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Scott Ryall

Scott Ryall, Analyst, Macquarie Research Equities

Let me start by giving you a quick outline of what I plan to speak about. Firstly, I always find it helpful to give a quick snapshot of what a telecoms equity analyst actually does. Then I shall look at where we think broadband take-up is, and the reasons for some of the press around broadband growth being slower than expected, given some global growth trends. Then I'll look at some of our growth projections, how we look at companies planning investment for broadband, and also some of the threats to sustainable broadband growth.

Our role day to day is to assess for investors both institutional and private, whether the listed telecom stocks are undervalued, overvalued or fairly valued. That requires us to look at technological, competitive and regulatory issues, and also form views on a range of things from a range of sources which I have listed in a slide and I won't go into too much detail on.

Chris Atkins of Accenture has touched on current broadband take-up a little bit. What is pretty clear about broadband take-up is that there is no one perfect source of information. The ACCC data has potential for quite significant double counting in some degrees, and the splits between residential, business and other appear to us to be dubious. Survey data from the ABS obviously has some statistical shortcomings. Similar to dial-up, broadband has many providers, as Paul Paterson has indicated. Even some of the major carriers have restated some of the customer numbers that they have given to the ACCC over the last year or so. So if the major carriers are having difficulty providing data, then obviously some of the smaller carriers will as well. And even the number of potential SME customer numbers is a source of debate. So you will see that our estimate of penetration is much lower than what Paul Paterson of Telstra quoted in this seminar. We look at about one million SMEs as more or less the addressable market.

So where are we now? We think the number of SME broadband subscribers at September 2003 was around about 225,000, which represents just over 20 per cent of penetration of those businesses, I mentioned before. Our estimate for consumer broadband is around 400,000. That is about five per cent household penetration. Bear in mind that internet penetration is about 55 per cent total (including dial-up), which is just under PC penetration. At the moment PC penetration provides an upper limit to that.

Just on the split between consumer and SME, there are some vagaries in splitting between consumer and SME which are important to realise. A lot of smaller businesses, particularly SOHOs and enterprises with less than 5 people, just buy products that are aimed at residential users. That is pretty clear. My parents both operate businesses out of their home, with one DSL connection and then a wireless hub which services both of them. There is a lot of subjectivity in splitting up the numbers.

There has been a lot of press and noise about Australian broadband growth lagging other OECD countries. Some of this has been pretty self-interested. It is quite important to realise when games consoles and devices like that require a broadband connection, you would expect that some vendors would make a song and a dance about broadband connection not being available. However there has been some historical reasons for such growth levels. I will touch on a number of them going forward, and attempt to give you our view on where they stand at the moment.

Pricing: it may too high. There is a bit of speculation about that. We actually think that given the entry level prices of DSL against dial-up (the latter including connection plus the cost of a second line with call costs) it is actually not a huge step up to take a broadband product. Probably the bigger issue is the uncertainty of pricing as a result of download limits. This is a very important issue for carriers and customers. Not many customers are used to being measured by the megabyte. It does represent about 17 per cent of Telstra's broadband revenues at the moment. That is the stated number. That really provides a level of uncertainty which we think leads some customers to hold back on moving from a dial-up plan to a broadband plan.

Telstra has done some things to address this. One example is their introduction of usage meters for their broadband customers which now just sit on the top of your screen or somewhere near there. We have also seen a number of ISPs throttling speeds, and some even offering unlimited downloads now. Our view is that those ISPs throttling speeds will actually be the ones that are most successful going forward. We have seen a number of examples of people who have had huge download charges levied upon them. Just for your interest, it is pretty easy to negotiate them down to about 10 per cent of what your actual bill is.

Content and applications. These factors are critical and we don't believe that they have got there for the mass market yet. As content and applications become bandwidth-hungry, broadband obviously becomes more compelling, and, importantly for the carriers, the price becomes less important. As people see more of the value proposition they are less likely to look so stringently at price, and look more at what value it adds.

SMEs we think have compelling reasons for take-up, you will see that in our projections when I get to those in a second. Although we don't believe the mass market does have content and applications which are wholly demanding at the moment, there are clearly some information benefits and health care benefits, particularly for regional communities. We think entertainment and lifestyle content and applications will be most important for driving mass market consumption going forward.

Obviously, stable technology is a must. Telstra has been the subject of poor publicity a number of times over the last couple of years on this. It is pretty fair to expect that in the early years of a technology that there will be some hiccups with respect to roll-out of technology. Early on, some of Telstra's DSL problems could be traced back to that. Recent problems regarding e-mail won't help Telstra, won't help their brand. They are probably not so good for take-up, especially when people think that it may be more related to broadband products than traditional dial-up.

We actually do view a lack of network competition as one factor that has led to lower broadband take-up in Australia. It is particularly noticeable in the US, and although that market (as Paul Paterson correctly pointed) out does have a very high cable TV penetration, there are competing networks of telcos which typically will drive lower prices and therefore increase take-up. What does look set to change in Australia is that new networks look like they are being built or considered. I shall mention some of those later.

Consumer education as to the benefits of broadband has improved significantly. You have seen huge marketing campaigns by Telstra in particular, and also by some of the smaller players, as Paul Paterson mentioned.

Capital market discipline to some degree has caused some of the carriers not to roll out infrastructure where they didn't know there was demand. That is something that has caused a lot of difficulty in the smaller end of the market. Certainly people like myself have been part of that drive to ensure that capital is not spent in areas where it is not matched on demand. That is obviously part of the reason for the demand register, so that Telstra doesn't go rolling out technology and spending capital where there isn't a demand.

Now the only issue is that it actually could prove to be a short-sighted view in the longer term. State governments, particularly New South Wales and Victoria, currently seem to be taking matters into their own hands with respect to broadband rollout, particularly to regional communities. You have seen that both in Victoria over recent years, and in requests for tenders in New South Wales. Both have specifically mentioned the fact that the market has not met the demand that they see in regional communities in particular, and we will hear a bit about that later in this seminar. The other thing just to keep in mind is that this is obviously a two edged-sword for Telstra, in that where you don't roll out infrastructure, it creates quite a bit of opportunity for competitors which we will get on to in a second.

So our broadband growth projection going forward is something like the following. We do expect Telstra to hit its target of one million subscribers by 2005, particularly as in the last couple of quarters they have accelerated take-up quite substantially. The current run-rate of added subscribers per month will be sufficient to get them there. This will be given a kick along by Optus, the second biggest broadband or internet brand in Australia, selling DSL products. DSL have obviously been the fastest growing products over the last year or so. You can see we get up to around about 4 million subscribers to broadband by 2010, with Telstra on their network having about half of that. Obviously you will remember Telstra has been pretty good at studying market trends and rolling out infrastructure and networks where the demand is. So even if a wireless network does get rolled out in the next of couple of years, you would expect that Telstra would at least have some competing product.

On our growth projections, we do see quite significant benefits for SMEs and we think all SMEs that need internet in their business will have a broadband connection by the financial year 2008. Now there is no magic to those numbers: I don't think we can say it will be earlier or later than that; what we are saying is inside our forecast period we do expect that all SMEs will roll over to a broadband connection.

Telstra's recent launch of business-grade DSL services will assist that. Prior to its launch in October 2003 there was a little bit of a hole in Telstra's product range. It was focussing to a large degree on high-level services which are more appropriate for medium enterprises. That is in addition to ISDN services, which increasingly if you walk into a Telstra store don't appear to really have been sold for the purpose of data. Household penetration of broadband we expect to be greater than 35 per cent by 2010, with overall internet penetration greater than 70 per cent. Now, obviously that signals that we continue to believe that dial-up internet will have a place in the market.

The alternative here is a low-cost broadband product. Singtel has introduced one in Singapore that has been particularly successful in driving broadband take-up: a $19 per month entry level plan. It has a pretty low download limit, but that is the alternative. So we think that there will be some sort of low-cost internet product that will be there towards the end of the decade. For Telstra, we think the retail versus wholesale split will be critical in its attempts to achieve its $1 billion of broadband revenues in 2006. I will get onto that in a second, but keep in mind that wholesale products refer to not only wholesale ADSL but also to the layer 2 and layer 3 symmetrical products that Telstra offers.

For those companies planning investments at present, it is fair to say that the market is unsure whether or not new broadband applications and revenues will provide material incremental earnings growth. By that I mean incremental to the whole industry. Obviously broadband will substitute some products such as dial-up and ISDN. There is an up-front cost of connection which has to be taken into account when you are rolling out these products, and churn control will be particularly important in the longer term in order to add value to the market as a whole.

Broadband does however have the potential for redistribution of revenues between carriers and ISPs, and also between business lines out of voice and into data. We are looking at some of the primary areas at the moment of potential network investment over the next couple of years. In terms of wireless broadband networks, we have seen a fair bit of press about Unwired raising $100m recently. DSL infrastructure rollout is really made possible by the local loop and line sharing regimes. We expect that you will see an increase in wholesale rollout by a lot of Telstra's competitors. Optus is a primary one, but there may be a bunch of others as well. When you reach scale in a particular exchange we think those ISPs will look at the decision using either ULL or line sharing service prices, and will look to put infrastructure into those exchanges.

We have actually published some research which estimates that an 18-month break-even could be achieved with less than 100 customers in a particular exchange using line sharing as opposed to straight wholesale DSL services. That is really something that the players such as Optus and Primus, and not the small guys, will look at. That is obviously a threat to Telstra's wholesale revenues. It illustrates why Telstra needs to maintain its retail scale as well as driving wholesale. Voice revenues will be a crucial source of revenue for considering the build-out of these networks. Those new networks I think will carry voice over them at some stage. Retention, as I said, is a massive issue for the DSL industry in particular. Once you as a consumer have got the modem, there is not a hell of a lot keeping you there, unlike the mobile telephony market where the operator can for instance offer you a new handset.

Lastly, although there is obviously a pretty good market opportunity for new networks and potential DSL infrastructure rollouts, you do have to keep in mind the other metrics apart from subscriber growth when you are considering value consideration. That means ARPUs and acquisition and retention costs. The threats to those arise from high levels of competition, particularly infrastructure competition. This can be manifested through too much infrastructure, too many players with insufficient scale to roll out infrastructure, or lack of brand equity; and therefore ease of churn. Those are some of the threats that we see.

For Scott Ryall's powerpoint presentation click here.

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