Ruddnet too good to be true

commentary Kevin Rudd promised a broadband revolution if he became Prime Minister. A state-of-the-art, fibre-to-the-node broadband network would reach 98 per cent of the population. It would be built by the private sector with a $4.7 billion investment from the government.

That was the promise in 2007.

Malcolm Turnbull (Credit: Liberal Party)

Last week the tender was proclaimed a failure. None of the bidders came up with a worthwhile proposal. The Rudd Government's broadband revolution was dead.

It is a story too good to be true, told by a Prime Minister with no experience of business, happy to denounce the corporate world but not prepared to abide by the rules that apply to mere mortals

So, in order to distract attention from the total failure of his broadband policy, Rudd made an even grander promise. He said he would provide affordable, high-speed broadband at a speed of 100 megabits a second to 90 per cent of Australian households via a $43 billion fibre-to-the-household network.

Who could disagree?

Especially when the Prime Minister told us it wouldn't cost the taxpayer anything beyond the original $4.7 billion investment because the new National Broadband Network would be a commercial venture, so commercially attractive the private sector would invest (up to 49 per cent). It was going to be such a great deal that the Prime Minister urged "mums and dads" to invest in it via "Aussie Infrastructure Bonds".

But it is a story too good to be true, told by a Prime Minister with no experience of business, happy to denounce the corporate world but not prepared to abide by the rules that apply to mere mortals.

The assertions he made in his announcement and which he used to solicit investments from the public are not supported by a business plan, a financial study, advice from Infrastructure Australia or, so far as we know, anything other than his desire to get a big headline (it worked).

His own Treasurer, Wayne Swan, was unable to say how many people he expected to take up the service or what they would be asked to pay. And yet those are the two key assumptions that determine whether a venture such as this will be a good investment or a complete catastrophe.

A company director who encouraged the public to buy bonds in a company in similar circumstances would be spending a lot of time in the company of Australian Securities and Investments Commission investigators.

So, fantasy time is over. Let's look at some facts.

Everybody is in favour of widely available and affordable broadband internet access. And nobody more than me. But I am also a believer in telling the truth. So here are some truths.

Big infrastructure projects such as telecommunication networks, roads, tunnels and water schemes all have very high fixed costs largely made up of the cost of servicing the huge up-front capital investment.

For that reason it is vital to accurately estimate the likely level of patronage and the price the customers will pay.

Consider the Cross City Tunnel in Sydney. It cost nearly $1 billion to build; today, after a bankruptcy and its shareholders losing their investment, it is worth a fraction of that. Why? Because the owners' traffic assumptions proved to be wildly optimistic. As they were for the Lane Cove Tunnel and Melbourne's Eastlink. Just as well these were private sector projects and the capital loss was not borne by the taxpayer.

So if you invest $43 billion to run fibre into 90 per cent of Australian homes and businesses (about nine million potential connections) you need (unlike Swan) to have a view about how many will take it up and what they will pay.

And there are real risks and real competition.

Telstra has its own extensive broadband fixed line hybrid fibre network offering higher and higher speeds including, so Telstra claims, up to 100Mbps before Christmas in Melbourne and within a year or two in other capital cities.

In addition to competition at the fixed-line level, the new company, let's call it Ruddnet, will face competition from wireless. In the past six months 650,000 people signed up to wireless broadband services, four times the number that signed up to fixed-line broadband. As wireless broadband becomes faster and cheaper, its mobility and flexibility will offer real competition with fixed-line services, just as it has with telephony.

But let's make some very optimistic assumptions about Ruddnet.

Let's assume half of all the potential customers covered by the network take up the new service: that's 4.5 million connections.

Let's assume that they will pay $100 a month to their ISP and that $70 of that finds its way to Ruddnet.

If we assume half of Ruddnet's revenues go on operating expenses and depreciation is a low 5 per cent, then Ruddnet will lose $260 million each year without having paid a cent in interest or dividends.

All of these assumptions can be changed of course, but whichever way you slice or dice the numbers, one thing is very, very plain. Unless we (completely unrealistically) assume the vast majority of potential customers take up the Ruddnet services and that they will pay very high monthly fees in the order of $150 to $200 a month then there is no way that Ruddnet can deliver a commercial return on $43 billion of investment.

The truth is that a new broadband network of this kind could only operate with a massive government subsidy, probably most of the full $43 billion

Now some people might say: so what? Why doesn't the government just pay for it and then sell the services for whatever price it can get and take the loss on the chin?

This is another way of saying the government should borrow $43 billion and build a business that will, when complete, be worth a fraction of that amount if it is worth anything at all.

And Rudd has undertaken to sell the business five years after it is complete, so we could see the government spending $43 billion on an investment it subsequently sells for a pittance. Too bad for the taxpayers. We could have a debate about the merits of investing and losing billions in broadband: after all, we do not demand a commercial return from public roads or schools or hospitals.

But it is not the debate Rudd has kicked off. He has asserted his broadband network will be run at an arms' length from government in a separate company, generating a commercial return sufficient to entice private-sector investment in the shares and to warrant "mums and dads" subscribing to bonds, the interest on which could only be paid if the company was profitable. He made that assertion without any basis in fact. He has produced no analysis or advice to back it up.

The truth is that a new broadband network of this kind could only operate with a massive government subsidy, probably most of the full $43 billion. It is not good enough for the Prime Minister to bathe in the glory of adulatory headlines for his "broadband vision".

He must tell us, not later than the budget, what advice he has on the economics of this network, what assumptions it is based on, what returns it can deliver and if — as is inevitable — it requires tens of billions in government subsidies, what are the roads, the schools, the hospitals, the water projects and the ports that will not be built to satisfy his broadband vision.

Prime Minister, show us the numbers before you spend the money.

Malcolm Turnbull is the Federal Leader of the Opposition. This article first appeared on his website and is re-published here with his permission.