A long and complex negotiation process has been concluded and Telstra will be putting to shareholders a vote to gain $11 billion of “value” from taxpayers. David Havyatt asks if taxpayers or shareholders are the winners.
In economic theory market transactions occur because both parties gain from the exchange. That is, the buyer values the goods at a higher value than their price while the seller values them lower.
When the Government changed its NBN plan to a fully Government-owned fibre-to-the-home network, Telstra was confronted with a risk of overbuild and stranded assets versus the opportunity to provide services to NBN Co. NBN Co had the opportunity to reduce its costs by accessing Telstra infrastructure, and improving its business case by speeding up the revenue earned for its infrastructure.
It looked like a transaction was possible. But there was a problem; NBN Co valued the participation of Telstra at $8 billion, while Telstra thought the value was $12 billion.
The gap was closed by the Government offering $2 billion of value to Telstra, and each of the other parties giving up $1 billion of value. That means there are two sets of important agreements whose final details have been announced, those between Telstra and NBN Co and between Telstra and the Government.
Telstra and NBN
Telstra is receiving two sets of payments from NBN Co; one for migrating its customers and another for leasing of infrastructure.
There isn’t a sudden payment to Telstra of $11 billion. Telstra receives cash-flows over the ten year roll-out for disconnection payment and a thirty-five year period and for infrastructure. The latter is also indexed to CPI (inflation).
Telstra hasn’t been forthcoming about the actual distribution of the cash flows. An analysis of who wins and loses from this deal requires that level of detail.
What we are left with are assumptions.
The $11 billion value claimed by Telstra is the Net Present Value (NPV) of these cash-flows. Calculation of an NPV – the value of what those payments represent to shareholders today - requires use of a “discount rate”.
Telstra has chosen its internal cost of capital of 10 percent to value the NBN deal. That ten percent rate is rather arbitrary, but matters much in terms of the figures Telstra is telling the market.
What if we used a different discount rate? In submissions to regulator ACCC in 2008, Telstra argued that a WACC (weighted average cost of capital) of 12.27 percent should be used to calculate the prices to be paid to access Telstra’s network, in an attempt to maximise how much its wholesale customers should have to pay to cover the cost of capital for infrastructure.
What if we applied the 12.27 percent figure, rather than the ten percent?
Cash flows can be estimated by creating a profile of the payments and – with judicious use of Excel’s Goal Seek function - working out what the actual level is to match the NPV disclosed.
Considering the long time scale involved in NBN Co’s lease of Telstra’s infrastructure, using the higher WACC as the discount rate the Net Present Value comes down to a shade over $7.5 billion.
That’s something Telstra shareholders should consider.
Whether its $11 billion or $7.5 billion, Telstra CEO David Thodey claimed the transaction will deliver more value to shareholders than the alternatives.
The primary alternative was to not use the NBN and compete against it. Shareholders aren’t so far being provided with the cash-flows under the different scenarios to make that comparison.
Telstra, as expected, is limiting future use of its HFC network to Pay TV. Optus also apparently committed to not use its HFC for residential services of any kind – including Pay TV. That might explain the apparently higher value per migrated customer being paid to Optus.
It will be nice if Telstra and Foxtel can come to an agreement about their migration to the NBN. We could then have a big environmental win of losing two lots of overhead cabling.
Telstra has also committed not to use its wireless network to compete against NBN Co for migrating customers, though this is stated by Telstra to be only a “very small percentage of revenue going forward” for NextG. In other words, it has never been part of Telstra’s plans to target wireless only homes.
Contrary to assertions by Malcolm Turnbull that the NBN results in broadband prices that will “be high and stay high”, the Telstra NBN deal locks in the $24 per month Basic Service Offer. That’s $24 wholesale for a 12/1 broadband with 150 Kbps of protected transmission for voice.
Telstra and the Government
The agreements with the Government – the attempt to close the gap between the differing valuations of Telstra’s network - are more confusing.
Changes to the way the Universal Service Obligation and Emergency Call Services are provided are a welcome relief; these are now transparent transactions rather than internal cross-subsidies.
Ultimately, however, Telstra is getting a long sought for lift in the recognised cost of the USO, but the level of industry levies will be capped for the next two years. The new amount is based on a report from Castalia which estimates the USO net cost for the Standard Telephone Service in the range $215 - $262 million.
This is a long way short of the billions of dollars Telstra has historically claimed. That the author of the Castalia report, Dr Paul Paterson, was once Director of Regulatory at Telstra in eras when they claimed a much higher value adds an ironic twist.
Half of the $2 billion value from Government is described as “Other Government Commitments”, the only such commitment commented on thus for is for the “retraining and redeployment” of Telstra staff.
Implications for future and alternative policy
The agreements are all backed by various financial guarantees from the Commonwealth.
Telstra in particular has a guarantee for a contribution if they get left with a piecemeal network due to a delay in NBN Co being completed. Any change of policy will require new negotiations, not simply walking away.
The coalition has moved on from the proposition that wireless could be a substitute for fibre and is now talking up the option of Fibre-to-the-Node. There is nothing in these agreements to particularly facilitate that, but equally nothing to prevent it being renegotiated.
But Telstra itself probably isn’t that interested anymore. That was a strategy of five years ago, a strategy that was destroyed by the intransigence of Sol Trujillo and his inability to contemplate structural reform. And Malcolm Turnbull has stated he is equally committed to structural reform.
David Thodey was stark in reminding shareholders that at the AGM they will be asked to “to vote on what is best for Telstra within Government Policy, not vote on an alternative Government Policy”.
The transactions are still subject to a number of approvals including that of the ACCC on the Structural Separation Undertaking. Any move by the ACCC to use this process to impose additional separation now could jeopardise the deal. “Legislation doesn’t cover the double separation of Telstra and Telstra will not consider it,” Thodey said.
Telstra regarded ongoing ownership of its assets as important, but the company also will reconsider its capital management once the transaction completes. One option they might consider would be to spin some infrastructure assets off into a tidy separate utility company.
Telstra in particular solves its problem of needing to replace its fixed access network and to be able to replace its voice switches with the “soft switches” that featured in their technology strategy in 2005. NBN Co gets a secure customer base and more importantly can get on with the network build.
The deals actually seem to meet the economists’ description of being good for both NBN and Telstra. In which case the winners will be all of us – whether we are communications customers, Telstra shareholders or taxpayers… or in many cases, all three.