The Ministry of Economic Development has issued a request for proposal for pilot projects exploring methods of fibre deployment for the ultrafast broadband (UFB) project. This follows a request earlier this year for expressions of interest (Computerworld, June 28).
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The Government is understood to be working on legislation to erase a potential $1 billion tax liability for Telecom if the company proceeds with a proposal to split in two.
The issue has arisen as Telecom seeks a way to take part in the Government-subsidised plan to connect high-speed fibre optic broadband to 75 per cent of homes.
The scheme's rules effectively bar Telecom from the $1.5b state subsidy unless it structurally separates into two companies, one owning the retail business and one owning the network business.
While such a move has numerous complications, the tax problem would be a deal breaker.
If Telecom demerges network assets likely to include those currently in its Chorus infrastructure unit the market value ascribed to them would be much higher than their value in Telecom's books after years of depreciation.
This would lead to a clawback by the IRD of past depreciation charges and a giant tax bill for Telecom, with a correspondingly large windfall for the Government.
A research note in July from analyst Greg Main of First NZ Capital estimated the tax liability at up to $1b.
"We assume the Government would waive any potential tax liability related to a demerger of Chorus ... and that any costs of separation ... are offset by benefits from regulatory relief.
"This would leave TEL shareholders with one share in Chorus and one remaining share in TEL."
Without legislation to bypass the tax liability, the economics of structural separation would not stack up for Telecom shareholders.
Telecom declined to comment on the matter, citing confidentiality around negotiations with the Government's Crown Fibre Holdings.
However, a spokesman said "the tax implications of a demerger are subject to the specific way in which a demerger would be enacted and we have not reached that stage.
"Talk of specific numbers is conjecture."
Communications Minister Steven Joyce would not confirm or deny the Government was working on the legislation but said Telecom's proposal for the ultra-fast broadband initiative was being evaluated alongside other bidders through a confidential commercial process.
"Any wider regulatory impacts would be assessed by the Government should they be required,'' he said.
At Telecom's full-year results announcement on August 20, chief financial officer Russ Houlden emphasised proposals for structural separation required a set of issues to be resolved.
"What we've put forward [to the Government] is a package deal.
"You can't just look at the commercial piece or the regulatory piece or the tax piece or the legislation piece in isolation. You need a package."
"If it works for New Zealanders, if it works for government and if it works for shareholders, we need that package to be captured in a heads of agreement.
"Once we've got the package into a heads of agreement then we can kick off all of the necessary streams to work with debt holders, the shareholders, passing legislation and so on."
eIt is understood the Government has made progress on the Leg 5principle of tax relief for Telecom but the details are yet to be worked out.
Although the sum involved could be large, the Government may see tax relief as a technicality because the liability is hypothetical and no money is actually lost to the taxpayer caused mostly by circumstances outside Telecom's control - the depreciation charges from previous years are the result of tax rules.
Telecom would not act to trigger a liability, so it's not money that is actually being lost to the taxpayer if another solution is found. Any solution is likely to be structured to ensure neither shareholders nor the government benefit.
One market source said the Government would want to avoid a demerged Chorus revaluing the network assets and getting a second bite at the depreciation tax benefit cherry.
But the Government's willingness to look at tax relief could indicate its desire for Telecom to stay in the Crown Fibre process, he said.
"If the government does think 'Telecom are at least a credible bidder', which is a given, and 'we do think there is a sensible chance we choose them', which is probably also true, but there is this big hurdle around depreciation, you'd think naturally enough they would have a look at what they could possible do that's not too costly to help them out."
Telecom says it needs a "heads of agreement" on ultrafast broadband with the Government by year end before it starts preparations for a potential shareholder vote on a structural split.
Chief executive Paul Reynolds says the telco has just started talks with Government departments on its ambitions to win chunks of a UFB national fibre network build.
He says those talks will remain largely confidential.
Telecom says it needs deal terms, or a heads of agreement with the Crown by year end before any shareholder vote in early 2011 to split into two companies by July.
"We'd need to reach a heads of agreement with Government on terms, and following that we would need to create scheme documents for two new companies – the network business and the service business of Telecom," Reynolds said after the company's annual meeting in Christchurch yesterday.
The Government would also need to introduce legislative changes to enact regulatory and other changes.
If talks went well the company would go to shareholders with two prospectuses for the envisaged companies, outlining prospects for those businesses and why taking shares in the two was better than the status quo.
Chairman Wayne Boyd said Telecom wanted to be part of the Government's UFB initiative, given it already had more than 25,000 kilometres of fibre optics in operation, roughly half of the 75 per cent of households total required.
Should Telecom not agree an appropriate package with the Government, it was well positioned to co-exist with state-owed infrastructure too.
Reynolds said Telecom could partner with electricity lines companies on a fibre build but wanted to be the "cornerstone" partner of a national bid.
While Crown Fibre Holdings has already said it would negotiate with electricity lines firms WEL, Northpower and Alpine Energy, "no-one" had yet been accepted for the fibre build, Reynolds said.
Telecom could do a great job in those particular geographic areas given its existing fibre presence, but there was "scope for partnerships in this".
"If there is a lines company or someone else who has a proposal or a means of building it that is cheaper than ours or a source of capital that is cheaper than ours, we would be open to a commercial agreement."
Reynolds said negotiations with the Crown by the end of this year would need to show that "a deal can be done".
Telecom has already submitted a detailed proposal, – including a move to split the listed telco into two entirely separate companies – one that builds and maintains infrastructure and another that sells services to end users.
International investors had tended to put their money elsewhere than Telecom given the high amount of regulation here, Reynolds said.
If the company could take away that uncertainty he believed the share price would appreciate. Estimates had put that between 10-30 per cent. Telecom shares yesterday closed 6c lower at $2.02.
In the past two weeks Telecom representatives had begun the negotiation phase. Talks with the Ministry of Economic Development, Crown Fibre Holdings and regulatory meetings run by the MED, were going well.
"We'll now be discussing absolutely what can be committed to. Things like where you (are geographically), how fast you go, how much it costs to build."
Asked if he could end his term as chief executive if he achieved the aims for a fibre build and separation, Reynolds said: "I would take a look at it at that time."
During his address at Telecom’s Annual Meeting in Christchurch this morning, Telecom chairman Wayne Boyd made a case for Telecom to play a pivotal part in the Ultra-Fast Broadband initiative.
The time has come to start testing our imagination as to what to do with the government’s Ultra-Fast Broadband network, Communications minister Steven Joyce believes, and create some excitement around the project that he says is crucial to New Zealand’s future.
Joyce recalled his past studies at Massey University, studying programming with paper punch cards twenty-nine years ago, in his keynote speech at the Huawei Ultra Fast Broadband Summit 2010 in Auckland, to establish his tech credentials with the 200-strong audience.
What exactly the UFB will be used for when the project is completed and twenty-nine years ahead, Joyce isn’t sure however. He singled out education in particular as an area that would benefit from the UFB, saying “unless you’re getting a strand of fibre to [schools], you’re not doing your job.”
Keeping students who are used to being online all the time at home, but not so at school, interested in education is one challenge that Joyce hopes the UFB will solve.
Rural schools will be supplied with UFB on par with the urban counterparts, Joyce promises. “We cannot have a digital divide between urban and rural schools,” he said.
Another area that Joyce sees as natural application for broadband is tele-health, and electronic patient records, and remote working to take the stress off transport infrastructure.
He also dismissed that improved broadband for residential users is “all about gaming and watching more channels on TV”. File-sharing, home video conferencing and the ability for extended families to keep in touch and share digital content were some of the applications that Joyce imagined that residential customers would use the UFB for.
IPTV and 3D media are other applications that may become popular with residential users, Joyce said, adding “there are huge opportunities out there” when the UFB is ready.
Repeating his theme from past speeches on broadband on New Zealand’s remoteness and small markets, Joyce stressed that UFB will help the country to overcome the “tyranny of distance” that’s hampering businesses here compared to ones in the US that have access to a vast internal market.
However, while NZers are “good with bits and bytes” and used to living by their wits as early adopters of technology, Joyce says we are held back by poor connectivity. “We miss out due to connectivity issues,” Joyce says, citing the fact that while NZ is ranked in the top ten as an OECD digital economy, we’re only at 21st place in terms of connectivity.
Overall, Joyce believes the UFB has made lots of progress lately, with the Crown Fibre Holdings announcing its first set of partners. Asked if Huawei would be a CFH partner, Joyce denied that his appearance at the Huawei summit indicated any particular partner preference or that there is a secret agenda to select these.
To keep the UFB process on track, Joyce called for cooperation between fibre operators and local councils, saying nationwide standards are being developed by the CFH to facilitate the deployment of the network.
When Crown Fibre Holdings announced the first three companies to have got through to the next stage in negotiations for the government’s Ultra Fast Broadband plan it took everyone by suprise — not least the three successful bidders, who only heard half an hour before the official announcement.
If Telecom fails in its bid to become the government’s sole partner in the $1.5 billion fibre network, it would be unlikely to participate at all.
The Telecommunications Carriers’ Forum is seeking public feedback on its Draft Standards for the government’s proposed Ultra Fast Broadband proposal.
Telecom's profit is expected to fall at least a 10th to between $360 million and $370m when it reports its annual results on Friday.
Analysts looking ahead to an anticipated deal between Telecom and the Government over its $1.35 billion ultrafast broadband plan and the breakup of the company, are not expecting significant fresh insights from the company.
Forsyth Barr analyst Guy Hallwright said Telecom's profit would be dragged down by a $38m tax charge caused by the removal of the ability to claim tax depreciation on buildings. "It is just an accounting construct, it doesn't mean they will ever have to pay $38m, but it will impact on the reported profit number."
There was some chance Telecom might change its earnings forecasts for next year, but this was unlikely. The result could also be affected by the timing of interest payments and tax gains.
Mr Hallwright forecast a net profit of $370m, at the upper end of expectations. "As long as it's in the ballpark I don't think anyone's going to be too worried. They are going to be focused on the future."
A Dominion Post report that Auckland lines company Vector had submitted "an alternative proposal" to Crown Fibre Holdings involving Vector's possible participation in the ultrafast broadband initiative had heightened speculation that the contract to build the network would be awarded to Telecom's network arm Chorus, with any other companies playing only a secondary role.
"The body language coming from Telecom is more and more [bullish]." There may still be room for the inclusion of other parties "but it is a question of on what terms", Mr Hallwright said.
"I still think Crown Fibre would like, if it can, to get all parties that have useful assets to contribute – and not just ducts and poles – but it is a difficult thing to engineer."
Craigs Investment Partners analyst Geoff Zame said market sentiment had shifted toward expecting Telecom to be "inside rather than outside the tent" and that could explain the rise in Telecom's share price. He forecast a net profit of $360m but did not expect the result would be a big driver for the stock.
Goldman Sachs JBWere analyst Tristan Joll did not believe Telecom had the UFB contract in the bag, however.
"If the Government wants the thing to have a certain economic future and be the best it can be, then probably having Telecom involved in some way makes sense. [But] we still think the rules governing the [UFB process] could change. I'd be surprised if the Government wasn't trying to ensure everyone who had something to offer was involved."
He forecast a $370m net profit. "Last quarter was pretty weak in terms of domestic revenues. They did okay, but it was mostly based on cost-cutting. This quarter you are going to see the same sorts of things, but probably a bit milder on both fronts."
Telecom had stopped paying compensation to customers hit by outages on its XT network but costs would have risen as it dusted off XT's marketing campaign.
Mr Hallwright hoped Telecom's annual result would show faster growth for Telecom Mobile, after "softer numbers" from rival Vodafone, but the impact of new mobile entrant 2degrees was unclear.
Sources suggested overall growth in the broadband market had slowed as it moved closer to saturation. TelstraClear chief executive Allan Freeth forecast competition for new customers would intensify in the year ahead.
That prediction appeared to be borne out with the announcement that internet provider Slingshot would launch an uncapped broadband plan on Thursday costing less than $80 a month, though it is limiting customer numbers to no more than 10,000.
Previous efforts to provide plans with unlimited data caps have faltered because of high use by few customers. Telecom has had two failed attempts, axing its uncapped Big Time plan in May.
Communications Minister Steven Joyce says he is unable to release the Cabinet paper that sanctioned the Government's $1.35 billion ultrafast broadband investment initiative as some of the information it contains may be misconstrued to indicate bias on the part of the Government.
It is understood the Cabinet paper includes some information provided by Telecom about the viability of the flagship government initiative.
The Dominion Post requested the paper in September. The Office of the Ombudsmen is investigating whether to order its release.
Setting out his reasons for refusing to release the Cabinet paper, Mr Joyce told the Office of the Ombudsmen that doing so could prejudice negotiations over the UFB scheme.
"The paper includes detail of informal propositions and financial detail provided by potential partners for the initiative. Neither these propositions, nor the fact they had been asked for, is currently public information.
"Whereas this information was only requested of potential partners as illustrations for my Cabinet colleagues, there is a significant risk that its release may (incorrectly) indicate favouritism towards some potential partners."
He says the Cabinet paper also discusses some potential risks related to the initiative, the release of which could "undermine the Government's ability to maintain a strong negotiating position".
The Office of the Ombudsmen is investigating whether to order Mr Joyce to release a letter sent by Telecom chief executive Paul Reynolds in August last year that is believed to discuss Telecom's possible involvement in the UFB initiative.
Mr Joyce was advised by officials to respond to the letter by phone. Mr Joyce said records of what he said did not exist or could not be found.
Vodafone and Canadian fibre grid specialist Axia have formed an alliance through which they will bid to deliver the solution to the government’s planned ultra-fast broadband project.
The government has committed to spending $1.5bn to help New Zealand make a quantum leap from a copper-based network to a world class ultra-fast broadband network.
In a media statement released by Vodafone today, Vodafone CEO Russell Stanners says the partnership with Axia will enable Vodafone to not only take part in the UFB project as a retail provider, but also help invest in the future of New Zealand.
“Mobile companies are one of the biggest users of fibre in the world —we need it to connect our cellsites together. But for Vodafone it doesn’t stop there; we want to help New Zealand build on the promise of ultra-fast broadband. We will work with Axia and hopefully with the government to deliver to New Zealanders the infrastructure to take us to the next economic level," Stanners says.
Axia has built similar next-generation networks in Canada, France and Singapore and doesn’t compete with its own customers.
The Ministry of Economic Development has selected programme managers for its $1.5 billion Ultra-Fast Broadband investment and for its Rural Broadband Initiative.
As the government evaluates proposals for its ultra-fast broadband (UFB) scheme, it remains unclear exactly how the benefits of this $1.5 billion investment will be measured.
Electricity grid operator Transpower is downplaying any ambitions it may have to participate in the government's ultra-fast broadband deployment