
In order to overcome the problems associated with the one-price-for-all requirement, Telstra countered by breaking down its broadband delivery costs to customers into distinct bands based on download limits and speeds. If you are attached to the local loop you can start at the cheap end – dial-up – and then move into ADSL levels and finally ADSL2+ levels. While cost may be one thing, the speed you can achieve will still rely on your location. Thus not everyone can access fast broadband, even if they wanted to. To understand the difference this makes, consider the table produced on the Telstra website.
The table suggests that if a customer wanted to download a television show, or perhaps a short film, for which the file size was 500Mb, the old 56kbps dial-up connection would download the file in 19 hours and 38 minutes. Most Australians can now at least achieve 256kbps on ADSL, which would download in 4 hours 21, and some have 1.5Mbps ADSL, which would take 44 minutes. If you are among the few with ADSL2+, you can achieve 8Mbps, which would take 8 minutes, and if you’re really lucky, and close enough to the right exchange, you could get 20Mbps which would download that file in just 3 minutes and 20 seconds.
If your broadband comes down the cable (same as your pay-TV) rather than the phone line, you can achieve similar speeds up to 8Mbps. If you are on wireless (which includes mobile phone connections) you can get 1.5Mbps. And if you are forced into using satellite, you can only get up to 512kbps.
FTTN should achieve speeds of 12Mbs as an average, again depending on just how long your local loop is, which can be quite a distance in Australia. Nevertheless, FTTN is already old hat, with some countries now installing FTTH, or fibre-to-the-house, completely eliminating that pesky copper. You don’t want to know what sort of broadband speeds FTTH can achieve.
While it might seem to many that the greatest advantage fast broadband might provide is to allow for the quick download of movies, rendering it no longer necessary to drive to the DVD rental shop, the reality is that fast broadband also speeds up the machinations of business in a globalised world that has come to recognise the internet as the great commercial revolution of the twenty-first century. If Australia can’t match its overseas competitors on broadband speed then it will find itself suffering as a result.
This fact is not lost on the Federal Labor Party, which has declared as an election platform that it will join in a public/private partnership (PPP) to ensure that an FTTN network will be built as soon as possible. The money will be drawn from the Future Fund, which the current government created. The current government maintains that this is tantamount to stealing money from Australians’ future, but given that money is currently invested in Telstra shares, it’s hard to discern the difference. While Labor is not concerned as to who is, and as yet has not suggested who might be, the private partner, it’s very hard to see any company or consortium other than the one that owns all the copper that makes up the local loop – Telstra – as being able to compete. However the ALP is talking some $9-10 billion of combined expenditure.
When Telstra did withdraw in a huff earlier in the year a consortium of competitor telcos, known as the G9, proposed that they would combine and build their own FTTN network in place of the recalcitrant utility, thus ensuring Australia would not fall behind the rest of the world while one monopolistic organisation wasted time trying to extract leverage from the government. The offer from AAPT, Internode, iiNet (IIN), Macquarie Telecom (MAQ), Optus, PowerTel (TEL) (TCN.NZ), Primus, Soul (SPT) and TransACT was well received in general but was really only a sabre-rattling exercise at the time as detail was pretty scant. The question remained: How was it going to deal with Telstra’s ownership of the remaining copper local loop? And besides, in order to make a network commercial the G9 would still need Telstra to rent space on the G9 network instead of the other way around.
But nevertheless the whole FTTN question has now become an election issue leading to rumblings that Minister for Communications Helen Coonan would attempt to negotiate a deal that would satisfy Telstra and ensure the government could go to the polls with a promise that indeed FTTN would be provided in due course, lest the ALP retain the upper hand on the issue. Such a deal would require some change in the legislation and probably a bit of a sweetener from the expansive government coffers.
While the battle lines over FTTN have been drawn, at least one telecommunications consultant has argued that to spend the money installing such a network in the least populated continent on earth (where 80% of the population lives in a coastal strip from Brisbane around to Adelaide) is sheer madness, and that the only feasible, commercially viable and imminently possible solution for Australia is wireless broadband. But that’s another story. Readers are directed to “Behind the Scenes of the Wireless Broadband Revolution” (Sell&Buyology; 03/04/07).
The analysts at JP Morgan also suggest that Australian’s have been browbeaten into believing that FTTN is some sort of panacea:
“Courtesy of a 12 months propaganda campaign by Telstra, the Australian public is now convinced that salvation from broadband hell will require the FTTN messiah. We would argue that in reality, ADSL2+ on the current copper network could offer respectable speeds (6Mps) to 75% of Australian homes and would go a long way in closing the current gap.”
So that would mean a 500Mb television show in about 10 minutes, which is not too bad, but that would be the best we could do given the limitations of copper as supposedly, once again, the world advances ahead of us. That is unless some software genius comes up with ADSL3+. But either way, Telstra is still fighting with the ACCC on ULL pricing without resolution. We are in a stalemate one way or the other. And so Telstra is holding the country to ransom – arms firmly folded and nose turned skyward – waiting for the government to bow on its FTTN pricing. Notes JP Morgan:
“We do not believe the G9 proposal constitutes a standalone alternative to Telstra’s and therefore, as the only possible driver of an FTTN roll-out, Telstra has some leverage in what has become an election issue.”
Of course, Telstra is only doing what it thinks is best for its shareholders, and that’s all a company’s management can be expected to do. That Australians in general should be disadvantaged by this business reality should be neither here nor there. Except that it was those Australians that used to own Telstra before the government took it away and sold it back to a lucky few of them. But is Telstra being greedy? As far as the telco would have us believe, unless it can get what it needs to charge for space on its FTTN network then the network would be a loss-making venture. It is the ACCC holding up Australia’s future, Telstra says, not your beloved telco.
Citigroup analysts might disagree:
“Telstra maintains that it could not generate an acceptable ROIC [return on invested capital] on its FTTN build unless it charges its competitors ~$85/line/month (fixed line + broadband service). Our analysis suggests that Telstra could charge an access price as low as $50 and still generate a payback in less than five years.”
JP Morgan analysts have weighed up the various pros and cons as well, and suggested that:
“Using the current ULL and LSS economics as a benchmark, we believe access to FTTN could be priced between $65-75 per service per month.”
Virtually every analyst in town agrees that there is little hope of the government arriving at some resolution with Telstra between now and the upcoming election, irrespective of what they can determine is a commercially viable access payment scheme. In fact, the general feeling among analysts at present is that Australia won’t see FTTN any time soon. In the meantime we’ll be stuck with the potential for reasonable, but not competitive, broadband speeds. We currently pay more for our slow broadband than most countries pay for their fast. JP Morgan notes that local loop unbundling began in most European countries some four or five years ago. We haven’t even resolved that issue yet.
JP Morgan notes that ULL represented only 10% of broadband connection in Australia by the end of 2006. If the issue of payment to Telstra for this (rapidly becoming obsolete) technology can be agreed upon between the telco and the ACCC then prices should at least start to come down even if speeds don’t get much better.
But wait! Is that the sound of thundering hooves? Here comes the G9 cavalry to solve all our problems!
Yesterday the G9 released its long-awaited proposal, complete with some specifics. The document gave over a lot of space to criticism of Telstra, and why a Telstra-owned FTTN proposal is fundamentally flawed. The solution that is best for Australia, said the G9, is one where all willing telcos contribute to the development of an FTTN network – Telstra included.
To overcome the Telstra monopoly problem, no one telco will own or control the network. Instead, a Fibre Access Network Operating Company will be set up. This will even be open to private investment, such that no government – even a new ALP government – need contribute to the building of the infrastructure. An independent body – nattily named SpeedReach – will be established to operate and manage the network. According to the document:
“No individual carrier will control SpeedReach, and all access seekers will be entitled to membership of SpeedReach, including Telstra. SpeedReach will have both access seeker-appointed and independent directors and managers tasked with optimising the use of the fibre to the node network.”
Moreover, the G9 proposes a 12-year agreement with the ACCC from the outset, ensuring the government or the quasi-government will not continue to stall, prevaricate, vacillate and generally dawdle with regards to Australia’s telecommunications future.
And now for the clanger. Wholesale access to the network will be provided at $21-24 per month. At that price, Graeme Samuel would help lay the fibre himself. This is truly a triumph for capitalist democracy.
But alas – the same old stumbling block remains. This is still only an FTTN network, not an FTTH network. The G9’s proposal still requires the use of that last length of copper that stretches from the node to your house. Will Telstra see the value of becoming part of an Australia-wide consortium that will actually resolve the country’s broadband problem? Or will it simply say “It’s our copper, get stuffed.”?
On face value – if the $21-24 price is realistic – there is still room for Telstra to charge a good margin on that copper while the overall price of broadband access could remain reasonable. So will Telstra go for it? History would suggest no. Telstra would lose the best part of its monopoly status, and would lose face, if it succumbed to G9. However, it would not be surprising to see Kevin Rudd embrace the G9 proposal quickly as workable solution still open to some Future Fund money if that would help.
The government has had the G9 proposal in front of it for a while now, as well as whatever Telstra’s latest proposal might be. Time is running out for the government to come up with something, as there are very few Senate sitting days left before the election to implement the passing of requisite legislation.
It’s now a case of Watch This Space.
And then when it’s all said and done, what about the poor old Telstra shareholder? There are plenty of John and Jane Citizens out there who own Telstra shares in the form of T1, T2 or T3 or all of the above. If they bought T3 at issue then they’ve done very nicely thank you. But where to from here? Telstra might be holding the country to ransom, but how the telco emerges from this debacle will affect many Australians both as shareholders and superannuants, and even as supposed owners of the Future Fund.
Citi suggests FTTN could deliver a $1.10 per share “windfall” to Telstra (assuming Telstra is the company that builds the network alone) based on an access charge of $60. That’s $10 more than what the analysts consider to be a commercially viable $50 charge.
Under JP Morgan’s “base case” scenario – in which Telstra charges $65-75 – the valuation upside is 37c per share.
The bottom line is that all brokers have looked at FTTN and decided that there is a chance – and only a chance – Telstra will go ahead and build it. That “chance” has been reflected in recent target price movements. The average target price in the FNArena database now stands at $4.76 which is very near where the stock is trading. However, there is a reasonable spread of both targets and ratings.
Simply assessing the per month price for wholesale FTTN access is not the end of the equation for Telstra revaluation. There is consideration that Telstra would also slow down its loss of subscribers to its Public Telephone Switched Network (PTSN) – that is the rapidly becoming redundant “land lines” – and most likely be able to increase average revenue per user (ARPU). But there is still more to the Telstra story, including what to do with the very valuable Sensis directory service, and how the IT upgrade is progressing. All in all, it’s not hard to see why there is a reasonable spread of Telstra valuations, uncertainty over FTTN notwithstanding.
At the bottom of the range is JP Morgan, whose analysts, despite having done all the numbers, still rates the chance of an FTTN network being under construction by Telstra in the next twelve months as pretty low. JPM’s target is $4.07 with an Underperform.
At the top of the range is Credit Suisse – once Telstra’s only real positive voice – whose analysts have taken a different but now common tack and decided that size is not necessarily a barrier to Telstra being subject to a private equity takeover offer. CS believes a suitor could pay $6.50 and still be looking at a 20% internal rate of return (IRR). The analysts have maintained, as they have long done, an Outperform rating.
At present, the B/H/S ratio in the FNArena database stands at 3/4/3, which is little help to your average shareholder. Realistically, it’s become a waiting game. What will happen from here is anyone’s guess.
Will Australia get fast broadband before Bangladesh puts a man on Mars? It really is an unknown. Irrespective of the whole pricing issue we have an election to get through yet, and one in which it’s looking increasingly like we might have a change of government. John Howard has said that not only does he have no rabbits to pull out of a hat, he has no hat. Outside of election game-playing, one would tend to think there is not going to be some revolutionary game-saving deal announced on FTTN. We are still in a stand-off.
We are yet to learn of the government’s, Telstra’s, or analysts’ responses to the G9 proposal. It is simply the latest chapter in the long saga that is Australian broadband.