Sunday, 17 March 2013

NBN: The Rivers of Gold scenario.

In commenting on the CommsDay puff piece meant to rebut The ABC's Nick Ross "All Known Issues" [Part 2], I couldn't remember anyone floating an analysis of
What if NBN Co does really well?
All we've seen are the doom/gloom scenarios and assertions of "Many Projects Fail, the Govt/taxpayer will lose their shirts", but what if NBN does really well would that be interesting?

If NBN Co succeeds beyond their wildest dreams, like Apple, Google, Amazon, Facebook... or the railroads of 1890's, what will it look like.

First, the numbers.

NBN's 2012 forecasts for sales in 2021 are ~$6B on 8.5M premises passed. The 2010 sales forecast was $5.6B in 2021 and $7.1B in 2025. In 2025 they expect 10.5M premises, from memory.

ARPU/mth forecast for 2025 is $70+/mth ($900/yr?)
Cash Flow Positive projected for 2021, project Break-even date 2033 and IIR 7.1%.
2021 Gross Margin is around 75%.

Telstra has a Price-Earnings (P/E) ratio of 15.9 on Net Income of $3.5B, Sales of $25.5B, better than the industry average P/E of 12.5.

Telstra achieves: 75% Gross Margin, 40% EBITD Margin, 18-19% Operating Margin, 12.75% Net
profit margin, but is held back massively by under 1% growth on Sales. They can't grow their market, while NBN Co will experience nothing but high-rates of growth for the next 20+ years.

NBN sales of $7.5B  in 2025 with same Net margin as Telstra is $1B Net profit with a Market Capitalisation (Mkt Cap) of $12.5B-$16B, using the same P/E of 16 as Telstra. For a $30B investment, that's not a good valuation.

But within 5 years that Net income will double as both ARPU and take-up increase:
a $25-$32B Mkt Cap, starting to look OK as a valuation.
The market does value growth and market dominance (~100% of fixed-line Customer Access Network or CAN) highly.

It would make sense to value NBN Co on its future earnings potential as a high-growth stock, not as a 'mature' business with steady cash flows & margins. P/E's of 20-30 are more realistic:
Putting the 2025 valuation at a respectable $30B, rising to $60-$100B within 5-10 years. More if revenue has taken off.
I think there's a real possibility of both ARPU and take-up rates moving well ahead of projections and hence profitability to be much higher as Gross Margin will skyrocket because most of their Expenses are Interest and Fixed Costs while the marginal costs of increased bandwidth is very close to zero (they charge the RSP's, but might upgrade transit networks). The marginal (additional) revenue over 90% profit, increasing the Gross Margin well above 75% projected.

Because of their cost structure (mostly sunk fixed costs, low fixed operating costs, modest variable costs), NBN Co can stimulate demand by lowering line rental costs, especially for higher speeds and increase profits.

This is  driven by Demand Elasticity... Lower the price 10%, increase sales a lot more, say 20-30%, with a big boost to the bottom line, because costs increase maybe 1% and revenues 10+%.
If your variable costs are 2-5% of total costs, then you increase profits by a large fraction (>50%) of the demand increase. I suspect that the Elasticity is much more, but don't know where that is documented or if it has been researched.

This commercial understanding underpinned OTC's explosion in Sales and Profit in the new ear of Voice (cables & Satellites, then fibre) starting around 1975.
They understood "People love to talk" and even though they were a monopoly and could like Telstra, "doing nothing and charge whatever the market will bear", they actively encouraged new technologies and exploited them, driving profits with Demand Elasticity when possible.

There were 20+ years of steadily decreasing Overseas phone charges ending at the 'Telstra merger' with a cheap service from a US phone company that connected Sydney and Perth more cheaply than Telstra STD via two international calls. How could that be economical or efficient? It highlighted the difference in commercial approach between Telstra, the classic Telco model, and OTC, more insightful marketing-driven approach not unlike the current Internet Revolution.

In 1984 when Group 3 Facsimile (Fax) broke through on ordinary phone services, OTC created the "0015" access number to both address Circuit Multiplication Equipment (CME) problems and with dedicated links to Overseas partners, provide 10-12 fax calls on a single 64kbps digital circuit. Customers got a better, faster service with no errors, and OTC, for a very modest investment, decreased costs by 10-fold.
In 1986 brought their national e-mail service, Dialcom, on-shore. Telstra started an offering some time later. The two services were combined in the merger.

The other wild-card is:
The Internet, its content, uses and access devices is still rapidly evolving. You aint' seen nothing yet.
What could these surprise uses be? We just don't know, like Facebook, Twitter, the smartphone and Tablets, new services take off quickly but always come as a surprise. That's the nature of disruptive innovtaion: most people don't see it coming until its unstoppable, like a freight train. To argue "the Internet Revolution is Over", or, "unless you can show me accurate predictions, you're talking baloney" is to argue against the biggest, most productive Innovation Engine the world has ever seen: Silicon Valley. Hewlett-Packard started the revolution in the 1960's and it shows NO signs of letting up.

The only questions about The Next Big Thing are, not "if it will happen", but:

  • When?
  • Just how Big?

Something as simple as "Free WiFi in all shops & Malls" diverts traffic from mobile networks onto Fixed line networks, enabling tablets & "Augmented Reality" devices  like Google Glasses, to do their thing at multi-megabit rates and provide that effortless experience. On WiFi, 802.11n is 300Mbps, isn't
the next round up around 1Gbps? That will have to make a difference in what devices can do.

If there's free high-speed WiFi generally available, 3G/4G networks get freed up in Metro CBD's, Mobile Service Providers can deploy very cheap "pico-cells" to maintain high-margins, while the majority use of 3G/4G will become "access whilst mobile":
 Voice and Video calling, Content Access, Locality-aware Apps (Augmented Reality etc).
There will be three effects coming out of the high Demand Elasticity:

  • higher ARPU/customer
  • more customers
  • increasing Gross Profit Margins

Lead to exploding Sales Volumes, at more than mere 'exponential' rates.

That's a Gold Mine:

  • The break-even year will be well before 2033
  • the 2025-2030 Mkt Cap will be over $100B, maybe as high as $200B.
  • investors, large and small, will be scrambling for a piece of *That* pie!
  • the real question then comes, "When will it end?"

I'd like your feedback on this scenario possible? Is it probable? Can and will the NBN become future Governments' Rivers of Gold, the envy of the rest of the world?

We've already seen a sleepy, little, almost irrelevant Telco, OTC, that specialised in old technologies: Telegrams, Short-Wave long-distance voice and a little Telex, transform itself and continue a world-class evolution of service, profitability and affordability for 25 years.

The model is there and Australia has shown it is happy to fly in the face of conventional wisdom and back its homegrown innovation to great effect.

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