Financing Stimulus for FTTH.Funding Europe’s €260 billion Access Fibre Upgrade:A Radical Seven Point Action Plan

Financing a World Class Digital InfrastructurePresentation to Scottish Government Event, Edinburgh 13 May 2013Stefan Stanislawski, Partner, Ventura Team LLPBuilds on the November 2012 Ventura/Portland report for the FTTH Council Europe

Kick-off

My credentials: We partly own a successful fibre

operator in Sweden; Last year we helped Jersey Telecom

commit to a complete and profitable fibre switchover;

We are helping start some new fibre projects in real estate telecom;

Our November report for the FTTH Council addressed how to stimulate FTTH financing.

Financing Stimulus for FTTH.Funding Europe’s €260 billion Access Fibre Upgrade:A Radical Seven Point Action Plan

Report by Ventura Team LLP and Portland Advisors

World class infrastructure = fibre

I make no apologies for focussing on fibre in the access network: Fibre into - or very close to - the home is needed for 100M or

1000M; 100M is the fundamental, though not on its own sufficient, basis

for a digital future; Fibre is cheaper: Ultimately lower costs should benefit both

shareholders and customers.

Source: www.rala.com

REALITY CHECKSome things you may not know about the fibre business

BT stock has risen 50% in the last year easily beating the FTSE100Virgin Media has more than doubled driven by the takeover

Compared to other utility stocks BT and Virgin Media are financially healthy and have comparatively high returns on capital employed

London market listed utility sectors with BT and VMED broken out separately.Data from Stockopedia 11th May 2013.EV is total. Other indictors are averages weighted by EV.

Yet our lack of modernisation is an embarrassment

Even comparative laggard Germany has 10x the % fibre coverage we do

Lets not even mention Kazakhstan – they are installing more fibre connections in one year than the UK ever has

Customers of regulated utilities pay a specific amount each month for asset refresh

If neither the regulator nor competition prompts timely asset refresh, then the customer ends up paying for something they do not get …..

𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑐𝑜𝑠𝑡+ 𝑓𝑎𝑖𝑟 𝑟𝑎𝑡𝑒𝑜𝑓𝑟𝑒𝑡𝑢𝑟𝑛𝑎𝑠𝑠𝑒𝑡 𝑙𝑖𝑓𝑒 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒𝑢𝑡𝑖𝑙𝑖𝑠𝑎𝑡𝑖𝑜𝑛

Over 25 years fibre should spread everywhere, already paid for in the monthly bill.

This social contract underlies all utility regulation – a fair and stable price is paid for periodic asset renewal.This ensures modernity, efficiency and fitness for purpose.

…. and (unless it maintains a sinking fund) the utility gets “free” money distorting its investment decisions - and potentially the perception of the more casual equity investor.

Asset Class Capital Asset Life WACC MonthlyCost to pass 1038 25 7.4% £7.44

WHAT IF I WERE MADE TELECOM MINISTER OF A NEWLY INDEPENDENT SCOTLAND?

Let’s assume this is my brief…..

The whole country must be modernised in no more than 12 years from today

We are out of the EU so you can move on from 1980s style regulation

Your plan must be capital markets / rating agency friendly

Money is tight so minimise calls on the public purse

This would be my approach

My goal is to modernise the access network while keeping prices at or only slightly above current levels in real terms – we are going to make the fibre switchover.

Next I change policy to be based on a contractual approach to infrastructure.

I redefine universal service to be broadband at 100MBit/s symmetric. This means that estimated USO payments within Scotland of £54m per annum must now flow – through my Ministry - to fibre projects rather than to propping up an obsolete copper voice business.

If that is not possible then I have to start a new fibre utility.In this case I assume I cannot find an “investor friendly” way of clawing back renewal money from BT so the project has to be funded independently.

My first goal is to do a deal with BT to commit to the Fibre Switchover voluntarily on transparent fair terms with contractual guarantees and tough performance bonds.

Glasgow 592,820Edinburgh 486,120Aberdeen 217,120Dundee 144,290Inverness 56,660Stirling 89,850Urban 1,586,860Total 5,250,000

My “fag packet” estimate is that it will cost £2.6 billion to pass every home and business in Scotland with fibre

About 30% of the population is urban

2.5 million premisesAverage cost £1038 each

Assumes some re-use of existing utility assets including BT Openreach

Rough Estimate

My plan is to run GPON from 50-100 aggregation pointsEach fibre carries two networks: open access telecom & closed DOCSIS

One or more NetCo(s) will build and manage the passive fibre

An asset manager will run the open access active layer of the telecom network

Having both major telecom brands and cable available from day one should deliver a year one take rate of 50%

A Typical Swedish Style Money Tree Gives the Different Parties About a Third of ARPU Each

Average monthly spend 45.00Exc VAT 37.50

Retail Service Provider 13.13Wholesale Concession Operator 24.38

Wholesaler Net Revenue 11.25

NetCo revenue 13.13

Project creates about 6000 jobs for a few years spread all over ScotlandThese generate EXTRA tax revenues

At the peak of construction the project creates 6400 new jobs

Over the 10 year period, direct labour taxes plus VAT on half of net wages would generate almost £400m of extra tax revenue

Of this I assume £200m is invested back as equity in the project, phased over 7 yearsGovernment Cashflows

1 2 3 4 5 6 7 8 9 10Equity (if all Govt) -20 -30 -30 -30 -30 -30 -30 0 0 0Tax revenues 2 19 43 58 58 58 58 51 31 10

-18 -11 13 28 28 28 28 51 31 10Cumulative -18 -29 -16 12 41 69 97 148 179 189

One way of financing the NetCo(s) is to copy Germany

I heard that Germany is funding 30% of some FTTH project costs using an EIB loan at 1.3% backed by a sovereign guarantee

Let’s assume Scotland funds 25% of financing needed each year in the same way, either from the EIB or some pension funds

This sovereign guaranteed loan is really a form of pseudo-equity, so if all goes according to plan, then its fairly easy to fund the rest with normal bank debt

By year 9 the NetCo(s) will have 1.3 million paying customer premises and revenue of £230m pa

Year 9 CapitalEquity 200 13%Pseudo Equity 417 27%Bank Debt 949 61%

1,566

Bank debt/EBITDA 4.5Debt service/EBITDA 0.6

Year 9 Tax Payer Cost-BenefitExposure -417 Cumulative cash 179Net Risk in year -238

Equity Value 1,912 8xA new modern national infrastructureIndirect economic benefits

Another way would be for regional PPPs to buy the legacy network from the incumbent with a call option so that they can buy it back later

Compensation

Rental payments

Incumbent cashflows resulting from moving access network off balance sheet

THANK YOU

Stefan Stanislawski

stefan@venturateam.com

Received wisdom is that investors will flee telecom stocks if faced with fibre capex but hard evidence suggests the opposite. Telecom New Zealand shareholders made 37% TSR in one year because of mass fibre!

Comparison of Telecom New Zealand (faint orange line - TEL:NZC) and Chorus (red - CNU:NZC) share prices before and after end Nov 2011 divestment of the local loop into Chorus.

Shareholders received 1 Chorus share for every 5 TCNZ and this split seems to have released hidden value – the TCNZ price remains stable or grows instead of of falling 20% as one might expect. In fact total TCNZ shareholder returns were 37% over the 12 months up to 23rd Feb 2012.

Source: Financial Times, FT.com

In Australia the Government will renew the local loop by buying Telstra’s assets and providing wholesale access in a rolling programme – compared to the AUS 250 index Telstra shares seem fine (16% up)

Comparison of Telstra (red line - TLS:ASX) with the Australian 250 Index (faint orange - XJO:ASX).

2007: On 24th November the election returned a Labour Party Govt committed to the NBN. 2008: Legislation passed 1H 2008 and an RFP process officially excluded Telstra from NBN in December.2009-2011: NBN starts-up and begins deployment2012: Q1 Telstra structurally separated and agrees “pit and pipe” compensation deal with Govt.

Source: Financial Times, FT.com

EU average LLU charges over recent years (according to the DAE)