A report by Centre for International Economics (CIE) June 2008
Executive Summary
As part of its election commitments, the federal Government plans to build a national high-speed broadband network that delivers fast internet to 98 per cent of Australian homes and businesses. This network will support high quality voice, data and video services using FTTN (Fibre to the Node) technology.
On 11 April 2008, the Communications Minister released the Request for Proposals for the FTTN network's rollout and operation. Telstra has announced its interest in building and operating this network.
Sometime last year it was reported that Telstra would seek "an internal rate of return on a FTTN network of 27 per cent". Recently, the Weekend Australian quoted Phil Burgess (Telstra's Group Managing Director, Public Policy & Communications), when he said "We need a return north of 18 per cent".
This seems to be a high return relative to many other investments in the Australian capital market. Indeed, a rate of return of this size may be consistent with the abuse of market or monopoly power.
Alternative models to build the FTTN network that would not be open to the abuse of market power have been proposed by investors.
The key objective of this study is to provide evidence on the economic impacts of alternative models for the provision of a FTTN network. In particular, this study:
Notably, the WACC plays an important dual role. Not only is it used as the discount rate to value capital investment projects, but it also plays a regulatory role. Indeed, the WACC is used by regulators to control the maximum prices charged for some services and assess the level of return proposed by companies. By calculating the efficient WACC, regulators can stop the regulated companies from charging inefficient prices and earning more than normal market returns.
Table 1 (view Table within the report) presents the WACC estimates for Telstra's FTTN network and an alternative supplier's network. This table also presents estimates of the revenue required by each network to achieve the targeted returns to capital on an indicative asset base of $4.6 billion, which is Telstra's estimated cost to build a FTTN network in the five major capital cities and the Gold Coast.
Additionally, Table 1 shows the revenue estimates for a $9.3 billion national network, which includes Telstra's offer of $4.6 billion to build the network in major capital cities and the Government's investment of $4.7 billion to help build the network.
Importantly, there is currently no guidance from the Government about the return it will require on its $4.7 billion investment. In the absence of detailed information, the estimates in Table 1 assume that the Government would take the same equity risk as the private sector investor and hence would receive the same equity returns.
Recently, Telstra suggested that the cost of the FTTN network would be up to $15 billion. As such, the last column in Table 1 also provides estimates of the revenue needed to achieve the targeted returns to capital on an indicative asset base of $15 billion.
The key points are as follows:
Chart 2 (view chart within the report) shows the average annual impacts of adopting Telstra's model under different asset costs, when compared to an alternative supplier's model. These results should be interpreted as permanent changes to the economy that will prevail after the construction of the FTTN network and all of the various flow-on changes have worked through fully. The key points are as follows:
Telstra's return from the FTTN network on an indicative asset base of $4.6 billion would translate into an increase in the CPI of about 0.07 per cent, when compared with an alternative supplier's return. If the network cost were $9.3 billion or $15 billion, Telstra's high return on the FTTN network would translate into an increase in the CPI of about 0.14 per cent and 0.22 per cent, respectively.
Higher prices for households and businesses would lead to a long-term decrease in GDP of 0.11 per cent if the network cost is $4.6 billion (equivalent to about $1.12 billion of annual GDP in 2006-07). The effects on the economy would be larger if the costs of the network are higher. Indeed, as shown in Chart 2, if the network cost were $9.3 billion or $15 billion, Telstra's return on the FTTN network would translate into a decrease in GDP of about 0.22 per cent and 0.35 per cent, respectively. These costs include the direct impacts of Telstra's model (i.e. the increase in the cost of the service and the extra income of Telstra's shareholders), as well as the indirect effects that higher costs have on industries upstream and downstream the telecommunications sector.
Another way in which the community would pay for Telstra's high return is via wages. Compared with an alternative supplier model and depending on the cost of the network, disposable wages under Telstra's model would be lower by up to 0.44 per cent.
The best single measure of the impact of Telstra's FTTN network return on the community is consumption. Consumption is a better indicator of well being than GDP. As mentioned before, the direct loss caused by Telstra's model on an indicative asset base of $4.6 billion is about $443 million per annum due to higher prices. There is also an offsetting effect due to an increase in Telstra's shareholders income. The economy wide analysis shows that Telstra's return on a $4.6 billion network would reduce real private consumption by 0.06 per cent, when compared with an alternative supplier's return. That is, after considering the direct and indirect effects, Telstra's FTTN network return would cause a net real loss of $363 million in consumption. Over the 14 years that Telstra would have locked in its price for its FTTN network services, this loss in consumption would translate into a net present value of about $3.4 billion. This is roughly three quarters of Telstra.s $4.6 billion expenditure on the FTTN network.
Telstra.s return from a $9.3 billion and a $15 billion FTTN network would reduce real private consumption by 0.13 and 0.2 per cent respectively, when compared with an alternative supplier.s return. This would be equivalent to a net real loss of $733 million and $1.18 billion in consumption, respectively.
A sensitivity analysis of these results using WACC estimates for broadly comparable assets was undertaken. This analysis shows that, while the economy wide impacts vary in magnitude depending on the options being compared, the margin between Telstra.s required return and the returns received for broadly similar assets translates into significant negative impacts for the Australian economy and the wider community. In particular, it consistently translates into lower output (GDP), higher prices (CPI), lower wages, and lower living standards (household consumption).
Conclusion
This report finds that the difference between the expected capital returns from Telstra.s FTTN national broadband and that of an alternative supplier has a significant negative impact on the Australian economy.
The full CIE Report is available at http://www.tellthetruthtelstra.com.au
Executive Summary
As part of its election commitments, the federal Government plans to build a national high-speed broadband network that delivers fast internet to 98 per cent of Australian homes and businesses. This network will support high quality voice, data and video services using FTTN (Fibre to the Node) technology.
On 11 April 2008, the Communications Minister released the Request for Proposals for the FTTN network's rollout and operation. Telstra has announced its interest in building and operating this network.
Sometime last year it was reported that Telstra would seek "an internal rate of return on a FTTN network of 27 per cent". Recently, the Weekend Australian quoted Phil Burgess (Telstra's Group Managing Director, Public Policy & Communications), when he said "We need a return north of 18 per cent".
This seems to be a high return relative to many other investments in the Australian capital market. Indeed, a rate of return of this size may be consistent with the abuse of market or monopoly power.
Alternative models to build the FTTN network that would not be open to the abuse of market power have been proposed by investors.
The key objective of this study is to provide evidence on the economic impacts of alternative models for the provision of a FTTN network. In particular, this study:
- identifies the difference between the expected capital returns from Telstra's FTTN national network and that of an alternative supplier that was not able to extract monopoly prices; and
- assesses the implications to the community and economy of this difference.
Notably, the WACC plays an important dual role. Not only is it used as the discount rate to value capital investment projects, but it also plays a regulatory role. Indeed, the WACC is used by regulators to control the maximum prices charged for some services and assess the level of return proposed by companies. By calculating the efficient WACC, regulators can stop the regulated companies from charging inefficient prices and earning more than normal market returns.
Table 1 (view Table within the report) presents the WACC estimates for Telstra's FTTN network and an alternative supplier's network. This table also presents estimates of the revenue required by each network to achieve the targeted returns to capital on an indicative asset base of $4.6 billion, which is Telstra's estimated cost to build a FTTN network in the five major capital cities and the Gold Coast.
Additionally, Table 1 shows the revenue estimates for a $9.3 billion national network, which includes Telstra's offer of $4.6 billion to build the network in major capital cities and the Government's investment of $4.7 billion to help build the network.
Importantly, there is currently no guidance from the Government about the return it will require on its $4.7 billion investment. In the absence of detailed information, the estimates in Table 1 assume that the Government would take the same equity risk as the private sector investor and hence would receive the same equity returns.
Recently, Telstra suggested that the cost of the FTTN network would be up to $15 billion. As such, the last column in Table 1 also provides estimates of the revenue needed to achieve the targeted returns to capital on an indicative asset base of $15 billion.
The key points are as follows:
- Telstra's expected return from the FTTN network is more than 2 per cent higher than the return that an alternative investor would expect from the same asset.
- This difference feeds through directly into differences in revenue that needs to be extracted from customers. Compared to an alternative supplier, the additional revenue that Telstra would need to achieve its targeted return to capital on an asset of $4.6 billion is on average $443 million per annum. If the network cost were $9.3 billion, the additional revenue that Telstra would need to obtain each year is $897 million. This is similar to having a telecommunications private tax.
- It was reported earlier that Telstra would lock in the price for broadband for 14 years if it builds the FTTN network(7). An additional revenue of $443 million per annum over 14 years is equivalent to $6.2 billion. This is comparable to the following measures announced in the 2008-09 Budget:
- the increase in alcohol tax (estimated to have a gain to revenue of $3.1 billion over 5 years); plus
- the removal of the current exemption of condensate from crude oil excise (estimated to have a gain to revenue of $2.5 billion over 5 years); plus
- the increase in the luxury tax rate (estimated to have a gain to revenue of $555 million over 4 years).
- Similarly, additional revenues of $897 million and $1 447 million per annum over 14 years are equivalent to $12.6 billion and $20.2 billion, respectively.
- Telstra's higher cost of capital would translate into higher prices for customers. If Telstra obtain its targeted return, consumers would paid on average 15 per cent more for the service than if the network was provided by an alternative supplier with a lower capital return. This price differential is the same under the three assumed asset costs.
Chart 2 (view chart within the report) shows the average annual impacts of adopting Telstra's model under different asset costs, when compared to an alternative supplier's model. These results should be interpreted as permanent changes to the economy that will prevail after the construction of the FTTN network and all of the various flow-on changes have worked through fully. The key points are as follows:
Telstra's return from the FTTN network on an indicative asset base of $4.6 billion would translate into an increase in the CPI of about 0.07 per cent, when compared with an alternative supplier's return. If the network cost were $9.3 billion or $15 billion, Telstra's high return on the FTTN network would translate into an increase in the CPI of about 0.14 per cent and 0.22 per cent, respectively.
Higher prices for households and businesses would lead to a long-term decrease in GDP of 0.11 per cent if the network cost is $4.6 billion (equivalent to about $1.12 billion of annual GDP in 2006-07). The effects on the economy would be larger if the costs of the network are higher. Indeed, as shown in Chart 2, if the network cost were $9.3 billion or $15 billion, Telstra's return on the FTTN network would translate into a decrease in GDP of about 0.22 per cent and 0.35 per cent, respectively. These costs include the direct impacts of Telstra's model (i.e. the increase in the cost of the service and the extra income of Telstra's shareholders), as well as the indirect effects that higher costs have on industries upstream and downstream the telecommunications sector.
Another way in which the community would pay for Telstra's high return is via wages. Compared with an alternative supplier model and depending on the cost of the network, disposable wages under Telstra's model would be lower by up to 0.44 per cent.
The best single measure of the impact of Telstra's FTTN network return on the community is consumption. Consumption is a better indicator of well being than GDP. As mentioned before, the direct loss caused by Telstra's model on an indicative asset base of $4.6 billion is about $443 million per annum due to higher prices. There is also an offsetting effect due to an increase in Telstra's shareholders income. The economy wide analysis shows that Telstra's return on a $4.6 billion network would reduce real private consumption by 0.06 per cent, when compared with an alternative supplier's return. That is, after considering the direct and indirect effects, Telstra's FTTN network return would cause a net real loss of $363 million in consumption. Over the 14 years that Telstra would have locked in its price for its FTTN network services, this loss in consumption would translate into a net present value of about $3.4 billion. This is roughly three quarters of Telstra.s $4.6 billion expenditure on the FTTN network.
Telstra.s return from a $9.3 billion and a $15 billion FTTN network would reduce real private consumption by 0.13 and 0.2 per cent respectively, when compared with an alternative supplier.s return. This would be equivalent to a net real loss of $733 million and $1.18 billion in consumption, respectively.
A sensitivity analysis of these results using WACC estimates for broadly comparable assets was undertaken. This analysis shows that, while the economy wide impacts vary in magnitude depending on the options being compared, the margin between Telstra.s required return and the returns received for broadly similar assets translates into significant negative impacts for the Australian economy and the wider community. In particular, it consistently translates into lower output (GDP), higher prices (CPI), lower wages, and lower living standards (household consumption).
Conclusion
This report finds that the difference between the expected capital returns from Telstra.s FTTN national broadband and that of an alternative supplier has a significant negative impact on the Australian economy.
The full CIE Report is available at http://www.tellthetruthtelstra.com.au
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