June 2009

01 Jun 2009

Rolling Out Ultra-Fast Broadband To (a Majority of) New Zealanders

The New Zealand Government has announced its Broadband Investment Initiative (Broadband Initiative) and plans to invest up to $1.5 billion alongside private sector co-investors. The bold proposal seeks to accelerate the introduction of ultra-fast (>100 Mbps) broadband to 75% of New Zealanders. The Government hopes to increase New Zealand's global competitiveness by introducing, within the first six years, ultra-fast broadband to priority users such as businesses, schools, health services as well as certain home-users.

The Broadband Initiative focuses on providing ultra-fast broadband to town and city dwellers in 25 regions, representing 75% of New Zealanders. The $1.5 billion commitment to the Broadband Initiative is in addition to the Government's budget commitment to provide $48 million to improve rural broadband, details of which are soon to be released. 

How Will it Happen?

The Government proposes establishing a Crown-owned investment company (Crown Fibre Investment Co or "CFIC") to drive its investment. Under the proposal the Crown, through the CFIC, would provide cash to, and take a shareholding of up to 50% in, regional fibre companies alongside private sector co-investors. The co-ownership between the Government and private sector will be governed by a negotiated shareholder agreement and some over-arching objectives which the Government has specified. 

The regional fibre companies (Local Fibre Companies or "LFCs") would offer a wholesale service, deploying and selling access to fibre (either 'dark' fibre or limited wholesale managed services) in the 25 designated regions. LFCs will be created through the public-private partnership structure in the 25 regions, although the Government is not against proposals establishing LFCs which cover a combination of regions, or indeed, New Zealand in its entirety. ISPs and other telecommunications providers will be able to access the LFC's dark fibre, 'light it up' by adding their own electronics, and consequently provide end-users with ultra-fast broadband.

Private sector co-investors in the LFCs will be chosen in a contestable process by the CFIC. The co-investors are expected to offer both sufficient investment in the initiative and possess the commercial and technical ability to deploy and operate a fibre network. A co-investor which owns or operates a telecommunications retail operation is not entitled to have a majority of voting control on an LFC board unless it fully divests itself of its retail operation. For example, Telecom's Chorus will be able to participate in the contestable selection process, but Telecom will only be entitled to a majority of voting control in an LFC if it divests itself of its retail division, which it is not likely to do. This mandate is clearly intended to provide an opportunity for entry by new or niche players into the wholesale broadband market, since many telecommunications providers, particularly the larger ones, operate at both wholesale and retail levels. 

The Government's shareholding may, initially, be concessionary and subject to a lower rate of return than the private sector co-investors, although the Government intends to take a share of any benefits in the future. 

Each LFC, like any other New Zealand company, will be subject to the existing regulatory regime, principally the Telecommunications Act 2001 and the Commerce Act 1986, as the Government does not intend to introduce substantive regulation specifically for this initiative.

What Will it Mean?

For a major city like Auckland the Broadband Initiative could be a huge boost to economic growth, particularly as it enters a new era as a super-city. For smaller places like Tokoroa, or Oamaru, it could also create new job opportunities in the information technology industry, and boost economic growth. For the 25% of New Zealanders who are not covered by the roll-out there is potential to be connected through wireless or satellite coverage. This form of coverage is proposed in an initiative introduced recently in Australia.

Will it Work? 

The Government acknowledges there are risks for those investing in the initiative and many of the submissions received by the Government have highlighted such risks. There is still considerable debate as to whether the Broadband Initiative is the best way to deliver ultra-fast broadband. In terms of the quantum of investment, a cost study prepared for Treasury estimated the real cost of investment to be between $5 billion and $6 billion. Given the Government's proposal for a total investment of $1.5 billion there would need to be an significant injection of capital from other sources, or a re-examination of the current Broadband Initiative objectives.

The Government has identified the following issues as risks associated with its Broadband Initiative:

Insufficient Viable Proposals

With no government-guaranteed return to private sector co-investors, there is a risk there may be insufficient viable proposals presented to the Government, as was the case in a similar initiative launched in Australia. In the current economic climate, obtaining capital has become more challenging and some submissions have highlighted that the business case presented by the Broadband Initiative is too weak to attract investment. 

Economies of Scale

On the one hand, having many LFCs, especially smaller ones in regional areas, could open the door for investment to non-traditional telecommunication investors. However, from an economic efficiency point of view, it could be more efficient for a smaller number of LFCs to be created given the high sunk costs and level of co-ordination required to achieve the outcomes envisaged by the Government's proposal. There is a particular risk that a regional broadband player with limited scale may fail to become profitable or find the costs of deploying a fibre network greater than expected.

Complex Selection Process

The Government has foreshadowed that the selection of private co-investors and the prioritisation of preferred projects could be complex and difficult as it may be required to compare regional proposals with multi-regional proposals or nation-wide proposals. In addition, it will need to be able to weigh up the different capital structures and roll-out timetables when comparing proposals. To complicate matters further, some of New Zealand's larger telecoms companies have suggested variations to the initiative proposed by the Government, which will require consideration. The Government will need to be cognisant of bids above cost ('rent seeking') and other tactics employed by potential co-investors when comparing proposals.

Lack of Demand

There is a risk a LFC may fail financially because of a lack of retail demand in its local area. Local surveys indicate that New Zealanders are not prepared to spend much more than they currently do on broadband as they are comfortable with current broadband speeds, meaning that retail service providers will not invest in ultra-fast broadband. Managing the disparity between estimated costs and the demand for services will be a major challenge for all involved. The Government has foreshadowed that it plans to carry out a range of demand-side initiatives to enable and encourage the healthcare and education sectors to take on ultra-fast broadband as soon as possible. 

Duplication of Networks

Another risk is the possibility of overbuild (or duplication) of existing networks. Projects to increase broadband capability are currently being carried out throughout the country independently of the Broadband Initiative. In theory, overbuild can be avoided through LFCs seeking access to existing fibre where there would otherwise be duplication. However, this may become a problem if existing owners do not provide such access or only provide access on terms which are uneconomic or unacceptable to retailers. 

Competition

The role of Telecom as the largest internet wholesale provider in New Zealand will come into particular focus and its role in the fibre-optic roll-out will be crucial. As owner of the copper lines that prevail throughout New Zealand, and existing fibre optic networks, Telecom has a potential competitive advantage which could be capitalised upon. Telecom, pursuant to its operational separation undertakings, is required to extend fibre into its network by December 2011. The threat of such competition may discourage investment by a private sector co-investor. 

What are They Doing in Australia?

The Australian Federal Government announced earlier this year that it intends to spend $43 billion to create a new wholesale-only fibre optic network across 90% of Australia with a uniform pricing structure, regardless of customer location. The aim is to service the remaining 10% of Australia with a combination of next generation wireless and satellite technologies at a minimum speed of 12 Mbps. 

Similar to the New Zealand Government's initiative, the Australian Government will co-invest with the private sector over the next seven to eight years to build the network. This will be achieved through the creation of the National Broadband Network Corporation (NBNCO) to manage the Government's investment. In contrast to the New Zealand Government's position, the Australian Government is proposing to take a majority ownership stake in NBNCO during the construction phase of the broadband network to protect the Government's objective of a wholesale open-access network, and, only intends to operate the network for five years once completed before selling down its stake. In New Zealand, the Government has remained silent on exit terms from its investment.

Next Steps

The New Zealand Ministry of Economic Development, having received 103 submissions from interested parties, is currently reporting to the Government with a view to creating the CFIC in June 2009.

Telecommunications Carriers Forum ex-Chief Executive Ralph Chivers has been appointed to oversee the establishment of the CFIC that will administer the billion-dollar broadband initiative, and took up his post on 5 June 2009.

The next couple of months are 'crunch time' for the Government and it is far from certain that the Broadband Initiative will be implemented in its current proposed form.

Authors

Earl Gray

Partner - Intellectual Property

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Karen Ngan

Partner - Corporate & Commercial

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