EXCLUSIVE: Cabinet warned nearly 3 years ago on risks to NBN Co from cherry picking, end of Telstra non-compete clause

Posted on: Monday, 14th April 2014

Federal Cabinet was warned as long ago as June 2011 that NBN Co’s business case was vulnerable to cherry-picking in the short term and to competition from Telstra in the longer term when their non-compete agreement lapsed, CommsDay can reveal.

The warning was contained in confidential advice prepared by global financial advisory firm Lazard for Federal Cabinet on 20 June 2011, several months after watered-down ‘cherry picking’ amendments to the Telecommunications Act were released and just days ahead of the signing of the definitive agreement between NBN Co and Telstra.

The advice warned that the policy preference for uniform pricing created strong incentives for cherry picking in “high value areas”. It warned that the only “realistic opportunity” to enact anti-cherry picking legislation “is at the commencement of the NBN project.”

“The risk of significant cherry picking behaviour has not, in our view, been adequately addressed,” warned Lazard in its advice.

Three months earlier, the Federal Government had released its amendments to anti-cherry picking rules in the Telecommunications Act, which allowed exemptions for networks targeting enterprise, backhaul and government customers as well as an exemption for “extensions” to networks built before 1 January 2011 not more than 1km in length. Subsequently, in late 2013, TPG has announced its intention to exploit this so-called “loophole” to build FTTB networks to 500,000 apartments across Australia. Telstra and Optus are rumoured to be considering competitive responses.

TELSTRA COMPETITION THREAT: Lazard also warned that a 20 year non-compete clause in the Telstra-NBN Co definitive agreement would come to an end some two years earlier than NBN Co was scheduled to recover its investment or seven years if financing costs were included.

In its advice to Cabinet on 20 June 2011, Lazard said NBN Co had not reflected any “value impact” for this in its financial projections and apparently viewed it as an “acceptable risk.”

But Lazard took a contrary view saying “take or pay liabilities to Telstra are 50% of NBN Co’s ongoing costs post rollout and Telstra is likely to be NBN Co’s largest retail customer.”

“A further demerger of Telstra into Network Co and Retail Co would mean Network Co can re-enter fixed line competition against NBN Co in 20 years’ time and in Lazard’s view would have a strong incentive to do so,” it continued. “This mismatch is not a risk profile we believe a commercial entity would assume, especially since all of the investor’s returns are projected to accrue after the network preference/non compete expires.”

PRIVATE DEBT WARNING: Lazard also warned on NBN Co’s expectation that it could raise private borrowings ahead of generating positive net cashflows from the project. “NBN Co’s assumptions mean the Commonwealth recoups all its equity before the lenders are repaid and before the end of the Telstra network preference/non-compete commitment… in our experience lenders often discount projections that assume future price increases not guaranteed by contract, and want to be able to be repaid before equity, especially if there is a significant prospective market change pending before debit is repaid such as the end of a non-compete.”

Lazard said that if this “conservative” scenario came to pass, the government’s maximum equity commitment would swell from $29 billion to $41 billion.

WARNINGS CAME 9 MONTHS EARLIER: Although Lazard’s advice to Cabinet was only proffered a mere three days before the definitive agreement between Telstra and NBN Co was announced on 23 June 2011, the firm had made similar warnings the previous October.

In advice offered to the communications department after reviewing the draft agreement between Telstra and NBN Co announced in mid-2010, Lazard has also warned on the potential for Telstra to compete against NBN Co after 20 years and calculated that the draft terms announced at the time had a “net negative” value to the Commonwealth of between $25 billion and $31 billion.

Grahame Lynch

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