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Telstra Down But Not Out

Australia | Jun 19 2007

By Greg Peel

Self-titled “car stereo installer” Dick Smith commented on ABC radio last night that he has countered the potential for Telstra (TLS) to exploit its monopoly telco position in Australia at the expense of humble householders by buying shares in the company. Later in the evening the ABC’s Four Corners program ran an eye-opening expose of Telstra’s workplace practises and treatment of its employees. It wasn’t a good day for Telstra.

The telco is seething over the government’s announcement yesterday that a deal had been struck between the government and a 50/50 joint venture between Optus (SGT) and Elders (FCL) known as OPEL. Telstra was not invited to tender.

The deal sees the government putting up $958m towards the rollout of a combination ADSL2+ and WiMAX broadband network to service regional and rural Australia. OPEL will kick in $200m in cash, plus a further $717m worth of existing assets. The government’s objective is that a combination of this bush telegraph, plus a high-speed fibre network in the cities, will ultimately provide fast broadband for 99% of Australians. The other 1% – those who live two days trek to their front gate, let alone a town – will be subsidised for the expense of having only a satellite connection available.

Is this the perfect solution? Well no and yes.

The perfect solution would have been for the government to announce it alone would build a country-wide FTTH broadband network. Then it would offer up the infrastructure for even competition amongst broadband retailers. This would provide basically unlimited download speeds for everyone at reasonable prices. FTTH means fibre to the house, implying that the entire country would be connected by fibre optics rendering the old copper infrastructure obsolete. Some European countries are already moving to build such as network.

Alas, this is but a pipedream in a country with a large landmass and a small population. It would be prohibitively expensive. In fact, at this stage of the game an FTTH system is not even being considered for the capital cities, as the cost of replacing all those final connections of copper wire is still prohibitively expensive, even in a concentrated population.

The next best solution would be for the government to build an FTTN network country-wide. Fibre to the node means optic fibre stretches at least as far as the final street corner distribution point, or “node”, before existing copper wire takes over. However, it would be pointless, and expensive, for the government to build such a network, given Telstra already owns the existing infrastructure that could be much more cheaply adapted to fibre.

Clearly the best solution, thus, would be for Telstra to build the country-wide FTTN network. Well, Telstra had its chance and blew it. From its supposedly unassailable position of Australian monopoly telco, Telstra demanded too much in access fees for competitors. A lot of the argument was to do with the government’s requirement that rural Australia would not pay more for broadband than urban Australia. This meant access fees had to be uniformly high such that the cities would subsidise the bush.

The ACCC, and every telco analyst in town, decided Teltra’s price was far too high. It said no, and Telstra said get stuffed then – we simply won’t build the network. The government announced that everyone should be quite happy with ADSL2+ (across copper) anyway. Then a funny thing happened.

The funny thing was the scathing backlash the government received from the business community. Australia, it said, was under threat of becoming a global business pariah if broadband speeds remained at archaic levels. The ALP was quick to respond, given the upcoming election, announcing it would build a country-wide FTTN network as a public/private partnership using money from the Future Fund in combination with a private tender. The G9 consortium of Telstra’s rival telcos also put forward its own FTTN proposal, suggesting an equitable solution could be reached without government subsidy but with private investment funds.

Having only woken up on the election issue of climate change five minutes earlier, the government then woke up to the fact that this broadband thing was also important. This is one reason for yesterday’s announcement.

The other reason is in direct response to Telstra’s petulance. By holding the country to ransom, Telstra managed to frustrate the government into moving ahead with a solution to the rural and regional Australia issue while leaving Telstra out in the cold. And so it announced the OPEL deal.

The OPEL deal means that rural and regional Australia will still have access to fast broadband at the same price as urban Australia, solving that part of the country/city divide argument. However, only the larger regional centres will be afforded the faster FTTN solution, while the balance will be made up by ADSL2+ and WiMAX wireless technology. This, of course, has sparked another round of indignation from country folk who never tire of a good whinge.

The difference between fibre optic cable and copper wire is that copper offers high levels of “resistance” whereas fibre (which uses light pulses rather than electrical pulses) does not. This means that the longer the stretch of copper wire, the slower the broadband connection. Hence rural Australia could not rely on its existing telephone connections to deliver fast broadband with ADSL2+ as those little bytes get awfully tired and tardy when they have to make it all the way out to some remote location.

To lay fibre network to every remote outpost is also an expensive exercise, so the government’s solution is to leapfrog large sections of the copper connection using wireless technology. As long as there is a line of sight, wireless technology (which uses microwaves) can also provide fast broadband to rival fibre. This means that someone on the net in Broken Hill, for example, will be receiving data down existing copper wire that has travelled at least some of the distance from the city as microwaves. It may even be able to leave the city on fibre.

Not good enough, says The Bush. The copper requirement will still slow things down, proportionate to the distance travelled over copper, such that country folk may pay the same price for “fast” broadband but in reality it won’t be as “fast” as broadband for city folk.

The ALP has seized on such criticism, noting that its own plan involves FTTN for just about everyone. Politics aside, the Bush should really just get over it. The reality is that in a country the size of Australia with a widespread population it is not economically viable for the most remote to have equivalently fast broadband – at this stage of the game. Wireless technology is an imminently sensible solution. Of course there are also complaints that WiMAX is untested, being in its infancy, but then country folk used to be scared of doors that opened by themselves.

By adopting this solution, even if it smacks of knee-jerk policy on the run, the government has now ensured that Australia can get on with the important matter at hand – FTTN for the cities. The problem of rural and regional Australia has been solved. And at the same time the government has shown Telstra just who’s boss by handing the deal on a platter to Telstra’s biggest rival – Optus.

Go on. Go and try and hold us to ransom again.

The second half of the government announcement yesterday relates to the building of an FTTN network for urban Australia. Such a network would have been under construction a year ago if Telstra and the ACCC hadn’t reached a Mexican stand-off (no pun intended). Aware that the stand-off could last to eternity, the government has announced the creation of an expert panel to develop the framework for the tender process for FTTN, and to assess the proposals. The panel is made up of captains of industry and representatives from the government, the ACCC and the Australian Competition Tribunal. By putting such a panel in place, the government has circumvented the pre-existing need to bounce proposals back and forth between various government and quasi-government bodies, which would have ensured that Australia would commence building a fast broadband network about the time the rest of the world had up and moved to another planet. A solution can be reached in record time, and the legislation required to protect the owner of the new FTTN network could be put in place.

Did someone say election in November?

What will now follow is what analysts like to call a “beauty parade”, where anyone interested in building an FTTN network can tout their wares in front of the panel before a winner is announced. As much as Telstra probably feels like telling the government where it can stick its panel, it will be one contestant. The G9 consortium will be another, as will anyone else with a sufficient interest. An offshore entity perhaps? Either way, Australia’s fibre network will be built by whoever comes up with the best proposal.

And that will be Telstra.

Sure – the government needs to be seen to be doing the right thing as far as a tender process is concerned. And John Howard is still suffering for having given the nod to Australia’s least popular charro – Sol Trujillo – in the first place. Telstra has furthermore abused its relationship with the government to the point of indignant frustration. However, only Telstra can realistically build the network.

The reason is that whether we like it or not, and whether it was a stupid idea in the first place or not, Telstra owns all the existing infrastructure. This has two ramifications.

Firstly, a lot of the existing copper infrastructure can be simply adapted to fibre. There will be no need to dig more holes, erect more poles or build new exchanges – it’s all there. If Telstra were to win, an FTTN network could be rolled out pretty quickly.

Secondly, the government is only putting out to tender for an FTTN network, not an FTTH network. Hence the “last mile” of broadband delivery to the home will still have to include the existing copper wire connection that Telstra owns. Any consortium tendering to the government will still be forced to rent access from the incumbent. Can it possibly do this at a cheaper price than the owner can?

There is also a greater economic reality that for any non-Telstra network build to be viable it would require Telstra’s vast customer base to have access. Hence consortia crunching the numbers on their proposals will need to assume an access price that Telstra will be happy with. And it’s hard to see Telstra being happy with anything.

Nevertheless, if it is Telstra that gets the nod from the government, it will have to happen fast. Can it happen before the election? Analysts think this is unrealistic.

Despite the government’s move to speed up the process via establishment of the panel, there are still plenty of hoops that have to be jumped through in the tender process, and legislation that has to be rushed through as well. It is possible, but unlikely, that a resolution will be reached before November, which is when most observers suggest the election will be held.

Macquarie analysts suggest that the longer the tender process is drawn out, the less chance there is Telstra will be the shoe-in winner. It could take anywhere from two months to a year. A convoluted process would imply that the panel, and thus the government, is seriously considering that a viable, cost-friendly solution could indeed be reached if someone else builds the network. And if the ALP wins government in November, then we’re back to square one and anything could happen. The ALP’s current policy neither includes or excludes Telstra.

It is the because of timing uncertainty that most analysts are not prepared to make a call on Telstra valuation just yet. Credit Suisse, on the other hand, believes a Telstra win is the most obvious outcome and predicts consensus upgrades of 10% on Telstra valuation in FY08. The OPEL deal will mean that Telstra will lose its competitive advantage and dominant market share in the Bush, but the company has always maintained it only receives 5% of revenues from its rural customers. Furthermore, CS suggests that having given the Bush to Optus, the government fully intends to give the City to Telstra. CS is, was, and possibly always will be Telstra’s greatest champion, showing a target price of $5.54 against an FNArena database average of $4.76.

Moving now to Optus, there is a general agreement that the government’s announcement is a big positive. However, it is only a big positive within an otherwise negative scenario. Given Telstra’s domination Optus needs a leg up to boost returns on its fixed line network. While the rural win is just what the doctor ordered, Optus still has to face the prospect that Telstra will now seal FTTN, and then it’s back to a competition bunfight once more.

Merrill Lynch, however, suggests Optus could add $100-150m to earnings on the back of the rural network, and given the FTTN network will probably still be delayed. The reality is, nevertheless, that Optus contributes less than 20% of analysts’ valuations of the parent company SingTel, and so share price adjustment is minor. Macquarie has made no changes to either its SingTel valuation or its Futuris (parent company of Elders) valuation. SingTel remains Outperform but Futuris stays at Neutral.

The landscape is changing. Things are actually happening. But we’re still going to have to wait a while before we know the outcome.

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