161021 water & telecoms dmcb

Monetising Water Industry Assets in Australia The Case for Fibre Optic Deployment

Prepared by David Brown

Introduction

• New revenue streams are available to the Water Industry for monetising its water infrastructure for non-prescribed purposes by

installing fibre optic cable to serve the telecoms sector and other utilities. It would unlock the value that is tied-up by the telecoms

sectors maintaining a monopoly over its ducted infrastructure.

• This discussion document is in response to interest from selected representatives within the water industry.

• Out of Scope:

– Revenues or cost savings from value capture opportunities outside the telecom sector.

– Technology, regulation and commercial model

• A summary of high level methodologies and calculations are contained in the Appendices.

03/11/2016 Prepared by David Brown; [email protected] 2

About the author

David Brown

Mobile (Aust): +61 459584298

mailto:[email protected]

http://www.linkedin.com/in/davidmcbrown

David Brown is a telecoms professional and consultant with 20 years of experience spanning strategy,

business case development, implementation, commercial operations and stakeholder management. He

operates at C-level to present carefully crafted strategic narrative. His experience spans mobile and fixed

operators, investors and consultancy firms in the UK, EMENA, North America and SE-Asia. He is now

collaborating with Australian enterprise and government in developing their smart city strategy

encompassing the Internet Of Things, smart utilities, as well as presenting new initiatives to utility

operators on how best to monetise their assets for non-prescribed purposes.




Table of Contents

• ICT value opportunity for the Water Industry

• Appendices-1: Cost of construction calculation

• Appendices-2: Annualised revenue opportunity calculation methodology

– Cost plus WACC

– Incumbent monopoly access

– Market value opportunity

• Appendices-3: Industry revenue breakdown


Summary

• Estimated passive infrastructure annual revenues from $0.6bn to $5.6bn depending on the extent to which Telstra ducts can be used;

a scenario where 20% of the market shifts to fibre owned by the Water Industry, with up to 80% moving over if Telstra ducts prove too

congested.

• $1bn additional annual revenues are possible if selected Water Utilities pursued a wholesale active strategy, or offered retail services;

however, it is assumed the revenue share gain would be a lot less at around 10% for wholesale and 5% for retail.

• This analysis excludes potential value capture opportunity arising through shared infrastructure deployment. The overlapping

footprints of other utilities ought to be considered in the planning process (eg smarts grids).

• Fibre installed in sewage ducts and sub-laterals using specially designed cable trays to accommodate routine scouring has been

successfully deployed in Europe and the USA over the last 20-years without major disruption to normal operation. Uptake of this

technology has been slow due to the fragmented nature of the water industry world-wide. Access to an un-congested ducted

infrastructure opens up a range of alternative fibre topologies which can have wider long term application and revenue up-side.

• A high-level assessment of the regulatory and Industry barriers to be overcome and the revenue opportunity is required.


Justification for new 3rd-party access regimes for water passive infrastructure

• There is substantial unrecognised value in the form of new income and cost savings that could be un-locked across the utility sectors

and industry from a broader use of existing infrastructure for non-prescribed purposes.

• Technological change has made it possible to exploit infrastructure in new ways not previously possible, or understood. The rising

cost of deployment to meet marginal demand means that shared infrastructure is a more efficient use of resources.

• The certainty that 3rd–party access regimes have created need be to be extended to include access for non-prescribed purposes

different to the purpose of the host infrastructure. This needs to accommodate rules governing maintenance, access and provider of

last resort.


BackgroundProductivity of telecoms compared to water assets ~ 8-times higher


Notes: Telstra has been used as a proxy for the entire telecoms industry. Total Assets for Telstra is limited to PPE at historic costs (source: Telstra Annual Return 2016). Total Assets for the Water Industry is limited to infrastructure valued in current dollars (source: BoM (2015b)). EBITDA has not had finance and depreciation added back, which is customary when calculating the EBITDA return on assets.

• Both industries are similar in terms of the the asset base

containing a large portion of passive infrastructure.

• Technology options exist for the water industry to make

incremental investment on top of a large existing cost base

to generate non-prescribed revenues.

• This value is generated from being able to provide an

alternative ducted infrastructure in competition to Telstra

and Optus’s ducts which are congested. This would enable

competitive operators to use Water Industry fibre to

deliver an alternative service.

173

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16%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

-

20

40

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80

100

120

140

160

180

200

Water Industry Telstra

EBIT

DA

Ret

urn

on

IA

Bill

ion

AU

D

Fixed Assets Revenue EBITDA Return on Infrastrcurre Assets (IA)

Valuation methodsThree different methodologies are used to estimate the annual revenue(1)

The analysis takes a limited view based on the civilian telecoms industry and excludes the potential value capture from other

utilities as outlined in the Introduction. The three approaches together provide an indication of the range of the opportunity.

1. Cost plus WACC

– A revenue annuity based on an investment to be paid back over 30-years plus earning a WACC assuming the Water Utility can earn a

ROI higher than its WACC. Two WACC scenarios were modeled.

2. Telstra / Optus monopoly value

– A revenue annuity inferred from the deal value of the Definitive Agreement(2).

– It is assumed this has been engineered to cover the estimated revenue that would be lost to NBNCo and other resellers. Therefore, it is

a useful guide to the value placed on passive assets(3).

3. Market value

– A revenue annuity based on the Fixed Industry revenue assuming the total revenue for fixed services is split evenly into thirds: one-third

each for owners of passive infrastructure, active wholesale and for re-sellers(4).

– Two scenarios were modeled where 20% and up to 80% of the revenue potion attributable to the passive infrastructure shift to the Water

Industry.

– This approach also highlight the revenue potential for the Water Industry if selected Water Utilities decided to move beyond simply

leasing dark fibre and instead offering active wholesale or reseller services, which is could do so itself or in partnership with other

operators.


Notes: (i) Refer to Appendices for methodologies; (2) (PV) $11bn paid to Telstra and $0.8bn paid to Optus for access to copper and HFC assets as defined by the Definitive Access Agreement; (3) there are exceptions to this and if point to point fibre could be installed then this is the basis for a superior active services over GPON, which may be valued more highly.

1

2

3

(PV) $11.8bn paid by NBNCo under the Definitive Agreement suggests that pricing passive infrastructure is not a pure cost-plus WACC relationship


4.7

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s • The cost of deploying fibre optic cable and associated

passive infrastructure (API) (trays, cages, cabinets) within

existing sewage ducts is estimated at around $4.7bn (1).

• For a comparable asset, the price paid to Telstra/Optus for

the sale of copper and HFC and API is $11.8bn, which has

limitations on the re-sale of those assets after 30-years to

protect Telstra/Optus value.

• This suggests when pricing the value of passive fibre optic

cable, there is a precedent in Australia for pricing of assets

based on market value. In this context, the Water Industry

should consider the wider set of use case for fibre optic

Notes: (i) Refer to Appendices for methodologies.

Fixed industry value chain and structural separationRule of thumb – each OpCo might reasonably claim 1/3 of the retail price(1)


Notes: (i) Based on the experience in Sweden where there structural separation between passive, wholesale active and re-sellers is most common. It serves as a guide only, but the impact of local monopoly conditions need to be taken into account.

Layers Characteristics

Asset

Life

(years)

EBITDA

Margin

These are services.

Focus on content , b rand ing ,

customer service and pricing.

<5 15%-20

%

One company provides and operates

the active equipment so ensuring the

lowest cost for all.

7 20%-25

%

Optical fibre & ducts are best built-in

during the construction.

Usually remain the property of the

building owner, although the owner

may use the wholesale operator as

an asset manager.

Fibre

25

Ducts

40+

97%

Ducts & trenches

Optical fibre

Wholesale

Telecom services, cable TV, Apps

• This framework is used to estimate how

market value is apportioned (refer

valuation method-3). This is a guide only

and will vary from country to country.

• It is assumed the 1/3 of industry retail

revenues apportioned to ducts and fibre

represents the LRIC at replacement cost.

• Therefore, regardless of whether the

sewage duct is already existing and it is

only the fibre cable which is installed, a

regulatory economist might be able to

argue the LRIC in fact ought to include the

replacement cost of the duct even though

it an existing asset.Source: Ventura Team LLP 2013 (The Case For Smart City Communications Operators, sponsored MEFC)

1/3

1/3

1/3

$18bn fixed market revenue addressable opportunity Water Utilities can expect to target ~ 20% depending on the operating model


8.4

14.1

12.9

8.2

- 5.0

10.0 15.0 20.0 25.0 30.0 35.0 40.0 45.0 50.0

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Other Fixed Operators represent 62% of the total fixed industry

Notes: (i) Includes fixed revenues attributable to international customers.

• Around 20% of the addressable market could be targeted;

it is assumed 1/3 of this is attributed to passive

infrastructure following valuation method-3. Active

operator and RSP operating models would generate more.

• Overleaf, the detailed breakdown of the revenues is limited

to Telstra for simplicity with Other Operator domestic

revenues inferred based on Telstra’s 62% market share.

12.9

1.4

8.2

4.2

0.7 0.4

-

5.0

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Market value opportunity - up to $6.7bn in passive asset revenue p.aAn additional $1.1bn if Water Industry adopted active operating & RSP models


• Around 20% of the industry revenue could shift to active

operators and resellers on Water Utility infrastructure.

• If Telstra ducts are too congested to upgrade to FTTP at a

reasonable cost then expect a much bigger shift which

would involve NBNCo, or Telstra/Optus using the fibre; up

to 80% is assumed.

• Of this shift in revenues, the Water Industry adopting a

passive infrastructure operator model could expect to

generate between $1.4bn to $5.6bn p.a assuming 1/3 of

the revenues are apportioned to the passive infrastructure.

• Additional revenues are possible with wholesale active and

retail layers. Refer to Appendices.

5.6bn

Passive fibre operator model

Active wholesale and / or SP model

1.1bn

6.7bn

$0.6 to $5.6 bn annual revenue increase by adopting a passive operating model(1)

An additional $1.1bn assuming Water Utilities adopt active layer and retail


0.6 1.0

1.2

1.4

4.2

0.7 0.4

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Sewage CostPlus

NBNCoCopper &

HCF @ 85%EBITDA

NBNCoCopper &

HCF @ 39%EBITDA

Passive Layer@ 20%

Passive Layer@ 80%

ActiveWholesale

Layer @ 10%

SP Layer @5%

Bill

ion

AU

D

5.6bn

Cost-Plus WACC Market value Telstra / Optus monopoly value(2)

Increasing revenue opportunity from moving-up the value chain



Increasing revenue opportunity telecom duct congestion

2.2bn

1 2 3

+1.1bn

Notes: (1) Refer to Appendice2 Market Value Opportunity method; (2) The annual revenue estimated under Method-2 is based on reverse engineering the PV of the NPAT by assuming the EBITDA and corporate tax rate of 30%. Two EBITDA scenarios were modeled: a 39% scenario (Telstra’s current EBITDA margin) and a higher EBITDA of 85% which is more typical of passive infrastructure business’s.

0.6bn

Benefit to the Water Industry Increased EBITDA margin ranging from 2pc pts - 19pc pts depending on the model


Combined EBITDA1

Combined EBITDA to Asset Ratio1

10%1 10%1 10%112% 15% 16% 29% 29% 29%

0.9% 0.9% 0.9%1.2% 1.5% 1.6% 3.6% 3.7% 3.7%

Notes: (i) EBITDA for Water Industry assumed to be 10% under a business as usual scenario. The EBITDA margins assumed are: RSP 18%; active wholesale operator 25%; infrastructure passive fibre operator 85%.

16.1 16.1 16.1

0.6 1.2 1.4 4.2

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Shared infrastructure deployment Estimated benefits do not include value capture arising from shared infrastructure

Smart electricity grids will have a requirement for ultra-fast

low-latency communications to manage battery storage and

renewables leading to a more optimal investment outcome.

The overlap in telecoms fibre and electricity grid distribution

networks presents cost saving opportunities using a common

fibre platform. Other commercial commercial and public good

benefits are also possible. There are similar opportunities, but

perhaps not to the same extent for other utilities such as the

Water Industry.

The viability of alternative access technologies required for

Smart Grid management needs to be assessed vis-à-vis the

reliability and also opportunity cost to the telecoms operators

of not being able to serve alternative market segments.


Water

Telecoms Energy

Common ICT platform for mission critical

service management

Notes: (i) For simplicity transport has been excluded, but rail and transport infrastructure such as electric car charging terminals which will likely require resilient and diversity.

Similarities across major utilities(1)

3 tier operating model• Retail layer • Active / operating layer • Passive infrastructure layer

Concluding commentsThe first phase of a more formal industry level review would need to consider…

• The certainty that 3rd–party access regimes have created within infrastructure need be to be extended to include access for non-

prescribed purposes different to the purpose of the host infrastructure. This needs to accommodate rules governing maintenance,

access and provider of last resort.

• Flexible regulation to continue to evolve the use of infrastructure.

• Value capture opportunities, most notably the Electricity Industry, present opportunities for cost sharing.

• Maintenance - infrastructure-in-infrastructure presents challenges for complying with SLA’s. Risk lay-off models are required.

• Physical Proximity – review of legislation governing proximity with other utility assets and water.

• Duct Infrastructure Monopoly – whether or not rules prevent a 2nd ducted infrastructure operator from supplying passive fibre.

• Definitive Access Agreements – impact on existing agreement with NBNCo and Telstra and ensuing political impact.

• Employment Relations – a loss in Telstra’s market share may lead to pressure from employee stakeholder groups.

• Operating covenant – whether or not this limits funding for non-prescribed purposes.

• Licence Restrictions – whether or not the regime allows use for non-prescribed purposes.


Concluding comments / cont

• The Water Industry has the opportunity to create an advantage by building a more flexible passive fibre network for the long term.

Alternative fibre installation scenarios have an impact on the upfront cost, long-term total cost of ownership and application.

– Cost of maintenance underground vs. overhead – underground has a higher repair cost in the event of an incident compared to aerial; however, the

likelihood of a disrupted aerial cable is higher than compared to underground cable.

– Value of underground vs. overhead – underground installation affords the opportunity to install micro-ducts (blown fibre) which allows greater flexibility

compared to aerial cable installation which does not lend itself to micro-ducts due to the effects of torsion. The value gained from the flexibility of

underground air-blown micro-ducted fibre needs to be weighed.

– P2P fibre presents additional long term value creation opportunity compared to GPON installed in Telstra ducts.

• Underground installed, air-blown micro-duct P2P (point-to-point) networks can create long term value compared to GPON networks

installed underground or aerial due to the greater value arising from the installation methods available, cost versus likelihood of

disruptive incident and the greater competition within the IEEE standard compared to GPON, which is an ITU standard controlled by

a smaller group of vendors. Careful consideration should be given to the long term advantages of P2P given the Water Industry’s

available assets, including the opportunity to serve additional use case beyond residential broadband access.


APPENDICES-1: COST OF CONSTRUCTION CALCULATION


Estimated $4.6bn for installation of cable into main sewage and sub-laterals assuming no additional duct construction or major refurbishment.


This is high-level cost estimate. Further work and validation is

required.

• Installation Technology: Sewage main ducts using robotic

technology and in-pipe sleeve to deploy fibre in the sub-

lateral is estimated at around 1/3 that of normal trenching

• Assumptions:

o An average of 10 meters per sub-lateral per

premises.

o 20 USD / meter is assumed for robotic installation in

the main sewage and the same for installation in the

sub-laterals.

o 5% was added to accommodate cabinets and cages

to house active operator equipment.

Notes: (i)

Sewage main duct distance reported in BoM (2015) was validated against official dwelling data1 and average distance between dwellings

• Average dwellings in 2011 were adjusted to 2015 levels.

• The dwelling population assumed to be in rural areas as defined by NBNCo was adjusted from the separate house population.

• An adjustment was made to accommodate non-residential premises.

• Typical distances between dwellings (i.e. premises) were assumed.

• 146k km of street distances was estimated to pass all premises, which is roughly the same as that estimated using official reported data


Notes: (i) http://profile.id.com.au/australia/dwellings?submissionGuid=626a6853-7bf8-4a70-ab2d-079a717339f5

http://profile.id.com.au/australia/dwellings?submissionGuid=626a6853-7bf8-4a70-ab2d-079a717339f5

APPENDICES-2: ANNUALISED REVENUE OPPORTUNITY CALCULATION METHODOLOGY


Valuation methodsThree different methodologies are used to estimate the annual revenue1

The analysis takes a limited view based on the civilian telecoms industry and excludes the potential value capture from other

utilities as outlined in the Introduction. The three approaches together provide an indication of the range of the opportunity.

1. Cost plus WACC

– A revenue annuity based on an investment to be paid back over 30-years plus earning a WACC assuming the Water Utility can earn a

ROI higher than its WACC. Two WACC scenarios were modeled.

2. Telstra / Optus monopoly equivalence value

– A revenue annuity inferred from the deal value of the Definitive Agreement(2).

– It is assumed this has been engineered to cover the estimated revenue that would be lost to NBNCo and other resellers. Therefore, it is

a useful guide to the value placed on passive assets(3).

3. Market value

– A revenue annuity based on the Fixed Industry revenue assuming the total revenue for fixed services is split evenly into thirds: one-third

each for owners of passive infrastructure, active wholesale and for re-sellers(4).

– Two scenarios were modeled where 20% and up to 80% of the revenue potion attributable to the passive infrastructure shift to the Water

Industry.

– This approach also highlight the revenue potential for the Water Industry if selected Water Utilities decided to move beyond simply

leasing dark fibre and instead offering active wholesale or reseller services, which is could do so itself or in partnership with other

operators.


Notes: (i) Refer to Appendices for methodologies; (2) (PV) $11bn paid to Telstra and $0.8bn paid to Optus for access to copper and HFC assets as defined by the Definitive Access Agreement; (3) there are exceptions to this and if point to point fibre could be installed then this is the basis for a superior active services over GPON, which may be valued more highly.

1

2

3

Cost plus WACC


A simple annuity formula was used to calculate the annual

revenue annuity.

Assumptions:

• Regulated Asset - optimal EBITDA

• This scenario shows what the wholesale rate ought to

be with a WACC of 10% and payback period of 20-

years.

The calculation would be adjusted if the Water Industry

was able to earn a ROI above its WACC.

1

Telstra / Optus monopoly value


• The Telstra Definitive Agreement (DA) defines the lease of copper and HFC within the duct, including access for installation and maintenance,

but not the ownership of the duct itself and is considered a proxy for the value of fibre optic cable, excl the duct.

• This might be viewed by some Telecom industry experts as a “monopoly value” since it is expected the price would have been weighed against

what Telstra might lose in value to NBNCo.

• Based on publicly disclosed data, the annual revenue was reverse calculated assuming a tax rate and EBITDA margin. Two scenarios were

calculated assuming a Telstra’s average EBITDA margin of 39% and another assuming a typical EBITDA margin for passive infrastructure.

2

Market value

• This method is based on the experience of Scandinavian countries, in particular Sweden, where there exists a number of Open Access fibre

networks and where structural separation has meant competition amongst re-sellers (SP’s), active wholesale operators and owners of passive

infrastructure. Refer slide-8.

• As a general rule of thumb, traditionally about one-third of the service value is apportioned to each of the re-seller, active wholesale and

infrastructure layers. Re-sellers tend to have the lowest EBITDA margin (~ 15-20%), active wholesale ~(25-35%), with owners of passive

infrastructure assets earning the highest EBITDA margin (~ 85%+).

• This is a “rule of thumb” and is intended to give a sense of the upper bound value in the context of structural separation. It would be unwise to

solely rely on this method but it is a useful sanity check. Further, whether or not this relationship holds will vary from country to country.

• In terms of valuing the fibre cabling installed within existing ducted infrastructure, the cost will be less than if the duct and the fibre was being

installed. The question is whether or not it is reasonable to apportion a full third of revenues to paying down the investment.

• It is assumed the 1/3 of industry retail revenues apportioned to ducts and fibre represents the LRIC at replacement cost.

• Therefore, regardless of whether the sewage duct is already existing and it is only the fibre cable which is installed, a regulatory economist

might be able to argue the LRIC in fact ought to include the replacement cost of the duct even though it an existing asset.

• Two passive infrastructure revenue scenarios were assumed: (1) 20% of the market shifts to active operators using Water Industry fibre – this is

a reasonable amount that could be expected to be lost to a competing infrastructure provider; (2) 80% of the market shifts to the Water Industry

fibre including NBNCo and Telstra which establish their own active networks. This latter scenario is not altogether unrealistic in view of the

Telstra ducts being severely congested; this is one reason contributing to the shift to a multi-technology network (MTN) by NBNCo.


3

APPENDICES-3: INDUSTRY REVENUE BREAKDOWN


Total fixed market revenue opportunity ~ 18 bn AUDBased on Telstra revenues and inferring revenues of Other Domestic Fixed OpCo’s


27.1 24.6

14.1 14.1 14.1

2.4

12.9 7.0

12.9 3.0

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Telstra Domestic Fixed Portion

Total Telstra Revenues from Continuing Operations Telstra Fixed + Inferred Other Fixed Operator Revenues2

Estimated Int’l Rev’s1

Notes: (1) The international portion is estimated at 20% of Data & IP and NAS by adjusting the amount such that the total domestic (local) portion reconciled to the Telstra reported domestic revenues. (2) The revenues generated by all other Fixed Operators was inferred based on Telstra’s reported market share of 62%.

18 bn AUD

END

Prepared by David Brown



03/11/2016 28Prepared by David Brown; [email protected]



161021 water & telecoms dmcb

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