Monday, March 22, 2010

Ahhh Telstra and the demonstration of theories of value

Some years ago I crafted the line that "Telstra is like a giant broken washing machine - the only cycle that works is spin."

I think they are missing some of the magic they had in those days, but it is still distressing that we don't seem to be able to distinguish between "telecommunications policy" and "Telstra policy". That is probably the most damning indictement that can be made of the post 1997 telecommunications policy outcomes. While Richard Alston and his Liberal successors wanted to take all the claim for the competition reforms, they also need to take the blame for privatising the telco before they worked out the industry structure.

Our most recent discussions in the public sphere have revolved around the question of what value should be placed on Telstra's co-operation on the NBN. My first quick response to this has always been "nothing". The value to Telstra should be fully captured through a set of cash flows into the future - one from NBN Co to Telstra for use of exchanges and ducts, the other from Telstra to NBN Co for ongoing services. But it seems that what is being discussed is a lump sum for an asset.

It also seems that negotiation isn't progressing, despite the fact that the SMH (Ari Sharpe) reported on 16 March;

After meeting Telstra government relations chief James Shaw, the Family First senator said he believed a deal between the company and the government over Telstra involvement in the national broadband network was imminent, undermining the need for the bill to split the company.

The next day day Malcolm Maiden in the SMH had a tip that;

Political infighting about the government's proposed new national broadband network is continuing. Yet behind it the fact remains Telstra and the NBN Company are still far apart on the question of how much Telstra should be paid to co-operate with the network's construction.

Quite a dramatic step over one day! This story floated the preposterous idea that the gap between the value the NBN Co would put on the Telstra asset and that Telstra would place on it should be filled by the Government.

Maiden has been pleased to write on Saturday about Telstra's ASX release which provided the suggestion that Telstra does, indeed, fancy the idea of a gap closing payment by Government.

As Maiden seems to be so well placed we should consider with concern his suggestion that the USO will provide a mechanism for this strange extra payment. Maiden writes;

Nobody really disagrees: estimates of the true cost of servicing the USO range from $550 million to $1.7 million, a calculation Telstra made in 2007 when Sol Trujillo was chief executive and Donald McGauchie chairman.

I think we need to remind him that lots of people do disagree - that there is a thing called the intangible benefits of the USO. These intangibles are best summed up by the extent to which Telstra likes to take all the credit for servicing rural Australia as if they really do it because they care. Either they care or they don't - it is meaningless to claim you care when on the other hand you claim you'd run away if the law was changed.

ATUG award winning journalist Stephen Batholomeusz has done a great job in noting that Telstra needs to strike a deal or simply be carved out of future consideration. The NBN can and will be built without them, and Minister Conroy can limit their ability to compete merely through legislative instruments.

So what lies at the heart of these "valuation" gaps?

At its simplest the gaps represent the gap between an assessment of the value of an asset in use versus its value in exchange. The "value in use" is the classical net present value of the expected future cash flows of an asset. The value in exchange is the amount someone else is prepared to pay you for it.

Most times the numbers overlap the other way, we voluntarily participate in market exchange because the buyer places a higher value on the goods than the seller. But it is not always the case. One of the specific issues in the case of value in use is the reliability of the forward estimate. In this particular case Telstra's valuation probably includes an explicit provision for the value to Telstra if the NBN is not built. In NBN Co's case it is merely the actual asving they make on future costs.

This raises a really interesting question of the whole regulatory regime. In theory access prices for Telstra's network have been based on the "efficient forward looking cost" to provide the services. There should in that case be no gap. What Telstra is admitting is that their existing business model is one in which they continue to obtain above cost returns from their infrastructure. The valuation gap is the net present value of the mark-up they have obtained from market power.

The concept of "value" in economics has a long history. The poster boy of the neo-liberals actually subscribed to a Labour Theory of Value (as did both David Ricardo and Karl Marx). In this theory the value of a good is the cumulative labour necesary to create it. Actually the standard economic model would concur, because in equilibrium the price of everything equals its marginal and average cost. If everyuthing is in wequilibrium that means the same is true of the capital goods, and hence ultimately the price of everything equals the cost of the labor to produce it.

Unfortunately, in the real world, nothing is in equilibrium and almost no market approaches anything like the ideal. Consequently we continue to have real debates about "value".

And if we think economists have it tough, accountants have it worse. Should the assets of a firm be valued on their cash flows or "marked to market." How, for example, do you value a spectrum licence? By how muc the operator plans to make from it or how much someone is prepared to pay for it?

To avoid artificially inflating accounts on a future cash flow basis, many accounting standards require mark to market. This was true of the assets held by the SPV's in the finance sector, who suddenly saw their asset values plummet as sentiment towards various derivatives plummeted.

There probably is no "right answer." As Feyerabend would note it is important to use the appropriate theory at the appropriate time.

Telstra needs to figure out that their last valient effort to be paid out for siurrendering their market power is never going to happen.

Note: The writer owns Telstra shares.

No comments: