With John Howard’s victory in October 2004 any doubt that Telstra will be fully privatised is gone¹, ending a debate that stretches back nearly twenty years.

Howard opened the debate in mid-1985 in his first stint as opposition leader when he unveiled ‘Privatisation – the Liberal Way’, a target list of twelve publicly-owned enterprises that would be sold off by a Coalition government.

Of that initial list only one now remains to be fully sold, Telstra. The other eleven, including the Commonwealth Bank, Qantas and the national satellite company Aussat were all disposed of by ‘privatisation – the Labor way’.

Telstra, the public sector’s crown jewel, would also have gone under the hammer during the Labor term but for Hawke’s decision that competition was the foremost goal in telecommunications policy. As Hawke and his Communications Minister Beazley bulldozed market deregulation through in 1990 they sought to appease critics within the Labor Party by stating that Telecom, Telstra’s predecessor, would not be sold. It was a pledge set in stone by a panicky Keating when he pledged full public ownership of Telstra in return for financial support from the union movement in the 1993 election campaign.

Though the Labor Party holds to its stance that public ownership of Telstra should be maintained they are no longer in a position to do anything about it. Only a highly unlikely backbench revolt by the National Party can stop the sale, but as with other longstanding National Party concerns, such as sugar in the US Free Trade Agreement, there is no fear that cannot be allayed in the short term by subsidies and some solid pork-barrelling.

So the stage is set for Australia’s biggest share sale despite many unanswered questions. Those questions range from the price of a Telstra share, to what will happen to the national telecommunications network, especially in rural and remote areas. Despite an inquiry and extensive Senate debate in the late 1990s, plus two independent inquiries, what will happen in the longer term, both to existing shareholders and Telstra’s rural customers, is unknown.

The Government is not too bothered with such questions. All they are concerned with is realising the planned $30 billion from the sale which Howard knows is sufficient cash to take him into another term and close to Menzies’ record as Australia’s longest serving prime minister. Consequently the sale is now driven by political ambition and expediency rather than rational policy or even ideology.

If the Government was genuinely seeking the claimed benefits of privatisation then it need go no further. Telstra has been behaving as a profit-driven, cost conscious company for nearly a decade. Staff numbers have been halved, union power curbed and capital expenditure slashed to boost earnings, dividends and to sustain an inflated share price.

Hybrid ownership in Europe, where the giants Telecom France and Deutsche Telekom are still partly government-owned, shows that public ownership is no obstacle to growth and innovation. Both have recovered from self-inflicted wounds suffered during the battle for third generation mobile licences to become powerhouses, not just within Europe but on the global scene. Their success and the ability to manage the huge debts they built up four years ago proves that part public ownership need not hold a telecommunications company back. This is especially so when the ownership regime has been carefully meshed in with well-planned market liberalisation.

Unlike European operators Telstra does not enjoy the luxury of operating in a rational market. It finds itself operating in the world’s most highly competitive telecommunications market where regulation has been skewed not merely to encourage market entry but to force competition, irrespective of the costs and the damage being done to the national telecommunications operator and the public interest.

Regulation has transferred 30% of the former monopoly’s market to competitors. The Australian market is now saturated in both fixed and mobile services and at best Telstra is faced with flat revenues. It has little prospect for growth other than in broadband carriage and content delivery where it finds a rabid regulator, the Australian Consumer and Competition Commission, breathing down its neck.

Nevertheless Telstra has generated record profits. These have been achieved by savage cost-cutting and winding back investment to levels 20% below those of a decade ago. Telstra’s customers have also contributed significantly to those profits. With the myth that competition was looking after consumers’ interests the telecommunications companies, including Telstra, have not been obliged to pass on the full cost savings from technological change. Consequently Australia has slipped back over recent years on the Organisation for Economic Cooperation and Development’s league table of the costs of telecommunication services.

Yet despite these domestic realties and despite Telstra’s failure to achieve growth offshore, with $3 billion being lost in its ill-advised Hong Kong investments, Telstra’s share price remains relatively buoyant and it is touted as a strong performer compared to its international peers. Although the share price has slumped from a high of $8.25 shortly after the sale of the second tranche of shares in 1999 Telstra shares have settled down to trade comfortably at nearly $5 a share.

That share price makes Telstra one of the world’s most valuable telecommunications companies and has propelled it to a stellar position globally. In 2002 Telstra ranked 116^th in terms of market capitalisation amongst the Financial Times Global Five Hundred Companies, ahead of giants such as France Telecom, a company three times its size.

Comparisons with other telecommunication companies are fraught with difficulties because much has changed globally in recent years but one thing is clear. If the sale realises the hoped-for $30 billion it will confirm Telstra as being relatively far more valuable than the BT group (formerly British Telecom), France Telecom or Deutsche Telekom – all companies more than 2 to 4 times its size in terms of customers and revenues. (refer to)

It could be argued that Telstra’s exalted position is justified compared to these European operators as it does not have the mountains of debt that only a few years ago threatened the very existence of many of its larger peers. Telstra’s board points proudly to the fact that it only owes $6 billion, compared to the $100 billion plus that encumbers the balance sheets of international operators such as German and France Telecom.

Yet the fact that Telstra escaped a similar level of indebtedness owes more to good luck than to management acumen. Fortunately for Telstra the bubble burst on third generation licence fees before the Australian government auctioned wireless spectrum three years ago. Had the Australian government achieved its hoped-for $20 billion plus for third generation mobile licences, Telstra too would be massively indebted.

But crippling though those debts have been for the European giants, long-term prospects for growth and the use of debt to acquire valuable assets, such as France Telecom’s purchase of the global mobile operator Orange, means that growth prospects outweigh short-term concerns in the European market. The European companies sit at the heart of the ever-expanding European Community market of 300 million plus. They are not restricted to a small national market that is massively skewed against them by regulation and they have already secured significant and profitable international growth.

By any comparison it would seem that Telstra is massively overvalued and the inflated share price cannot be sustained under full privatisation. With half Telstra’s shares locked away there has effectively been a false market, especially amongst institutional investors. Many of the institutions are now more realistic in their assessment of Telstra, viewing it as a utility company rather than a growth prospect and they may not be willing to pay the Government’s asking price of $5.25 plus.

Retailer investors will also be wary as many are still carrying losses from the Telstra ‘Two’ sale. The average investor who each bought 700 shares in the second round is carrying a loss of $1700 and as the Sunday Age reported in January the return from investing in the earlier Telstra floats in 1997 and 1999 is now 9.9% compared to a rise in the All Ordinaries index of 66% since 1997.

In a rising market there are more attractive investments and Telstra will have to fight for shareholders’ interest. The army of advisers and bankers who creamed $429 million in fees and commissions in the first two rounds of the Telstra sale may have to work for their money and may even face a real risk in underwriting the issue. This has been acknowledged with potential advisers to the float arguing that Telstra may have to engage in a $10 billion ‘buy back’ of government shares to prop up the price. The challenge of ‘off loading’ the 50.1% stake will also become more difficult as the debate develops over coming months about how Telstra will deal with its ongoing responsibility to service rural and remote customers.

Telstra’s national network serves the world’s most geographically demanding market. Although 80% of its 10 million customers live in or near the capital cities, 20%, some 2 million, are spread over an area larger than Europe with 80% of the continent having only 40,000 customers. Unlike telephone companies in other large markets such as the USA and Canada, Telstra has never had the comfort of massive public subsidy, or co-operative and regional ownership of the telephone network in rural and remote areas.

Telstra, like its predecessor Telecom, has to support high cost and consequently loss-making rural and remote customers through a web of cross-subsidies which have kept telecommunications costs uniform across Australia. Despite the arcane economic theory about contestability and tendering out loss-making rural areas, these customers are of absolutely no interest to competitors and will remain Telstra’s sole responsibility.

The costs of the rural network are of course largely sunk in investments made in the 1970s and 1980s when Telecom, driven by an earlier ethos of public service, developed low-cost radio systems for rural service, installed digital exchanges and ploughed in copper cable to replace open wire systems strung down telegraph poles. Unfortunately those investments are now ageing. They are not competent to carry the traffic of the Information Age, most notably high speed Internet access.

Nor is the problem of an ageing network confined to the bush. In many urban and regional areas the network needs urgent upgrading. Despite the hype about an acceleration in broadband take-up in Australia, especially through ADSL (asynchronous digital subscriber line) technologies, the fact is that true broadband is available to few Australians and digital access to the Internet is limited in speed by the condition of Telstra’s copper network.

But the moderate broadband speeds now common in urban areas of between 126–250 k. bits per second are a dream for most of Telstra’s rural customers users. They are stuck with Telstra and no private telecommunications company could pick up the tab needed to deliver high speed Internet access in the bush. This has been tacitly admitted by the government’s most recent inquiry, the Estens Inquiry into the adequacy of regional and remote telephone services. In an attempt to determine whether these services met the Government’s test of ‘being up to scratch’ before a full sale could proceed, the inquiry found that rural and remote services could not be mandated at the same level of quality and speed as urban services.

Whilst Estens found fault rates, service times and the quality of standard telephone service were comparable in the bush to urban areas it noted that in reality many rural users could not hope for better than 19.6 kits per second for Internet access, a standard which they felt should be required by regulation. This means many rural users, who now find it difficult to do more than send simple emails, have no prospect of ever accessing the image-rich content of the Internet at reasonable cost. In effect a real and discernible gap in the price and capability of telecommunications services between the bush and urban areas is not only opening up but will become entrenched.

Quite what the cost of providing higher speed data and Internet access in the bush would be is an open ticket. It could readily exceed the $20 billion plus needed to push fibre optic to homes in urban areas so city dwellers can get true broadband access. Like it or not, no privately owned company can make such investments. They are investment programs of national significance which only governments can make.

The government’s answer to this investment challenge is to ignore it. Instead of addressing these issues the government prefers rhetoric about ‘future proofing the network’ which means little more than guaranteeing today’s services and service standards.

But even this is problematic. Telstra cannot maintain the Government’s hoped-for share price and also invest (especially in rural areas) even to maintain current service levels. This is particularly so under the current regulatory regime which has massive disincentives for Telstra to invest when it has to make its network available to competitors at little more than cost.

Yet despite these problems the government may get its $30 billion and Telstra may stand for a time as one of the world’s most valuable telecommunications companies. The share market can be irrational in the short term. Long-term realities are different. Either the network must be upgraded and Telstra’s earnings and share price fall to more realistic levels or rural and remote customers will suffer real and consistent declines in service quality and they will never get access to broadband, other than through high cost satellite services.

The answer to the problems of rural network investment canvassed by the Estens Inquiry is an infrastructure fund that would build on earlier programs such as the $1 billion Networking the Nation program which was funded from earlier sale proceeds. In its back to the future report the Estens inquiry recommended:

To facilitate more certain future funding for telecommunications purposes, the Inquiry proposes that the Government put in place formal arrangements for an ongoing funding allocation, specifically targeted at regional telecommunications.

Programs such as Networking the Nation and other initiatives funded from previous Telstra sale proceeds have been marked by high administrative costs and a difficulty in finding worthwhile and sustainable projects. It is clear that dishing out public money to community groups and local government is not an efficient way in which to develop a national telecommunications network.

Given this past experience with slush funds, on-budget subsidies cannot secure Australia’s telecommunications future. Nevertheless if the full sale proceeds, future funding of the rural network will be marked by the vagaries of ‘on-budget funding’, turning the clock back to pre-1976 when the Post-Master General’s Department administered the network.

Expediency and political ambition preclude any consideration of these complex questions. But they have also led the government to ignore a far simpler question: that the time for the full privatisation may be past unless the massive regulatory bias against Telstra is relaxed. That regulatory bias has forced Telstra into a corner from which it can only escape and meet the national need for advanced telecommunications services when its monopoly is largely restored. Without a return to a more rational market structure, which recognises the realities of natural monopoly in the telecommunications industry, a full sale can only lead to a downward spiral for Telstra’s investors and customers.

But in today’s climate, with competition still dominant on the policy agenda, it is highly unlikely that regulation will be wound back. Telstra will be sold in a market that offers it no scope for growth and under a regulatory structure that threatens its very survival.

Originally printed in magazine
issue No. 17 in early April 2005.