For the last few years the government-owned NBN Co has been busily building and selling their national broadband network (NBN) that is expected to bring Australia up to world internet standards. Whether or not this is accurate is not the point of this article, but to ask the question does the existence of a government controlled entity in a monopolistic position undermine the free market element of its economy?
First, let’s get one thing straight: there is a very good reason the NBN Co exists and why the NBN was not built by the private sector. That is because if it was left to the major telcos of Australia to build it, they would have all focused on the high margin, high population metro areas and ignored the low margin (or loss-making) rural areas.
NBN Co are building the network and wholesaling this to retail telcos so that they can ensure that the vast majority of the population can be connected to the NBN network, and will do so by averaging the wholesale price across all geographies, essentially allowing the metro areas to subsidise the rural areas – a notion which the private sector would absolutely not do because it is not profitable to do so.
But what about the existing networks? Telstra, TPG, and Optus all own a substantial amount of copper lines which they use to provide broadband services to their customers, as well as wholesaling this to operators such as Amaysim (ASX:AYS), Exetel and Dodo (who is owned by Vocus) who do not own their own network.
These companies who have built a business model and a customer offering around the fact that they own their network, are now forced to resell internet services for every customer that wants to move from ADSL broadband to the much faster (and only marginally more expensive) NBN service.
Noting that it is only marginally more expensive is key here because to upgrade to a mid-tier NBN package with unlimited downloads, it is only about $10 more than an unlimited ADSL2+ plan (I checked Exetel, TPG and Dodo). But here’s the kicker: NBN Co are charging a much higher incremental wholesale rate per customer than it cost these companies to provide broadband to the same upgrading customer.
Take TPG for example. Average revenue per NBN user is $8.50 higher than broadband customers (close to our $10 increase above), whereas cost of goods sold per NBN user is a staggering $28 higher than for customers on broadband contracts*. If all customers made the switch overnight, this would halve TPG’s gross profit margin.
Despite announcing results in line with guidance, the result is that TPG shares have lost 36% of their value since the results announcement because of the expected margin crimp that they have little control over.
In effect, this gives existing resellers such as Dodo or Exetel an advantage because they are already paying a higher cost to access the network from their existing wholesaler. So even though they might be receiving a similar margin to TPG, the impact will be lower as this margin is already their baseline, as opposed to TPG whose entire margin is likely to be rebased. All because of the legislated monopoly that the NBN Co holds over network.
Farnam holds Vocus Communications Limited in its Leaders Portfolio.
*TPG 2016 results presentation, Morgans Financial.
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