NBN a lose-lose deal for Telstra

A few weeks ago, I took on Optus for its decision to lodge not one, but two bonds giving it the right to bid on the national broadband network (NBN) contract.

This "schizophrenic" approach, I said, ran the risk of compromising the unified front that Optus and its partners-in-Terria had worked so hard to create. There was always the chance that the second bid was an insurance policy, of course, but I welcomed contact from Optus when it contacted me after that column.

I sat down over a cappuccino with Maha Krishnapillai, Optus' director of corporate and government affairs and one of the people most intimately acquainted with the bid, to find out what the hell was actually going on.

Maha Krishnapillai
(Credit: Slattery IT)

Conspiracy theorists could, he told me, move on: the secondary bid was indeed not so much an attempt to undermine Terria as a way to ensure that Optus was part of the bid no matter what happened with its consortium partners.

Apparently, the Department of Broadband, Communications and the Digital Economy is an entity so mired in its own probity that even a small change in Terria's composition could disqualify it from lodging a valid NBN bid. (If Telstra suddenly acquires one of the Terria members, we'll all know Sol Trujillo has been doing night classes at the Tonya Harding School of Negotiation).

Although Krishnapillai wouldn't share details about the company's NBN bid, he did expound on the structure of Terria, and the perception that it was just a way for Optus to heighten its profile during the tendering process.

If Optus was the largest player in Terria and had the resources to make its bid on its own, I asked, why even bother forming a consortium? The answer: Optus is carrying most of the financial weight, but the other companies are there as a show of support - and to show their commitment to bring their business with them onto the new infrastructure, should Terria win the contract.

Telstra has been quick to dismiss Terria in public, but after reading through its 2006-7 annual report, I suspect that in private its strategists have been quietly huddled in foetal position, thumbs in mouths as they contemplate just how to get out of this situation.

During 2006-7, the Telstra Wholesale business generated $2.957bn in revenues - 12.5 per cent of the company's entire revenues.

More important still is Telstra Wholesale's EBIT (earnings before interest and tax figures) of $2.867bn. In other words, accounting vagaries aside, Telstra apparently incurred just $90m in expenses, or 0.3 per cent of its revenues, administering operations that generated $2.957bn of wholesale revenues; that equates to a 97 per cent profit margin on wholesale services.

Compare this with the Telstra Consumer, Marketing and Channels business segment - the company's largest - which spent 41 per cent of its $9.509bn revenues on expenses. Or consider Telstra International, which generated $1.606bn in revenues but produced EBIT of just $61m - a sign of razor-thin margins (4 per cent) if ever there were any.

Now, consider the source of these wholesale revenues: a large proportion of them come from customers who buy their retail internet from Terria members.

Assuming the other Terria members keep their pinky deals with Optus, Telstra would lose nearly all of those wholesale subscribers as most of Australia's top 10 ISPs simply vote with their feet in the event of a Terria NBN win. There would of course be some customers forced to remain on Telstra wholesale services because of geography, but on the whole there would be no love lost - and one could expect the effect to be devastating.

Telstra knows all of this, which explains the belligerent tone its executives continue to take when discussing things such as operational change.

This has tainted the overall discussion about Australia's broadband future, turning the NBN tendering process into a debacle: timelines pushed back indefinitely, competitors exchanging derisive barbs like Spaniards at La Tomatina, Phil Burgess' predictable hyperbole, the government's futile attempts to keep everyone focused, and a growing tide of criticism that a minimum 12Mbps service is just too little, too late (for the record, I disagree; the mooted VDSL technology will run much faster than that in most areas).

Labor's policy of socialised broadband has certainly proved much harder than the party believed it would be back when it was in Opposition, but it is Telstra that stands to lose the most from the NBN - and that applies whether it loses the NBN contract or wins it.

Yes, even if it wins the deal, Telstra has a major problem on its hands. No matter how much it complains, it simply must provide competitors with open access to the network. History suggests that Telstra is hardly likely to embrace open access to its NBN infrastructure in the way that the government and its competitors are doing, and the growing tide of pro-separation rhetoric suggests that - in theory, at least - that remedy could await the company if its own concept of open access proves insufficient.

What's an ex-monopolist to do? Telstra executives have suggested they could pull out of the deal entirely if separation was mandated, and Optus has said it could do the same if separation was not. But that would cut Telstra out of a critical revenue stream, and handing the deal to Optus isn't going to improve things.

Telstra's Phil Burgess
(Credit: Telstra)

Given that Telstra's revenues would take a hit either way, I would suggest the company consider a third option: shelve its anti-separation arguments, draw up a workable plan for operational separation (I'm sure there are several contingency plans already filed away in Sol Trujillo's office), and work to build bridges with Terria members so that they're less loathe to jump ship as a symbolic measure.

When push comes to shove, Telstra has a tremendous amount of infrastructure that, if properly leveraged, could help it compete with any NBN that's out there. It could actually make competitors want to buy its services rather than feeling they were being gouged as if by a Big Day Out water vendor.

Terria, or any other tender winner, would also have to deliver commercial returns from its services, so it's not like the venture could just give away its wholesale services. This leaves Telstra a painful, but more beneficial in the long term, strategy for remaining relevant.

The issue may likely stretch out far longer than expected - I wouldn't be surprised to see the NBN become an issue with the 2010 election as well - but Telstra has well and truly painted itself into a corner. Terria has given Optus the market weight it lacked, and a bloodless NBN war with Telstra would give the whole industry a clear direction forward. The sharks are circling - and it's up to Telstra to decide just how big a bite they take.