Telecom will probably be chosen to build the government’s proposed fibre-to-the-premises network, subsidised by $1.5 billion in taxpayer funds.

A detailed report commissioned by InternetNZ puts the cost of a fast internet network to 80% of homes at $5 billion; a generally accepted figure.

The process of selecting a company to build the network won’t be quick – in Australia it’s now more than a year after the election, and the Rudd government’s tender is still a big mess.

But nevertheless, in the medium term, Telecom will have to find $3.5 billion, or more, to finance its leg of the $5 billion-or-so public-private megaproject.

Why do I think Telecom’s got the inside running?

It’s been mooted that power line companies have expertise at laying fibre optic cable in the ground, or draping it around overhead power cables. And Chorus has said that its roadside cabinets could take a G/Pon card from any fibre layer, and that it is willing to work with a power line company.

InternetNZ’s report concludes power line companies could deliver fast internet up to $2 billion cheaper.

I don’t doubt the paper calculation. But I have a couple of other issues (leaving aside for the moment the fact an  IT infrastructure project, like a new motorway or putting on a back deck, always runs far over cost).

First, by one consultant’s count there are 27 lines companies. For a network that’s likely to be highly regulated, that’s a big administrative headache, and cost. Second, while Telecom has had some well-publicised outages, the power and power line companies are no slouches in terms of service disruption. It could happen, but I suspect power line company involvement would be too radical a step for what already promises to be a fraught process. In Australia, Telstra is already asking for compensation (a cool $A80 billion worth, if other providers win that country's broadband network, then want to connect onto its backbone).

Kordia is already geared up to its eyeballs, and chief executive Geoff Hunt has already told me he’ll concentrate the state-owned company’s efforts on looking to secure a slice of the $1.5 billion for regional broadband (possibly based on Wi-max); the second transtasman cable remains Kordia’s other main broadband infrastructure focus.

TelstraClear has the resources, thanks to its parent company which, unlike Telecom, is a cash-generating machine with billions in reserve.

Yet after its epic fight over the national broadband network in Australia, Telstra’s political will has perhaps been sapped (as will its $A10 billion cash hoard, if it does win and start construction, which could cost at least that on top of the government's $A4.7 billion).

Build it, and others will come
Already, TelstraClear, is moving the focus of the debate. Speaking to me last month, TelstraClear regulatory affairs manager Chris Abbott said his company was still waiting to talk to Communications and IT minister Steven Joyce, and leaving all its options open.

However, Mr Abbott (an interesting choice to front on the fibre-to-the-premises network, given his job title) said the key focus had to be on access to the new network. Will it be open to competitors and fairly priced? And if so, Mr Abbott mused, does it matter who physically builds it?

(Watchers of events across the Tasman will find some irony here; TelstraClear in New Zealand is essentially adopting the position that AAPT took across the Tasman when faced with the overwhelming likelihood that a larger local telco would score the rights to build the national broadband network).

So: Telecom sits in the cat bird seat, even if Mr Joyce – still not giving anything away – is going to let its shareholders sweat for a while as he goes through the due consultation processes.

Now, where to find that $3.5 billion?

It will be tricky, given Telecom’s current financial position.

At Telecom’s second quarter results, CFO Russ Houlden reiterated that Telecom’s Moody’s rating is under review – and that “realistically” a Moody’s review only ends one way: with a downgrade.

No matter, at least for 2009. Mr Houlden says Telecom has no need to borrow long term for the rest of the year. Short term borrowings are underpinned by an $NZ800 million committed standby facility, negotiated with great foresight – or (whisper it) luck – before the credit crisis hit.

Feel the cash burn
Mr Houlden freely concedes that Moody’s will be worried about what the CFO calls Telecom’s “capex bubble.”

Of course, the slowdown doesn’t help, but chief executive Paul Reynolds told the briefing that the recession only impacted Telecom’s bottom line by around $10 million, with a $20 million hit anticipated for the full year. That’s chump change for a company that used to routinely record billion-dollar profits.

It’s Mr Houlden’s capex bubble weighing on profits.

Roughly a third of the extra expenditure is self-inflicted. Telecom is spending $574 million over the next two years on its W-CDMA changeover (and the cost of keeping its old, SIM card-hostile CDMA network open).

And roughly two-thirds has been inflicted by the government. The extra administrative costs of organisational separation under the Telecommunications Act amount to tens of millions. The cost of unbundling exchanges and building cabinets on an accelerated schedule amounts to around $1.4 billion.

Worst of all (from Telecom’s point of view), it’s spending more to gain less business. Local loop unbundling is part of the opening-up process that has seen competitors grab broadband action as Telecom's retail DSL market share has fallen from 76% in June 2006 to 66% in September 2008, by Commerce Commission figures, then intensify the pain by halving Telecom’s average revenue per broadband user over the period to around $38 a month today.

Now, building a fibre-to-the-premises network is about to impose another, huge wad of capex.

Telecom’s options will be the following:

1. Gear up. Hope that the credit crunch has eased by the time network construction starts (and it will be toward the end of National’s first term, if then). But after a credit downgrade, it will cost more to go to the debt market. Temporarily suspending its juicy dividend would help ease the pain, though many investors would lose what is easily the most compelling reason for holding Telecom shares.

2. Accept a government hand-out, but lose control. A government loan (as Telstra is demanding in Australia), a government-guaranteed loan or, horrors, a direct government ownership stake in the fibre-to-the-premises network would certainly make it cheaper to build. But these are deeply unpalatable options for Telecom: each would leave it beholden to the government, which would likely extract its pound of flesh by requiring open access to the network, at a price regulated by the Commerce Commission. It’s hard to see how that could be compatible with Dr Reynolds stated aim to make a 20% return on the network.

3. Issue new shares and sell a chunk of Telecom to an overseas telco. My pick: Singtel.

Singtel has access to deep lines of credit, if we can get over heebie-jeebies about sovereign investment funds, and an overseas company owning a chunk of the cable beneath our footpaths (just as, in the spirit of the global economy since the time of the Phoenicians, we hope that other countries will allow New Zealand companies to invest on their turf).

And Singtel has expertise in national broadband networks. Its successful bid to build its home-town national fibre-to-the-home network is well-regarded; I especially like the bit that Singaporean residents – albeit in a more geographically auspicious environment – will get 1Gbit/s fibre for just $19 a month, thanks to a hyper-efficient roll-out. (Singtel’s Australian subsidiary, Optus, also partnered with Telecom NZ’s AAPT as part of the “Terria” consortium bidding against Telstra and others for the right to build Australia’s national broadband network. Optus is now going it alone after AAPT’s withdrawal).

Telecom is already owned, if you will, by Johnny Foreigner, with 75% of its registry held offshore (which is why the low NZ dollar helps to prop up its share price).

Of course, an overseas telco – and a state-backed one at that – taking a direct stake is another matter, and one that would throw up popular opposition, especially given that it would have to be a large minority stake. But think about the faster broadband, people. And the creation of a telco who’s profits go up, not down.

Another point to consider: Telecom and Singtel already commercially partner on the Southern Cross Cable, linking Australia and New Zealand to the mainland US. Telecom owns 50% of the Southern Cross Cable Network (the Bermuda-incorporated company that runs runs the cable), Singtel 40% and Verizon 10%.