Monday, August 25, 2014

Telstra and all that (mythical) cash

There has been plenty of commentary recently about the original NBN/Telstra Definitive Agreements. Alan Kohler speculated on what Telstra should do with all its cash, the ACCC questioned whether the revenue earned by Telstra should be considered in determining fixed line access prices, and Vodafone (among others) has called the payments "outrageous."

Part of the problem here is that there really isn't a lot of detail here on what the payments actually are and what the $11 billion actually represents.  This can lead to the kinds of scary claims made in CommsDay that the actual payments to Telstra could amount to $98 billion by 2067. This was based on pre-tax cashflows at the time of the original agreement. Optus has even included this number in a submission to the Competition Review in a section claiming that the NBN reforms aren't sufficient to address Telstra's dominance.

Way back in March 2010 it was actually Alan Kohler who wrote "A 'significant gap' remains, thought to be $4 billion (the difference between $8 billion and $12 billion)." When the deal was announced in June 2010 it was reported that:

The two parties have signed a financial heads of agreement, announced Sunday, that will provide NBN Co with access to Telstra's passive infrastructure (pits, ducts and backhaul fibre) and eliminate Telstra as a fixed-line wholesale competitor to the Government-owned entity.

The assets to be transferred as part of the deal were valued at $9 billion, whilst Telstra values the financial gain from "public policy reforms" signed as part of the agreement at $2 billion.
The $9 billion will be paid progressively as Telstra's copper network service is decommissioned and cable broadband network service deactivated. NBN Co will pay Telstra a fee for every customer migrated from these networks onto NBN Co's fibre network (upon which the figure of $9 billion was assumed).

So to summarise Telstra was after $12 billion in Net Present Value after-tax, and settled for $11 billion, of which $9 billion comes from NBN Co and $2 billion comes from "public policy".

Telstra broke that down in its Explanatory Memorandum on the deal in the graphic below (taken from the CEO presentation).

 The fine print notes that the NPV is calculated at June 2010. This makes up the construction of the $11B. Elsewhere in the document it notes that the NPV used a discount rate of 10% (other than TUSMA payments which were 8%).

A quick calculation shows that talking about $11 billion today is wrong - because at that discount rate it would be $16 billion in June 2014 value.

However, that is also not an accurate reflection because the cashflow profile has changed as a consequence of both the delayed commencement (getting the ACCC to approve the separation plan) and the additional delay from the (Telstra caused) asbestos remediation suspension.

The Telstra explanatory statement

Let's see if we can reconcile this data with the Goldman Sachs report.  Goldman Sachs (according to CommsDay) says of the $98B:

The bulk of this—some $88 billion—would be for infrastructure leases covering ducts, dark fibre, rack space and conduits. As the NBN Co footprint expands to cover all of the Telstra copper footprint, these payments would rise: from A$400m annually this financial year, to $1 billion in FY2019 and to $1.6b a year by FY2042. By 2067, NBN Co would be paying Telstra some $2.9 billion a year in lease commitments.

From 2042 to 2067 there will be no additional ducts or fibres used, so that increase can be used to deduce the inflation rate (2.4%) used. The early years assume a rate of uptake from 2010 to 2021 which for simplicity we will assume to be linear. That set of assumed cashflows results in a sum of payments of $89.4B -so overstated a bit. The NPV at disciount rate of 10% is $9.58 billion. But that is pre-tax. Post tax (assuming 30%) it is $6.7B - so we are getting to the same ball-park as Telstra's $5B (which can be explained by the profile being wrong upfront and the overall overestimation).

The disconnection payments are about half the $9 billion in NPV that Telstra gets from NBN Co. They are however received over first decade. If they are re-profiled to the same as the duct payments the effective cash-flow is simply about the same as the cash-flow for ducts.  That means that the total effective compensation that Tesltra receives in 2021 is somewhere in the range of $2-$2.5 billion.

Let's now consider what these payments look like compared to what Telstra is surrendering. At June 30 2013 Telstra had 6,543 retail voice lines, 1,239 wholesale voice lines and 1,322 ULL lines in operation.  The wholesale price for a ULL is $16.21 per month, and for a Wholesale Line Rental is $22.84. Assuming that it is reasonable to allocate the WLR price as the retail revenue that should be allocated for line rental, these two items add up to $2.390 billion.

In brief, the cash payments Telstra is set to receive is consistent with the cash flow they are forgoing by switching off the copper network.

Now this is a very rough calculation, and hasn't foreshadowed what the copper network revenue losses to Telstra would have been had it chose to compete with NBN Co. But what it does demonstrate is that there is not now some huge additional cashflow coming to Telstra.

Finally a note on the ACCC access pricing question. As Telstra switches off an element of its network it receives disconnection payments and duct rentals, at the same time its asset base shrinks. If the ACCC were to conclude that the payment Telstra receives is higher than the return the ACCC regulatory framework "permits" for the asset, the ACCC may decide to discount the prices for copper access products to compensate. To see how this is the wrong outcome consider the following. Assume that the amount NBN Co receives is exactly twice what the ACCC thinks it is worth. Then the discounting approach would result in an access price of zero once Telstra had switched off half its network.

Put simply the only consideration for the ACCC should be the asset still in operation. To avoid continually re-jigging this depending upon whether it is dearer or cheaper parts of the network, the ACCC should simply draw a line under the current RAB and price determination and determine an appropriate future price path - a combination of increasing inflation and ongoing asset depreciation. Not particularly hard.

Note: Calculations used in this article can be found here.

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