High Fibre, Low Blow

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By Greg Peel

Let’s start all this with “nodes”, for nodes seem to confuse most average Australians.

Think about how you end up with water coming out of the taps in your house. From a central source (such as Warragamba Dam in Sydney) big pipes head off in different directions. After a distance they split and smaller pipes fan out towards different municipalities. Those smaller pipes then split into even smaller pipes which head towards different suburbs, which split into smaller pipes heading towards different streets, which ultimately split into the size of pipe heading into each of your neighbours’ and your own homes. Each splitting point is a “node”.

It may not seem obvious, but water pipes are the best analogy for telecommunication lines, such as your old-fashioned telephone landline. From a central exchange, telephone cables fan out and pass through several nodes before a line reaches into your house, just as water pipes do. And they start out as big, thick bundles at the source before whittling down to the single line which provides your phone connection. Decades ago, the Australian taxpayer built the country’s existing copper telecommunication network.

Since then, a separate network of pay-TV cables has also been laid (two networks in fact). Then along came the internet. Initially slow (dial-up) internet was delivered by telephone cable. Then faster internet (ADSL) was delivered over pay-TV cables. Then improvements in computer software meant even faster broadband could be delivered over the cable (ADSL2+) and even newer software meant the same speeds could be achieved on the old copper telephone wire.

While not expanding the diameter of the cable or copper wire being sent into your home physically, new technology expanded the diameter – or bandwidth – analogously, just as if you were now using a fatter water pipe with a greater flow rate.

The next technological step is to replace the copper telephone wire and copper coaxial cable with optic fibre. This is an expensive proposition, because now we are actually building our water pipes out of a completely new material, and thus need to replace the old ones, rather than just coming up with clever ways to improve flow rates down the same old pipe. But expense aside, fibre optics allow for a “fast” broadband network to become a “superfast” broadband network.

Currently Australia boasts the slowest broadband network in the civilised world. The reason why Australia’s network has them doubling over with laughter in South Korea, for example, is because the two previous governments made monumentally ignorant decisions which, ironically, were converse.

Paul Keating’s government introduced pay-TV, but insisted on competition. Hence Telstra ((TLS)) built one network at great expense, and Optus ((SGT)) built another. The average Australian could never afford pay-TV because both providers had to charge a fortune to recover the cost of their parallel networks. In New Zealand, they laughed themselves witless. NZ had pay-TV long before Australia did because the government sensibly recognised the population was too small to support more than one system and there was no argument.

Then along came the next government, which decided to sell Telstra and with it the taxpayers’ hard-earned telecommunications network. Public property one day, private plaything the next. The government also allowed Telstra to remain involved in pay-TV, meaning it had a monopoly on copper wire services and controlling interest in cable as well.

This has sides splitting in Canada, where the government made a sensible move and ensured the company with the copper wires was different to the company with the cable, such that competition meant ever better service at ever cheaper prices.

Telstra has been able to hold the government, and the Australian people, arrogantly to ransom ever since, and in so doing ensure that Australia remained in the telecommunication Dark Ages while paying twenty-first century prices.

Technology now allows broadband to be sent efficiently over mobile phone networks. This could also be a source of competition. But who leads this market in Australia? Oh yeah – Telstra.

But back to nodes and things.

The nature of fibre optics means that it can live within an existing copper network despite being a completely different medium. This is fabulous, because it means that the ultimately horrific expense of replacing all those millions of copper wires and coax cables can be spread out over time. One can start by just replacing that first step from the main exchange to the first node with fibre. That will provide the first incremental increase in broadband speed. That done, the next step is to replace the copper from the first node to the next set of nodes. Again speed is marginally increased. Keep going, and eventually you reach the last node before the really big split – the one that fans out wires to all the houses in your street.

By that stage, you would have created a network commonly known as Fibre To The Node, or FTTN. In this case, the “node” means the last one. As one can imagine, each nodal split-off of copper implies an exponential increase in individual wires and telegraph poles and so forth. So the really, really expensive part of replacing an entire copper telecommunications network with a fibre one is what is known as “the last mile” – that last step before the connection reaches an individual house. Yet by the last mile, the fibre connection has already sped up broadband access significantly.

Many countries across the globe long ago moved to FTTN. They now consider FTTN to be about as modern and up to date as bakelite telephones.

There was absolutely no reason why Australia, too, could not have had an FTTN system many years ago, except one – Telstra. One can imagine an exchange some years ago going something like this:

Government advisor: Australia needs FTTN to remain competitive.

John Howard: Ooh, well we better get Telstra to build us one then.

Telstra: We’ll build it, but it will be very expensive, and given we’re partly a private entity we will have to charge subscribers a lot of money to provide our shareholders with a positive return.

Howard: You’re still partly public and you will charge what I damn well tell you.

Telstra: We might be able to charge competitive rates in the cities, but the real expense will be getting it to the bush. They’ll have to pay a lot more.

Howard: No way. If the cockies don’t have high fibre to the noodle as well we’ll lose the National Party voters.

Telstra: Get stuffed then.

A Cooperative of all Telstra’s Competitors (for want of a better word): We can build an FTTN network. But it will have to be from scratch.

Howard: Who cares? I just lost the election.

When Rudd came in he did so on a platform of ensuring Australia would get FTTN ASAP. To that end, he created a vision called the National Broadband Network (NBN) and began a request for proposal (RFP) process from interested parties, including Telstra, to build it in FTTN form. The obvious candidate to build it always WAS Telstra, because for Telstra it was a just case of replacing the copper network by steps, rather than starting from scratch. In fact, Telstra has already done that to some extent, creating what is now known as a Hybrid Fibre Coax (HFC) network. Let’s just say the old copper network the Australian taxpayer once built and then had sold from under him is now the HFC.

But Telstra knew it was the only entity that could deliver FTTN at a reasonable price, so it told Rudd either give us the contract or get stuffed.

So Rudd got stuffed, thought about it for a while, watched an arrogant Mexican pick up a zillion dollar bonus and rack off, and listened to the complaints of every Australian for whom Telstra is the most despised corporate entity in the country. He also sifted through the proposals coming in from other parties, realised what limitations were involved and what expenses were implied, and then came up with a new plan.

Rudd told Telstra to get stuffed.

The biggest stumbling block to any FTTN network in Australia is Telstra still owns the last mile of copper, having been handed it by the Howard government. Even if Optus, for example, built a completely stand-alone FTTN network, it would still have to pay rent to Telstra for that last bit of copper. And like Telstra was never going to squeeze that for all it was worth. The NBN plan was always, always, doomed to failure. Telstra couldn’t care less – it was building a new generation mobile broadband network instead. Not as good, but not bad. Pretty expensive though.

Rudd’s bombshell, delivered yesterday, is that the government now intends to set up a public-private partnership to build from scratch an entirely new Australia telecommunications network alongside the one that taxpayers used to own once but now belongs to Telstra. It will not be FTTN, it will be fibre all the way into the back of your computer. This is usually called Fibre To The House (FTTH) but also (and preferred by Rudd), Fibre To The Premises (FTTP) given we’re talking businesses as well.

To put this into perspective, an FTTN system, freshly built at least up to the point it met Telstra’s last copper mile, was expected to cost about $5bn. The FTTP system is expected to cost $43bn. A bit more than half will be funded by a combination of existing infrastructure funds in the federal budget, and the issuance of Aussie Infrastructure Bonds to the public. The balance – around $20bn – will have to come from the private sector.

The Opposition yesterday called the whole thing a farce. Unfortunately it doesn’t matter what policy the government comes up with – popular, controversial or otherwise – the Opposition will call it a farce, but the Opposition has long ago lost any credibility so no one is likely to pay any attention.

Of consequence, however, is what industry and stock market analysts think about the whole idea. In short, industry analysts love it, but then industry analysts are not focused on shareholder returns. It is a stock analysts’ job to focus on shareholder returns, and the short answer there from some is “too ambitious – it will never happen”.

But the smart ones get it.

Not only did Rudd announce plans for a FTTP network, he announced a review of the very laws which command Telstra’s existence as a quasi-private, quasi-public monopoly. It is a couched threat to do exactly what John Howard should always have done right from the beginning – split Telstra in two.

Howard should always have done this first and sold only the sales arm of Telstra to private investors while keeping the Australian people’s infrastructure for the Australian people. Unfortunately it’s too late to get it back now, but Rudd can make Telstra split into two entities, thus disabling the Telstra monopoly. All service providers would then have equal access and competition could flow. Or Rudd could force Telstra simple to sell its HFC to a third party, thus smashing the Telstra monopoly once and for all. A similar result could be achieved by making Telstra sell off its cable (Foxtel) network and keep only its copper.

This time it’s the government calling the shots.

Telstra thus faces ignominious defeat on two fronts. If the FTTP is built, it will offer direct competition to Telstra’s previously monopolistic network. It will also be superior, condemning Telstra’s network into eventual obsolescence. A price war would ensue in the meantime. And if Telstra is hobbled by legislation, the game is all over anyway.

But wait – Telstra does have another option. And this is where Rudd’s proposal comes from the “I have a cunning plan” school.

Telstra is not excluded from participating in the new NBN in any way, shape or form. Having told the government to get stuffed, it was excluded from the original NBN plan. If it chooses not to participate, it will surely suffer, assuming the Rudd plan is indeed ever do-able. But if it chooses to sign up as a participant, Telstra’s still in the game, albeit at a reduced level of power.

The Opposition, and several brokers, say Rudd’s $43bn plan is a pipedream. The private sector was struggling to come up with $5bn let alone $20bn. The ultimate cost to the household will be way too much. Telstra can choose to agree and just get on with life as it is.

But $20bn for a system that really does take Australia into the next century is a lot better proposition than $5bn for one that might drag the country up to around the end of the last century, some note. The economies of scale might be there. But more importantly, an FTTP system could be built for a lot less than $43bn if the project started with Australia’s existing system – now Telstra’s HFC – and just upgraded it.

In other words, if we threaten to smash Telstra the likelihood is they’ll come on board instead. And then – believe it, or choose not to believe given some many bad experiences – the whole deal might just be in the interest of all Australians. At least there is now some vision on the table, rather than a short-term solution to win over swinging voters in a handful of marginal seats.

If the brokers agree on one thing, it is that Rudd’s new policy is monumental in scope, a complete shock, and something that leaves many questions to be answered. The good news for Telstra is that it is potentially back in the game, the bad news is it may be all over bar the shouting. The initial response from analysts is to be split.

Citi has upgraded its Sell rating on Telstra to Hold and GSJB Were has upgraded its Hold rating to Buy. UBS and Deutsche Bank have retained their Buy ratings while Macquarie and JP Morgan have reiterated their Sell ratings. RBS, Credit Suisse and Aspect Huntley have not yet chosen to comment, so the B/H/S rating in the FNArena database is currently 5/3/2. The average target is unchanged at $3.56. Telstra shares are currently trading at $3.36.

In other words, collectively analysts see Telstra benefiting by finally being a kid in the sandpit who shares his toys.

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