How much will the NBN actually cost the Aussie taxpayer?

by on 18 August, 2011

Sean-Garman Sean Garman analyses the financial claims underpinning the National Broadband Network:

 The National Broadband Network (NBN) has the potential to be an extraordinarily expensive white elephant that potentially exposes the Australian taxpayer to financial risks well beyond the political and business cycles. The NBN capital structure as it is currently set up increases the risk that this monopoly will be a financial, legal and operational drain on the Federal Government. There are a number of claims about the financial cost of the NBN which have not been rigorously examined by media commentators either because they do not understand or because they are too focused on the political or technological aspects of this project.

NBN will ‘only’ cost the taxpayer $27.5bn not $43bn

This claim is often repeated by the Government and pro-NBN supporters. At this moment, the Australian Government is directly contributing $27.5bn in equity into the NBN capital structure with the NBN Co. borrowing $13.4bn from 2015 onwards. The problem with this analysis is that it does not examine the potential downside risks to putting in ‘only’ $27.5bn in equity for an essentially unproven concept.

Waterfall impact – dividends, cost of equity and returns

In capital structures there is a term called a “waterfall” which is about tranche seniority when being paid an income (interest/dividend) or when the asset is sold. The most senior “tranches” are paid first with whatever remains being paid down the line, hence the analogy to a waterfall.

Debt ranks senior to the equity in capital structures. Under the proposed scheme, if the NBN does not return a sufficient net cash flow then the equity tranche will not return a dividend to the Australian Government. Therefore it will act similarly to dead capital – a sunk cost without any stream of constant income.

The Government assumes that the equity will be borrowed at a market rate of 5.39% (a 10-year Government bond yield) but the return will be 7.04%, thereby earning the government a 165 basis point spread or differential equivalent to $435.75m per annum on the total $27.5bn equity. The NBN will only begin to pay the government dividends from 2020 onwards. By that stage Australian taxpayers would have contributed the equity cheque but without receiving any compensating income from NBN Co.

Unfortunately this assumes that the NBN is profitable enough to provide that constant stream of income to the government. If the NBN is not profitable or there is not enough net cashflow at the end of the period to pay out a dividend cheque, the taxpayer still has to pay 5.39% to the bondholders but will not earn income to compensate for that. The net result is the taxpayer paying more in interest every year than they receive in income from the NBN.

Default provisions and a government guarantee

As I mentioned earlier, debtholders rank senior to the equity holders which raises some interesting questions around what happens in the event of a default. Every financial deal has a ‘term sheet’ which sets out the key terms and conditions. This is very important because technical details matter during times of distress.

NBN Co. is a company, we are told, who sign commercial agreements and the government will not guarantee NBN debt. Assuming this is true, when they borrow the $13.4bn in debt there will be a number of provisions in those documents which will be negotiated with the lenders. This raises additional questions:

  • What triggers a default? i.e. what financial covenants will NBN have and how easy would it be for them to breach it?
  • What legal rights do debtholders have when investing in the NBN Co.?
    • Can debtholders force a change in management in the event of underperformance?
    • Will debtholders take control of the fibre optic assets if covenants are breached?
    • If this happens, can the debtholders use their newly legislated monopolistic powers to push up prices for the retailers in the market?

I can go in this vein for a while. If the Government is serious about not guaranteeing the NBN then this will be reciprocated with debt holders demanding more security around their large investment in an untried company. If it is decided to change the debt structure to remove debt holder security, then investors will need to be compensated with a higher interest rate charged which reduces the internal rate of return (7.04%) that the government is forecast to earn.

A potential albatross around the neck of taxpayers

Supporters of an NBN do have a point that it can generate unexpected benefits over decades which simply cannot be quantified. If this was the only case for the NBN then the government should not pretend that they can quantify a defined benefit in perpetuity and should pay for it out of general tax revenue.

Unknowable benefits are not a good enough excuse to pay $27.5bn upfront, borrow an additional $13.4bn and then leave taxpayers who are pressured to take on a NBN at the mercy of an underperforming monopoly with private debtholders who may have legal rights to take over the company and potentially use their monopolistic powers by hiking-up prices.

In an era with greater-than-ever demands for public investment, we need complete transparency with the largest-ever government programme and we are being failed at every turn by an incompetent Minister who has nailed the trousers of the Australian taxpayer to the NBN mast. Let’s hope the ship doesn’t sink!

Sean Garman works in Structured Corporate Finance in London, he was the former Macquarie University Liberal Club President and is now Co-Chair of the Conservative Party’s City Future committee for Conservative supporters under 35 who work in finance in London.

 

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