SingTel – CIMB

The Down Under adventure

Australian NBN process

Telstra submits non-compliant bid. Bidding for the Australian next generation broadband network (NBN) has come to a dramatic end with the favourite Telstra submitting a non-compliant non-binding proposal. Telstra will only submit a full bid if the government deigns to address a supposed lack of clarity over structural separation, 12-month negotiations under the RFP, concerns over detailed use of Telstra’s information and the government’s proposed commercial terms. Key details of Telstra’s proposal are as follows:

• Telstra will invest A$5bn on a self-funded network capable of providing 25-50 Mbps downlink to 65-75% of the population and downlink of 12-20 Mbps to the rest of the population.
• Telstra will roll out to 90% of the population if the government can provide A$4.7bn as a loan with concessionary interest.
• The network would be open access where Telstra would not seek legislative protection against competing infrastructure.
• Telstra would provide a A$29.95/month entry level 1Mbps retail plan.
• The proposal is subject to certain clauses such as no further separation (at the sub-ULL level).

Six bids received. Six bids were received, with Telstra, the Optus-backed Terria Consortium, Axia Netmedia and Acacia submitting national bids. The Australian government also received two state-based proposals from the Tasmanian state government and TransACT. Many details are shrouded in secrecy but the panel is expected to make its recommendation in eight weeks and an awarded is expected at end-Mar 09.

Criteria for RFP requirements of the NBN. To recap, the network:
• Should deliver a minimum of 12 Mbps to 98% of Australian businesses and homes.
• Is to be rolled out and made progressively operational over five years using fibre-tothe-node (FTTN) or fibre-to-the-premises technologies.
• Should earn the state a return for its A$4.7bn investment.
• Facilitate competition through an open-access regime that will give all service providers equal access to the network on a price and non-price basis.
• Should enable uniform and affordable retail prices to consumers, no matter where they live.

Evaluation criteria. Evaluation criteria for the RFP consist of the following:
• The extent to which the proposal meets government objectives for the NBN project.
• Capacity of the proponent to roll out, maintain, upgrade and operate the NBN.
• Nature, scope and impact of any legislative/regulatory changes needed to facilitate the proposal.
• Cost to the government.
• Acceptability of the contract terms and conditions proposed and the extent to which they depart from the notified commercial terms.
• The extent of the proponent’s compliance with the RFP.

Our comments

Spanner in the process….
Much confusion hangs over whether Telstra’s noncompliant proposal can be regarded as a valid bid although the Communications Minister has accepted it. We believe that Telstra is hedging its position by keeping all options open, including ruling itself out of the running if the government does not sit down to negotiate on its terms. Should that occur, Telstra’s chances will be reduced dramatically as its proposal is in contravention of the 98% population coverage criterion and is in non-compliance with the RFP. If the government capitulates and sits down to negotiate, there would be a huge outcry from the other bidders which could lead to more complications.

…which improves Optus’s odds. As such, we believe that the Terria consortium (to which Optus is a partner), along with Axia Netmedia (which has extensive FTTN experience in France, Canada and won the rights to Singapore’s NetCo) have emerged as the new favourites for the NBN but that is predicated on whether the government considers the proposal by Telstra as a bid and whether it will sit down to negotiate on Telstra’s terms. Axia is also a consortium member together with SingTel that won the bid to build the NetCo portion of Singapore’s NGNBN.

Negative if Optus wins… We would be negative if Terria/Optus win as the economics of the NBN is questionable despite Telstra’s aim to achieve an 18% IRR on its investment. We question the economics of the project given the astronomical estimated cost of A$10bn-15bn to be spent over five years, the long gestation period for this service, the slower speeds (minimum 12 Mbps for FTTN) vs. current wireless speeds (14.4Mbps for Telstra now and 21 Mbps by 2009), the retail pricing (which is unlikely to be significantly below current levels) and legislation which could be employed by Telstra over last-mile access.

We are especially concerned about funding as Optus is likely to shoulder the burden alone as its other consortium members lack the balance-sheet strength for a meaningful equity infusion. There has been talk that SingTel would contribute A$1bn- 2bn in equity for the project and an Optus spokesperson has said that “it (SingTel) would contribute whatever (funding) we needed to.” However, we believe that such injections would stretch SingTel’s balance sheet, which currently stands at 1.1x net debt/annualised EBITDA, and drain SingTel’s cash of S$1.1bn. This would hamper SingTel’s ability to pursue any acquisitive opportunities.

…as the incumbent holds the advantages. Telstra is actually in pole position by virtue of its incumbency, as it has the financial means, ownership of the copper network and passive infrastructure, scale and expertise. If Telstra loses, we believe it is likely to proceed with its own network along the lines of its proposal and roll out faster and gain access to consumers faster by undercutting the business case of the official NBN bid.

But neutral if it loses out. As in Singapore, we believe that Optus’s bid is more of a tactic designed to keep Telstra’s bidding honest. While never likely to gain complete structural separation given the lengthy litigation battle that would ensue and the cries by Telstra over a complete destruction in value, we believe that Optus has already achieved a positive outcome by gaining open access to the fixed network which would leave Optus room to attack the fixed market dominated by Telstra. It would also save Optus on capex which could be put to more productive use.

Valuation and recommendation

Maintain earnings forecasts, Neutral rating and sum-of-the-parts target price of S$2.72.
Given the many moving parts and lack of transparency surrounding the NBN process, we are retaining our earnings forecasts and target price of S$2.72 for SingTel. Also intact is our NEUTRAL rating. We believe the stock lacks catalysts due to currency volatility despite its holdings in free cash flow-positive Tier-1 telcos in the region.

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