NBN cleared for bumpy take-off

The happiest, but most impatient, person in the country today is probably NBN Co's Mike Quigley. While there are a couple of procedural acts still to be performed, the controversial national broadband network is about to be cleared for takeoff.

With the NBN rollout now eight months behind schedule, and the window before the next federal election now half-closed, the delay in getting Telstra's structural separation undertaking approved by the Australian Competition and Consumer Commission was putting the network in jeopardy.

The Coalition has made it very clear that if it were to win the next election it will halt the rollout and replace the all-fibre NBN with a far cheaper mix of technologies that would deliver slower but ‘fast enough' broadband.

So, after today's ACCC acceptance of the undertaking, only a couple of government sign offs stand between Quigley and the ability to accelerate a rollout that has been hampered by NBN Co's inability to access Telstra's data, infrastructure and customers until the final pre-condition for the $11 billion (in net present value terms) deal between Telstra, NBN Co and the government – the ACCC approval – had been met and the deal locked in.

Quigley will now have Telstra's full and no doubt enthusiastic cooperation because it is in Telstra's own interest to expedite the rollout in order to maximise its own income streams both in the near term and the long term. Like NBN Co, Telstra will want to see as much of the NBN built as possible before there is any possibility of the rollout being halted by a change of government.

Telstra gets three streams of value from the agreement it struck with NBN Co more than 18 months ago and turned into a definitive agreement last year. In net present value terms it will receive about $5 billion from providing NBN Co access to its infrastructure; $4 billion for disconnections as its transfers its own customers onto the NBN and $2 billion from the government in the form of a range of payments and savings.

A big lump of the value is locked in early via the infrastructure access payments, effectively the leasing, long term, of access to the infrastructure, from annuity-style payments for the disconnections and from payments from the government for providing the universal service obligation.

When Telstra's independent expert, Grant Samuel, looked at the various outcomes that might occur from the deal with NBN Co it concluded that the best outcome for Telstra shareholders was one where the deal was locked in and subsequently terminated after a change of government. It calculated the benefit to shareholders at $11 billion of net present value.

At present, because of the long delay in executing the agreement – the NBN was announced nearly three years ago and the heads of agreement signed nearly two years ago – the rollout is well behind schedule. NBN Co has five test sites up and running and only about 15,000 customers.

While it expects to now have about 750,000 premised passed by the end of this year, the original schedule would have seen about 1.72 million premises passed – about 14 per cent of the eventual network coverage – and more than half a million customers signed up to the network by June 30, 2013.

Because of the extent of the delays in getting the undertaking approved that's not going to happen.

Quigley and Telstra's David Thodey would be well aware that even if there is a change of government next year the rollout can't be instantly or simply stopped. The Coalition almost certainly won't have control of both houses and therefore will face a battle to get the legislation required through parliament.

Even if it could, with Malcolm Turnbull promising a Productivity Commission cost/benefit analysis of the network, it would probably be some time well into 2014 before a new government could act. By then a meaningful proportion of the network – probably something in the high teens – will have been built and a disproportionate amount of the value of the deal with Telstra irrevocably committed.

The other problem Turnbull would face is that Telstra has retained ownership of its copper and cable networks. If the deal with NBN Co were torn up and Turnbull proceeded with his alternative, which also includes the structural separation of Telstra's fixed line retail business and its infrastructure, he'd have to negotiate a new and inevitably costly deal – Telstra might get to double-dip. Plus he'd then have to fund his version of a fibre network, presumably a fibre-to-the-node network, or at least some proportion of it.

While Quigley would be over-joyed that the rollout can now get properly underway, the eight month delay will be costly and is potentially very damaging for NBN Co.

Because the rollout is so far behind schedule there will be a significant financial impact for a project that has very skinny tolerance – there isn't much of margin between the expected 7 per cent return over the life of the project and the risk-free rate.

If the anticipated returns were to fall below the risk-free rates there would be a very strong argument that NBN Co's numbers – and it anticipated large losses during the early years, with losses of about $1.8 billion and spending of about $9 billion – should be included in the federal budget.

Those early-year numbers may have already deteriorated because the rollout is so far behind the schedule originally envisaged within NBN Co's business plan and because the take-up rate by households appears to be running below that forecast – although now that Telstra is on board and will start to shift its customer base onto the fibre that may well change.

NBN Co's corporate plan for the period to 30 June 2013 was released in 2010. It was supposed to have lodged its latest plan before Christmas but it has been delayed – presumably because of the hiatus until the ACCC dealt with Telstra's undertaking – with the government only recently receiving a draft.

It would appear a reasonable assumption that it will contain more red ink than the initial plan and that either the life-of-the-project revenue assumptions might have to be lifted or the expected returns lowered, which would be slightly unsettling for Wayne Swan as it would bring the $36 billion-plus project costs ever closer to his promised budget surplus.