Paul's Blog: NBN Business Case Summary Raises More Questions Than It Answers

The Government has today released what it describes as a ‘summary’ of the NBN Co business case.

The document does not include any of the key metrics that would be required for any sensible assessment of its credibility, particularly the prices that will be charged and the assumed take up of services by customers (that is, penetration and market share.)

But there is enough information released to raise serious questions.

The document says the NBN will generate a return greater than the long term average government bond rate (that is, around 6-7%).  Yet the Department of Finance states clearly in its guidelines that the government’s cost of capital is not the long term bond rate but a significantly higher rate.

The document reveals that NBN Co’s own weighted average cost of capital (WACC) will ultimately be 10-11% but in the short term will be as high as 25%.  It seems therefore that the NBN Co’s return will be significantly lower than the company’s WACC (given that the only commitment which is made is that the return will exceed the long term government bond rate).  This means that NBN Co is destroying value – it will earn less on the capital it employs than it must pay for the use of that capital.

The document notes that in most markets where fibre networks are operating, competition from cable operators remains strong.  This is in sharp contrast to the model which the government is imposing on Australia, where the two operators of cable networks (Telstra and Optus) are evidently going to be paid to shut those networks down.

The business case says that NBN will not be able to offer a fully operational service anywhere until August 2012 – that is some three and a half years after this policy was first trumpeted by the Rudd Government in April 2009.

The document says that construction on the wireless network will not commence until November 2011 – when if the Rudd Government had not cancelled the OPEL contract, construction of a similar wireless network would have commenced in early 2008.

The document says that NBN Co’s capital expenditure will be $34.4 billion, and that it would be higher by $1.7 billion if it were not for its deal with Telstra (which lets it use Telstra’s ducts and other assets as part of construction).  However the document also says that NBN Co will pay Telstra $13.8 billion by June 2020 under that deal.  Spending $13.8 billion to save $1.7 billion makes no sense – and simply highlights that the true purpose of the payments to Telstra is to reward it for exiting the business of operating a network that would otherwise compete with the NBN, and therefore to drive traffic onto the NBN because customers will have no other option.

This is the reason why the government has needed to legislate to authorise this transaction which would otherwise breach the Trade Practices Act as a contract which causes a substantial lessening of competition.

The document says that the equity requirement from government is $27.1 billion.  In other words, although the Rudd Government’s original announcement in April 2009 said that there would be private sector funding as well as government funding, it is now confirmed (as was first suggested in the Implementation Study released in May 2010) that in fact taxpayers will provide one hundred per cent of the equity for this venture.  

The business plan reveals that taxpayers will bear all of the risk, and private sector equity funding will come in only if the venture succeeds and begins generating a commercial return.  If that does not happen (for example, if take up falls short of what is assumed) then taxpayers will be stuck with a white elephant.  For taking this enormous risk, taxpayers will receive at best a paltry return which barely exceeds the government bond rate.   This is a very bad deal for taxpayers.