THE DISTILLERY: Telstra exchange

Some interesting new details emerge in old stories today.

First up, Malcolm Maiden of The Age, Alan Jury of The Australian Financial Review and Alan Kohler of Business Spectator all write about the ongoing Telstra/NBN saga. Jury has drawn-out calculations on value before concluding "...somewhere in the middle is a compromise that should satisfy everyone”. Maiden and Kohler, on the other hand, agree that current negotiations are stalled because Telstra management cannot legally accept NBN offers of around $8 billion for their cooperation because the figure is still value-destroying. Both also see little likelihood of the government stepping in with a one-off payment to Telstra to get a deal over the line. Which, in this column's view, is a relief, in this era of bailouts. Both also refer to the still-secret McKinsey report as evidence that the NBN can go it alone.

Kohler, however, takes the next step and declares that it is "less and less likely that Telstra and the NBN Co will agree on a deal". Supporting this contention, Kohler has a series of scoops beginning with the revelation that "Communications Minister Stephen Conroy is understood to have given them a month, after which the NBN will be built without Telstra's traffic or co-operation.” Also new is the information that the NBN's "wholesale pricing will be surprisingly low”.

But the freshness of Kohler's piece is most apparent in the thinking. He dedicates the closing half his column to the implications for Telstra of its continuing universal service obligation (USO), should negotiations fail. "There is no suggestion the USO will be removed once the NBN is built: far from it – it will be strengthened. The USO will not rest with the NBN Co, since it's a wholesale-only operation and can't actually provide all Australians with reasonable access to a phone service. So it stays with Telstra. The practical result of this will be that Telstra cannot shut down any of its 5000 telephone exchanges while there are still customers using that exchange – even if the exchange is no longer viable because most have switched to the NBN fibre ... the percentage of households and businesses in each exchange area that are needed to make the exchange worth operating is more than 50 per cent ... if half the customers in a particular area move to a fibre-based supplier instead of copper, then Telstra must close the exchange or lose money. But it can't close it because of the USO. That means the only sensible thing is for Telstra itself to switch whole exchange areas across to the NBN at once, rather than one customer at a time ... Telstra will still have to use the NBN to carry its traffic – not immediately, but progressively, within ten years.”

Another ongoing deal occupies John Durie of The Australian and Stephen Bartholomeusz of Business Spectator who address Kerry Stokes plans, but without Ian Verrender's verve of yesterday. Durie points out that under the deal, "... Seven executives will also get windfall gains. Under the terms laid down in the scheme booklet, Seven boss David Leckie and comrades including Bruce McWilliam, Peter Meakin and Peter Lewis get to convert 6.9 million options into Seven shares when the Stokes shuffle is completed. To be fair, they have to pay the exercise price, which ranges from $7 to $9 for the different schemes, but all of a sudden what were designed as long-term incentives suddenly get to be cashed out next month or thereabouts. This means the incentives are de-risked and a mockery is made of the remuneration policies approved by shareholders.” Durie also notes that a "$207m [tax] increase has magically been cut to just $21m thanks to asset shuffles completed in the deal.” He concludes, "the information overload delivered yesterday provides some more guidance, but the final decision rests with whether you are comfortable with the promise of a 22 per cent increase in earnings per share on your diluted ownership to back Stokes ... The word around town says the deal is still at best an even-money proposition.”

Bartholomeusz sees this even split as a function of "the unusually wide valuation ranges Deloitte came up with for both Seven Network and SGH shares. It valued Seven Network at between $7.65 and $9.51 a share and SGH at between $7.09 and $8.57 a share. Clearly, at the top end of the range of values for Seven Network, the non-Stokes shareholders would be giving up very substantial value by taking the SGH paper. The main reason the ranges are so wide is the difficulty in valuing Seven Network's 47 per cent interest in Seven Media Group (SMG), the joint venture with Kohlberg Kravis Roberts & Co that owns Seven's main underlying media businesses, and a similar difficulty in valuing WesTrac's China business. Seven Network's interest in SMG was valued at between $305 million and $493 million while WesTrac China was valued at between $272 million and $351 million. The valuation ranges for most of the other assets involved in the proposal were far tighter.” Bartholomeusz puts this "lack of precision” down to "SMG carrying about $2.3 billion of net debt, so relatively small differences in the valuations of its assets translate to large changes in its equity value.” And in the case of WesTrac, "WesTrac China is a relatively youthful company – it started operations only a decade ago – in a high-growth market, which means that its value is very sensitive to the assumptions made about its prospects and the way the growth, if realised, flows back into its profitability.”

This column will add that Deloitte's savvy is obvious in providing a range of valuation you could drive an earth mover through.

The spectacle of vested interests examined by Matthew Stevens of The Australian over the Queensland Rail privatisation continues. However, all that is new in substance in his latest comment, so far as this column can tell, is that "... last week the coal companies revealed an intention to prepare a counteroffer for QR and it is believed that any offer would be structured to provide the government with three or four options, each of which would be based on pricing metrics that offer a premium to the $3 billion publicly expressed as the target for an IPO.”

On the economic front, Tim Colebatch makes an impassioned plea to Australians to abandon their housing obsession because it is bad for us as a nation. First, he argues the young are being disenfranchised. "Since September 1987 ... average house prices in capital cities have risen by 433 per cent ... a typical house that was an affordable $100,000 in September 1987 cost $533,000 by December 2009. But haven't incomes risen too? Yes, they have: but by only 195 per cent ... The cost of a typical home, in this example, used to be 3.33 years' disposable income. But now it costs six years' income”. According to Colebatch, this has resulted in "... the proportion of 25 to 34-year-olds who owned their home [falling] from 52 per cent to 43 per cent” in the past twelve years.

Second, he argues "... since Labor restored the tax break for negative gearing, tax records show, the number of landlords has trebled to more than 1.6 million, while their declared losses have multiplied to more than $10 billion a year. The tax break means about $4 billion a year is paid for them by other taxpayers.”

Finally, he argues, "upgraders – despite being home owners already – are made worse off by rising prices. They now face a bigger gap between what they receive for their old home and what they must pay for their new one.”

He concludes that "rising prices are inflation. We don't think higher petrol prices or higher fruit prices are a good idea, although they certainly make someone better off. Why do we think inflation is such a good thing when it applies to owning a home?” This column couldn't agree more.

Alan Mitchell of the AFR argues that Tony Abbott would be better off looking at "cutting marginal tax rates for mainly female second-income workers” to help support parental leave.