Business 21C - Published by UTS Business

The Sydney Harbour Bridge cost $10m. Pretty good value really until you find out the quote was for $5m. We didn’t finish paying it off until 1988. So was it a mistake? Surely not. Did anyone perform a detailed cost-benefit analysis beforehand? Probably not. I’m sure the ferry operators worked themselves up into a bit of a fizz, but apart from them everyone knew that building the Harbour Bridge was the right thing to do.

Improving our national communications infrastructure is the right thing to do. But the question is how best to do it. And it’s a bigger bet than the Harbour Bridge. When the Bridge was built in 1932 Australian GDP was $1.3bn, making the Bridge 0.8% of GDP. Our 2009 GDP is about a trillion, so at $43bn the NBN would cost more than 4% of GDP. In that case maybe a cost-benefit analysis is warranted?

Last week saw the long awaited release of the Government’s national Broadband Network Implementation Study. The 500-page report prepared by KPMG and McKinsey has drawn a lot of flack because it hasn’t performed any sort of cost-benefit analysis. Oh, and it cost $25m. That’s $50,000 per page (or two-and-a-half Sydney Harbor Bridges, how times have changed).

However, the report does not stop short of recommending funding models. It recommends the Government fund the project entirely with equity during roll-out, only bringing in private sector funding once completed. This is for two reasons; private sector investors will expect a risk premium on returns whilst the project is under construction and secondly, they may get in the way of the Government’s social agenda, namely to extend the network into seemingly unprofitable areas.

Where does the Government get the equity? Well unless I’m missing something, it borrows it. But that’s OK because the model in the Implementation Study provides a 6% return on the Government’s money, sufficient to service the debt.

But there’s a problem here. To demonstrate that 6% return, the Implementation Study uses a Discounted Cash Flow to value NBN Co, essentially placing a present day value on the cash flows the business will generate in the future (fingers crossed). The value of those cash flows is discounted for risk. The problem is the study’s authors are only using a discount rate of 9%. Well under the market discount rates for similar businesses.

And that 9% includes the so-called risk free rate, or the return you would hope to get if you put your money in bank (not an Icelandic one). So when you minus out the risk free rate the risk premium is more like 3%.

Would you say 3% is a reasonable return for taking the risk it won’t go precisely as planned? What was that quote for the Harbour Bridge again?