Is the NBN Strategic Review's terminal value terminally wrong?

Is the NBN Strategic Review's terminal value terminally wrong?

Summary: As the country waits for the results of the NBN cost-benefit analysis (CBA) it's worth looking back over the NBN Strategic Review – and reconsidering whether its assumptions about the long-term value of NBN Co aren't excessively optimistic.

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Now that communications minister Malcolm Turnbull has put the national broadband network (NBN) and the entire telecoms industry into idle – while we wait for the results of the Telstra renegotiations and the findings of the Vertigan cost-benefit analysis (CBA) review – we have time to revisit and reassess the findings of the last official output we have seen from the current government.

That, of course, is the NBN Strategic Review (NBNSR) – completed in six weeks and handed down as gospel last December. This highly speculative document has been constructed and feted with an air of authority, yet was torn down in the interim report delivered by the Senate Select Committee on the NBN back in March – which was, predictably and despite its rather voluminous size, both refuted by the committee's Coalition members and completely ignored by the government.

NBNSR
Can stringing together legacy networks help NBN Co build another Telstra by 2040?

Among the many points that are buried within the NBNSR is a financial model that seems to have been tailor-made to justify the multi-technology mix (MTM) model promoted by the review as being more cost-effective and easier to complete quickly.

That whole objective was all but rubbished by NBN Co chairman Ziggy Switkowski, who has publicly conceded that the project needs to ramp up so aggressively as to be all but impossible to achieve under current guidelines. The Coalition has yet to offer a clear strategy about how and when the company is going to ramp up to roll out what Switkowski has conceded must be 100,000 premises per month for the next eight years.

Turnbull, as has become his habit lately, has failed to produce any real answers that don't directly indict Labor for everything wrong with the NBN today – even, seemingly, the 2020 rollout deadline to which the Coalition committed itself with the NBNSR.

The NBN Strategic Review has already been discredited on numerous counts (see, for example, here and here). Yet if we are to take its promised 2020 deadline seriously – and all indications are that Turnbull still expects us to do so – we must also take seriously the NBNSR's projections around the long-term value of the NBN Co business.

That projection relates to the terminal value of the NBN – that figure used in accounting in the same sense that The King and I's Yul Brynner used the words 'et cetera, et cetera'. In other words, the terminal value of the Coalition's NBN represents everything that it expects will happen in the future but can't be bothered detailing.

The NBN Strategic Review addresses terminal-value calculations on just one page (p107), explaining that its internal rate of return (IRR) calculation of 5.3 percent is based on a terminal value of $45 billion in FY2040.

The NBN Strategic Review has already been discredited on numerous counts. Yet if we are to take its promised 2020 deadline seriously – and all indications are that Turnbull still expects us to do so – we must also take seriously the NBN Strategic Review's projections around the long-term value of the NBN Co business.

This valuation is “mechanically” calculated as being six times EBITDA for the theoretical revenues of NBN Co some 25 years from now – and 15 years after 2025, when by Ziggy Switkowski's own reckoning NBN Co will have already started to transition to a FTTP model.

By 2040, the actual NBN – the one based on the fibre that the Coalition refuses to pay for now – will have been built and will be based fully on fibre. Real revenues will therefore be based not on the services the government wants to build over its MTM model now, but on those that will have become capable over the FTTP network as it comes online.

While the NBNSR doesn't highlight the expected schedule for the transition to fibre, its revenue projections over time leave us with enough information to assume that we can figure out when it will happen. Those projections forecast a drop in cashflow during FY2029 and FY2030 – a period when the MTM model will be seven to eight years past completion and starting to show signs of technological and physical obsolescence.

This will therefore drive an investment in the fibre network that the government still acts like we won't need – pushing cashflow back up in FY2031 and helping it rise through FY3036 – after which another two-year decline will likely accompany another period of decision-making as the current infrastructure once again shows signs of age.

We cannot expect a complete upgrade at that point, however: judging by the information in the NBNSR, the government expects that its network – upgraded twice after the current belt-and-braces upgrade – will have a market worth of around $45 billion in FY2040.

The Abbott government needs this figure to be correct, because it is directly tied to the potential return on its investment. That return is, of course, the combined total of all revenues through 2040 plus the value of the remnant operation at that time, as against the expenses required to build and run the business to that date. A lower terminal value would reduce the overall return – thereby trimming that 5.3 percent IRR figure down to something far less attractive.

That would be unacceptable to the current government because it would suggest that the MTM model would not generate as much economic value for Australia as they're saying it will. By extension, it would also narrow the claimed financial improvements over the rival all-FTTP model. This would, necessarily, raise questions about whether MTM is indeed the best way forward, as the Coalition government has unilaterally decided.

The question to ask, then, is simple: Does the $45 billion terminal value assigned in the NBN Strategic Review seem reasonable?

To arrive at an answer, consider comparable large-scale transactions that offer relative values for comparison. For example, Telstra's EBITDA in FY1997, just before one-third of its shares were sold off in the $14.3 billion T1 share offer, was $6.597b. Using the six-times-EBITDA measure we would derive a total value for the company of $39.582 billion in 1997 dollars, meaning that one-third of the company would have been worth around $13 billion and the government did very well because the market actually valued Telstra at $43 billion (6.5 times EBITDA).

In FY1999, leading up to the T2 offer, Telstra's EBITDA sat at $5.849 billion, giving a six-times-EBITDA value of $35.094 billion. By this measure, the 16 percent of shares sold during the T2 offer would have been worth $5.615b, but they generated $16 billion for the government – suggesting that the market actually valued the whole of Telstra at $100b (17 times EBITDA) at the time.

Judging by the information in the NBNSR, the government expects that its network – upgraded twice after the current belt-and-braces upgrade – will have a market worth of around $45 billion in FY2040... The Abbott government needs this figure to be correct, because it is directly tied to the potential return on its investment....A lower terminal value would reduce the overall return – thereby trimming that 5.3 percent IRR figure down to something far less attractive.

The T3 offer didn't fare so well: in 2006, the government sold 34 percent of Telstra's remaining shares for $15.5 billion; this valued the company at $45.58 billion (8.2x EBITDA) overall. Telstra's FY2006 EBITDA was just $5.497 billion – providing a six-times-EBITDA value of $32.982 billion.

In other words, in 1997, 1999 and 2006 the market valued Telstra at 6.5, 17 and 8.2 times EBITDA to give it market values of $43 billion, $100 billion, and $33 billion on revenues of $15,983b, $17.571b, and $22.75b respectively.

These figures would seem to support the 6-times-EBITDA metric – but can we therefore assume that NBN Co in 2040 will have an EBITDA of $7.5 billion?

A more recent overseas infrastructure purchase – the $US45b ($A48.52b) purchase of second-place US cable provider Time Warner Cable (with 11m subscribers) by number-one Comcast (with 30m) – gives us a point of comparison because the numbers are conveniently similar.

Sort of.

Comcast is paying 6.7 times EBIDTA for Time Warner Cable in a move that will increase its subscriber base by one-third.

Those figures, and the numbers assigned to Telstra above, might seem to vindicate the government's assessment of a MTM-based NBN Co based on a six-times-EBITDA valuation. However, they don't offer much guidance about whether the revenue projections for 2040 are anything more than fantasy.

Chief among those is the fact that NBN Co is not a retail provider, and will not be able to benefit from increasing markup on new products into the future; its business, under current design, is providing a wholesale bitpipe and nothing else.

Without the opportunity to value-add on top of its services, NBN Co will face gradual price attrition over time – driving down revenues by up to 30 percent against the previous FTTP model by 2021, as NBN Co modelling revealed late last year. Because the MTM technology would limit the type of services that can be offered, there is limited potential to add new revenue-generating services in the future.

Can a nationwide, mixed-technology, wholesale-only network be reasonably expected to generate similar revenues to Time Warner Cable? Remember that we are talking about a diversified TV-broadband-phone-and-services market with 11m subscribers and strong ties to not one but two content-distribution empires; there is an integrated infrastructure-and-overlays story in that purchase of which NBN Co can only dream.

Can the NBN therefore be worth as much as the NBNSR believes it will? It seems like a fair stretch, given that the Coalition's IRR projections depend entirely on the terminal value that they have assigned the business at that distant point in the future.

That terminal value basically depends on NBN Co becoming a money-spinner on the scale of what Telstra was when it was sold off to the market. And that's a big ask – but a necessary one if the NBNSR is to hold water. Were the actual terminal value to be, say, 25 percent lower by that point, the Coalition's entire revenue model would be thrown into chaos – and its decision to forego a more-profitable FTTP network revealed as being highly questionable indeed.

What do you think? Are you comfortable with the Strategic Review's terminal-value calculations? Can NBN Co become as big a venture as Telstra or Time Warner Cable without the same retail margins and breadth of services? And, what does all this mean for the Coalition's RoI calculations?

Topics: NBN, Broadband, Fiber, Government AU, Telcos, Telstra

About

Australia’s first-world economy relies on first-rate IT and telecommunications innovation. David Braue, an award-winning IT journalist and former Macworld editor, covers its challenges, successes and lessons learned as it uses ICT to assert its leadership in the developing Asia-Pacific region – and strengthen its reputation on the world stage.

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Talkback

9 comments
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  • Copper is valueless in a fiber world

    When copper is due to be replaced by fiber we already have a historical basis on which to estimate its value.

    Nothing.

    This is the amount that NBN Co was willing to pay telstra just a few years ago (when there was the intention to build fiber) for it's copper assets.

    What will change to magically increase this value?
    Paul Krueger
    • What will change to magically increase this value?

      The government.
      colonel.mattyman
  • Dragging their feet.

    "pushing cashflow back up in FY2031 and helping it rise through FY3036"

    1005 years. Seems about right ... :)
    colonel.mattyman
  • question about the comparison

    Just a query about the comparison to Time Warner and also the 30% reduction in incomes mentioned.

    If the NBN is the sole wholesale provider then what reason would it have for dropping its prices at any point? It's not like there is an alternative for the retailers to source their supply anywhere else after all - so what could drive that?

    And Time Warner although offering more services was only a part player in the market, whereas the NBN Co will be the market when it comes to the whole sale business - so isn't it more likely to be in line with the previous Telstra sales?

    Oh and is there a possibility for them to move into mobile or wireless infrastructure at some point meaning basically if you get an internet connection anywhere that it runs over their network?
    aesonaus
    • I don't think there would be support for it

      People support the NBN because it was government correcting a market failure in the fixed line internet business. Telstra basically abandoned fixed line except where it is made to support it due to the USO, and that is only for voice.

      While there are some areas that have 'issues', there is no such failure in mobile or wireless in Australia and I don't think folks would actually support them there.

      I'm also pretty confident in saying that Telstra, Optus and Vodaphone would mount major campaigns to keep them out of mobile/wireless...

      Also, the ACCC sets NBNCo pricing, so NBNCo can't just charge whatever it likes.
      Tinman_au
      • thanks

        Yeah fair point about the wireless /mobile part - i wonder if hotspot only would fly everywhere given that's how they are meant to be doing the regional/rural areas already.

        The ACCC doing the pricing makes sense then as to why there would be a potential for decreases. I wonder though - at sale time would that remain the case in which case wouldn't that hamper the sale value? Or would it be something like the power companies where they submit to get approval for their increases each year?
        aesonaus
  • Written off before its even completed. Tens of billions wasted.

    I think you are being way too generous. There are two reasons why the MTM is a recipe for failure. One is the physical state of the network and the escalation of maintenance/remediation costs. The other is obsolescence. Both of these are risks written in letters of fire a mile high. And both are ignored in a document that isn't just incompetent. Its fraudulent. Anywhere else you were to submit a business case like this and you'd get laughed at or taken to court. There's just no risk analysis. Its a con job.

    Cisco estimated that the worldwide trend in fixed internet connections is for a speed increasing at roughly 30 percent per year. Meaning that by 2016 the average fixed internet connection will be 36Mbps. On the same trend, by 2021 it will be 128Mbps. And toward the end of the 2020s it will increase to 1Gbps. You either subscribe to the theory that the Australia is unique and will suddenly and inexplicably experience an end to Internet growth. Or you have to acknowledge that the MTM prima facie will be obsolete before its completed.

    So we either head into the late 2020s so far behind the rest of the world that we change places with where much of Africa now stands, or the pressure to abandon the MTM is so strong that it has to be written off long before the tens of billions spent on it could be recouped. That's if it can be recouped. Which brings me to the other risk factor.

    Currently the copper network costs the better part of a billion dollars to maintain. That is based on a "voice only" level of performance. This isn't what it would cost to bring the network to ADSL competence and we already have an increasing number of residences where whilst the phone might still work, ADSL won't. Now, VDSL is a different creature. It relies upon a much higher set of frequencies. Now without getting too technical, not only does this impose higher standards on the copper, but all the effects of ageing, including microscopic defects in the surface of the copper add up to even higher levels of loss, and outright failure to synch. Not everyone of course will feel this, but if the SR were honest it would acknowledge that a true VDSL network is going to cost at least double in maintenance/remediation. No such luck of course. The significance is that whilst a MTM network will have lower revenues, on the other side it will experience copper maintenance costs creeping into the billions per year.

    Its entirely possible that even if you skipped over the obsolescence by 2020 part, the network might never break even. In plain simple terms, that's tens of billions of dollars written off.

    I do wish that the media would report this for what it is. The single biggest and most expensive government blunder ever. One we can still prevent.
    Russel-07615
    • Not a Blunder but a Backroom Deal.

      Just payback to Murdoch for his 3 years of blanket News Ltd anti Labor, pro LNP propaganda to get his mate Abbott installed to demolish the NBN in order to protect his media/Foxtel Empire from competition.
      He even provided the venue for the policy launch of this crippled dog's breakfast of mixed, outdated technology that gets him a free upgrade of his HFC network at our expense.
      grump-a1eeb
  • +1 The fraudulent NBNSR

    Russel, you & David have highlighted all that is wrong with the NBNSR & MT's thick headed bombastic attitude.

    Unfortunately we have a pig headed Senator (MT) who doesn't want to admit he is dumb bean counter who can't read & doesn't want to admit he is up a creek without a paddle..

    Nothing will change until we have a few more politicians who are educated & open minded. MT may be the former but he certainly isn't the later !
    Huntsman.ks