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Final report for the Ministry of

Economic Development

Telecommunications
industry investment
in New Zealand

PUBLIC VERSION
Network Strategies Report Number 25045. April 2006.

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0 Executive summary

0.1 Current and future investment

0.1.1 Telecom

An analysis of Telecom’s recent investment expenditure reveals the following:

• capital investment in new infrastructure does not appear to have increased at the
expense of growth and upgrade/replacements capex
• total New Zealand wired capex has increased every year since 2003
• an unusually high year-on-year increase in new investment capex occurred in 2004
(+63%)
• an unusually high year-on-year increase in total capex occurred in 2005 (+22%)
• in 2005 the least and greatest year-on-year increases in capex were for new investment
(-8%) and upgrades/replacements (+61%) respectively
• in 2006 the least and greatest year-on-year increases in capex are expected for growth
(-16%) and new investment (+57%) respectively.

The 25% increase in ‘growth’ capex in 2005 over that of 2004 was as a result of capex
used to:

• increase the coverage of broadband services


• purchase data centre equipment which had previously been leased
• upgrade Xtra’s email platform.

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Telecommunications industry investment in New Zealand iii

In 2006 Telecom claims that it will incur substantial capex in the implementation of its
NGN and in increasing its share of the broadband market. Telecom announced that it
would invest $220 million of a $1.4 billion total NGN capex in VoIP platforms, with the
aim of migrating all of its residential customers to VoIP between 2007 and 2012 Telecom
has very recently announced:

• plans to deploy ADSL2+ from June 2006


• a reduction in FTTC capex from $250 million to $50 million

In late March 2006, Telecom released updated plans for NGN rollout during an Alcatel
media briefing in Sydney (Exhibit 0.1).

Exhibit 0.1: Telecom’s high-level NGN plan, March 2006 [Source: Telecom]

The updated timeline indicates that timing for mass market NGN components, including
residential multi-service access (VoIP) and residential video services, has slipped by as
much as 2.5 years over previous estimates.

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Telecommunications industry investment in New Zealand iv

Telecom’s public NGN plan provides no information pertaining to milestones for project
completion. Despite this update which signals some delay, it very difficult to determine
whether other aspects of its NGN roll-out are on track or not.

The following table (Exhibit 0.2) compares the capital expenditure in New Zealand for top
tier carriers over recent years.

2003 2004 2005 2006 (forecast)


Telecom [
TelstraClear
Vodafone ]

Exhibit 0.2: Annual capital expenditure in New Zealand [Source: Operators]

0.1.2 Investment by other providers

This section profiles current and prospective telecommunications investment in New


Zealand by providers other than Telecom.

We consider:

• access networks
• core networks
• service provider plans

Access Networks

Alternative access network operators are summarised in Exhibit 0.3. It is clear that the
market for business service access is more competitive than that for residential services, at
least in the major cities. With respect to residential broadband services, competition only
exists where Telecom, TelstraClear and/or Woosh have overlapping access networks.

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Telecommunications industry investment in New Zealand v

ANO Services provided and network Footprint


BCL Business and residential data and Nationwide with focus on rural and
voice provincial areas
CityLink Business-focussed data services Auckland and Wellington CBDs
up to 1Gbit/s and dark fibre network
Hamilton City Council Dark fibre campus style network Hamilton CBD
TelstraClear Business and residential data, Christchurch, Kapiti and Wellington
cable TV and telephony siamese
cable TV network
Business-focussed data services Business districts nationwide
over fibre network
Vector Communications [

]
Woosh Wireless Residential and SME-focussed Auckland, Wellington, Christchurch,
voice and data using UMTS and Southland
network

Exhibit 0.3: Alternative ANOs in New Zealand [Source: Network Strategies, Operators]

The business case for alternate residential access networks is highly dependent on revenues
which can be derived from the traditional range of voice, ISP and ADSL services and
forecasts for future “triple play” bundles of service. Key factors contributing to the risk of
fixed residential investment are:

• declining fixed voice revenues and the likelihood of substitution with mobile and VoIP
• uncertainty over potential regulatory action on unbundling or unconstrained bitstream
services
• uncertainty around the value to network operators in the delivery of future content
based services.

In many remote and lower customer density areas of New Zealand, the revenues generated
by traditional residential telecommunications services may not cover the economic costs of
providing a copper line or conventional fixed wireless connection. In the short term,
assuming the regulatory status quo, widespread infrastructure based competition for
residential service requires a breakthrough technology which:

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Telecommunications industry investment in New Zealand vi

• has sufficiently low per line costs that it is cost effective in supplying basic residential
services
• is sufficiently future proof that it will be able to compete in the delivery of broadband
triple play services.

WiMAX? Future versions of the Woosh technology or equivalent WiMAX


operators may potentially be viable in competing for residential
voice and data services outside the metropolitan areas. Within
metropolitan areas, fixed fibre and copper networks are likely to
remain the most cost effective means of service delivery. Wireless
broadband operators may differentiate their service from fixed line
by adding mobility options.

Fibre to the node? A competing access provider could potentially make use of fibre to
the node systems though this may require additional cabinets to be
placed in public areas or co-location of an access seeker’s remote
DSLAM equipment in a Telecom cabinet. Key barriers to this form
of investment appear to be the need to obtain resource consent for
the former and the lack of regulated co-location for cable network
infrastructure (cabinets, ducts etc) in New Zealand for the latter.

Fibre to the home? For a long time viewed as the ultimate broadband solution, it has
been difficult to cost-justify due to the additional costs of network
and customer premises equipment. This cost equation has changed
considerably over recent years with the advent of fibre based
switched Ethernet systems, and some utilities such as [ ]
believe that there is a viable business case for a FTTH overlay
network in high customer line density regions such as [ ].

In summary, assuming the current regulatory status quo:

• there appear to be some prospects for fixed infrastructure based network competition in
the Auckland region, possibly extending to wide-spread FTTH

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Telecommunications industry investment in New Zealand vii

• there will need to be a technology price breakthrough for alternative providers to


deliver cost effective innovative NGN business and residential services to customers
outside Auckland and other metropolitan centres.

Core Networks

While Telecom has the only ubiquitous full service network in New Zealand, Network
Strategies believes that a level of competition exists in the transport of voice and data
traffic over core networks. Alternative core network operators include:

• BCL – national coverage, focusing on wholesale access to rural and regional areas
• TelstraClear – mainly North Island and inter-city. South Island coverage to be extended
and in conjunction with future work
• Vodafone – national mobile coverage with significant self provision of national
backhaul capacity.

The business case Additional capacity can be added when required in a cost effective
is regionally or manner by upgrading transmission system optical and electronic
community based systems and through commissioning of spare fibres. Additional
fibre routes continue to be added, particularly for the support of data
backhaul generated by broadband services in regional areas.

In summary, assuming the current regulatory status quo:

• operators will continue to upgrade bandwidth on core network links and add coverage
when required for backhaul or advanced service capability
• some provincial linking and backhaul capacity will result from regional and
community based projects.

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Telecommunications industry investment in New Zealand viii

0.1.3 Summary of proposed service provider investments

Below we provide a summary by service provider proposed investments for wireline and
wireless in New Zealand (Exhibit 0.4 and Exhibit 0.5 respectively). In some cases service
providers’ investment strategies are related to the future regulatory environment. We note
too that there is strong emphasis on metropolitan and regional centres in investment plans.
This is not unexpected, given the fact that typically telecommunications spending
distributions are highly skewed – in other words, a large proportion of spend is generated
by a relatively small number of customers. This influences planned geographic coverage,
and there may be a trade-off between targeting large customers and broad market coverage.

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Telecommunications industry investment in New Zealand ix

Service provider Proposed investment Regulatory sensitivity of investment


decision
CallPlus [ [ ]
]
Compass None proposed n.a.
ihug ADSL2+ - $20m+ capex over three LLU
years.
Telecom $470m (estimate) wireline investment regulatory status quo continuing
in 2006, $160m of which is for ‘new
investment’. Investment areas include
broadband, ICT and ‘triple play’ –
voice, video and data.
ADSL2+ deployment ] regulatory status quo continuing
4
Backhaul, NGN (WiMax, SKY TV etc) regulatory status quo continuing
TelstraClear More than $120m for ‘extending and None specified
enhancing services for customers
throughout the country’. $20m of this
will be for a backbone network linking
Christchurch, Dunedin, Gore,
Invercargill and Queenstown. It
expects to establish access networks
in the CBDs of Ashburton, Gore,
Invercargill, Timaru and Queenstown.
Vector ‘Multi-million dollar’ contract to supply None specified
energy and communications
infrastructure to Highbrook Business
Park in East Tamaki
[ Extent of wholesale regulation

.]

Exhibit 0.4: Wireline operators’ investment plans and conditions [Source: Operators]

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Telecommunications industry investment in New Zealand x

Service provider Proposed investment Regulatory sensitivity of investment


decision
BCL DTT (digital terrestrial television) None Specified
network
Extension of EXTEND broadband None Specified
wireless network
CallPlus [ ] No conditions
Compass None proposed n.a.
Econet In a national GSM network Regulated roaming and cell-site co-
location.
IPSTAR None proposed n.a.
IT Mainland
Sky Network Sky’s latest annual report (2005) does n.a.
Television not contain specific information
regarding future capital investments.
TeamTalk Continued expansion of mobile radio n.a.
network
Telecom $90m (estimate) for investment in No conditions
mobile in 2006
Vodafone 3G network roll-out, first phase Regulation of MTR
estimated at $300m [ TSO reform
]
Woosh Wireless Woosh has ordered 180 UMTS TDD None Specified
base stations from IPWireless to
‘further consolidate its network in
Auckland and extend the company’s
network in other centres around New
Zealand’
[ ] [
]

Exhibit 0.5: Wireless operators’ investment plans and conditions [Source: Blast PR,

Operators]

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Telecommunications industry investment in New Zealand xi

0.2 Impacts on investment

Regulatory Two key barriers appear to be the lack of regulated fixed public data
barriers to further network (FPDN) interconnection and the lack of regulated co-
market entry location pricing and processes.

Alternative CBD Although CBD areas appear competitive from the point of view of
operators require business data and voice, alternative operators often need to
effective supplement their network coverage with re-sale services to reach
wholesaling their clients’ outlying branch offices and home workers.
regime Consequently such operators are highly reliant on the existence of
an effective wholesale regime. Although this exists to some extent
in the form of UPC and UBS, these services are currently limited to
non-NGN capabilities, meaning that alternative CBD operators are
limited in their ability to use wholesale services to compete for
business with customers requiring widespread availability of
advanced services.

The role of regulation

Numerous barriers to market entry may be minimised or removed through effective


regulation, which typically includes the need to address the following issues:

• high interconnection fees


• access to facilities and infrastructure (including co-location agreements)
• disputes with the incumbent
• spectrum availability
• number portability.

In addition new investment is impeded in circumstances of regulatory uncertainty. This


includes uncertainty regarding regulatory conditions, rules and the timing and nature of any
likely regulatory intervention.

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Telecommunications industry investment in New Zealand xii

The OECD attributes the recent rapid expansion in broadband penetration in many
countries to successful regulatory action, specifically with the opening of local loops
despite sustained resistance from incumbents. The OECD implies that there has in general
been a transition now from bitstream to unbundling. This suggests movement on the topical
European progressive five-step ladder towards competition in telecoms networks:

• Resale
• Wholesale
• Bitstream
• Unbundling
• Infrastructure investment.

Regulatory positions of New Zealand operators and industry groups

As evident from Exhibit 0.6 below there are two clearly defined groups of operator opinion
on the need for regulatory reform. In broad terms these groups can be described as:

• operators with national advanced network aspirations that support reform as the only
practical means to achieve their goals (TelstraClear, ihug and Internet NZ representing
other ISPs and community based networks)
• operators that have achieved national coverage or are currently investing in advanced
network capabilities and see some aspects of regulatory reform as a threat to their
investment (Vodafone, BCL, Woosh,).

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Telecommunications industry investment in New Zealand xiii

Organisation LLU Effective Upgrade Upgrade IP/Data TSO TNZ


Wholesale UBS UPC Interconnect Reform Structural
Separation

TelstraClear Support Support Support Support Support Support


Ihug, CallPlus, Support Support Support
Orcon
Internet NZ Support Support Support Support
TUANZ Support Support Support Support
Vodafone Oppose Support
BCL Oppose
Woosh Oppose
[ ] Oppose Oppose Oppose

Exhibit 0.6: Regulatory Positions [Source: Operators and Industry Bodies]

Clearly there are individual exceptions to the above categorisations. However, even the ISP
Orcon which has publicly opposed LLU, but supported improved wholesaling in the past,
has now moved support to unbundling and even structural separation for Telecom.

In addition to the operators, TUANZ, representing retail users of telecommunications


services, has positioned itself strongly in favour of significant regulatory reform. This
suggests that the retail users represented by TUANZ do not receive or recognise the
benefits of there already being alternative national networks and advanced service
providers. In particular:

• Vodafone may still be perceived as a specialist mobile operator, currently unable to


provide the full range of fixed and mobile services required by modern business
• wholesale only operators (such as BCL and localised providers of fibre capacity) are
largely invisible to retail customers and the existence of their networks has not enabled
TelstraClear (for example) to compete effectively with Telecom’s national coverage
• Woosh and other wireless and satellite operators, although developing, have limited
coverage and service capability

Recent experience in overseas markets has demonstrated that efficient investment in


alternative access technologies can still be successful in an environment with high
penetration of unbundled local loops and competitive wholesale. An example is Unwired

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Telecommunications industry investment in New Zealand xiv

Australia, a wireless broadband provider in Sydney and Melbourne providing internet and
VoIP using early implementations of WiMAX technology. Its service is similar to that
provided by Woosh, appealing to apartment dwellers who do not have (or want) fixed
PSTN access from Telstra and who also find it useful to access their broadband account in
more than one location. The Unwired service does not therefore compete directly with
ADSL broadband, but has developed its own growing market niche.

Significance of convergence of telecommunications and media

In New Zealand the key players in any potential IP-TV and BMTV deployment are the
Fixed Network Operators, Mobile Network Operators and Media Content Aggregators. In
the latter group SKY’s position is unrivalled due to its ownership of TV rights to key sports
and Hollywood movies and television series. With this unparalleled range of content it is
difficult to see a strong competitive challenge in the market.

SKY’s importance within New Zealand is reflected in its involvement in IP-TV and mobile
TV developments. SKY and Telecom have announced that they have been trialling IP-TV
since October 2005, combining SKY’s digital service with a joint SKY/Telecom set-top
box, with enhanced interactive and TV functions being delivered over a Telecom ADSL
connection. Although Telecom is indicating an open content policy, SKY has first right of
refusal to supply content to Telecom. In addition SKY has entered into agreements with
Telecom and Vodafone to provide SKY video content to mobile devices.

Looking forward, the convergence of telecommunications and media, with fixed and
mobile delivery is likely to increase. New Zealanders will have increasing choices over
how and where they interact with media content, but choices between competing delivery
channels may be limited by exclusive agreements between carriers and SKY.

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Telecommunications industry investment in New Zealand xv

Investors’ perspectives

The focus of investors is primarily on Telecom including competition scenarios and


planned capital expenditure and forecasts. Alternative providers, other than TelstraClear,
constitute a very small proportion of the market and are not regarded as a serious threat to
Telecom’s market share.

0.3 International comparisons

We reviewed a range of comparative statistics in order to assess investment performance


against international benchmarks. We found that although New Zealand has relatively low
broadband, fixed and mobile penetration in comparison with OECD counterparts, New
Zealanders are comparatively large spenders on telecommunications. In 2003
telecommunications revenue as a proportion of GDP was almost 4% for New Zealand, one
of the highest in our sample. The OECD report that the OECD average for 2003 was 3.2%
of national income, having grown from 2.3% in 1995. Naturally the relatively high result
for New Zealand over time could be due to a number of factors, including:

• high (possibly monopolistic) prices


• high costs
• increasing usage as prices decline
• inefficiencies caused by a lack of competition in the market.

New Zealand is ranked 8th out of the 30 OECD countries for public telecommunication
investment per access channel in 2003, but appears to have exhibited a consistently low
average investment across the six years from 1997 to 2003. In 2001 New Zealand was
ranked 22nd.

It is important to note that over the short term public telecommunication investment per
access channel can fluctuates markedly from year to year. An examination of smoothed
data (such as short term averages) would provide a better indication of medium term trends
in investment levels. Based on three-year average investment data, we find that over the
periods 1988 - 1999 and 2001-2003 while the OECD median level of investment varied

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Telecommunications industry investment in New Zealand xvi

little, New Zealand investment declined relative to the OECD median and fell below the
OECD median during 1994-1996.

In order to compare very recent investment performance using equivalent operators, we


selected a small benchmark sample of operators in countries with some similarities to New
Zealand. All benchmark countries are developed countries in the process of deploying
NGN.

• Telecom’s levels of recent capital investment appear to be consistent with or above that
of comparable incumbent operators in our sample of countries
• Valid comparison of Telecom’s NGN rollout plan and NGN investments with those of
other countries is made difficult by the lack of detailed timing and cost information
• Timing for mass market aspects of Telecom’s NGN rollout have slipped significantly
in its recently released high level plan.

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Telecommunications industry
investment in New Zealand
Final report for the Ministry of Economic Development

Contents

0 Executive summary ii
0.1 Current and future investment ii
0.2 Impacts on investment xi
0.3 International comparisons xv

1 Introduction 1

2 Current and future industry investment 2


2.1 Telecom 2
2.2 TelstraClear 12
2.3 Vodafone 14
2.4 Broadcast Communications Limited 15
2.5 Woosh 17
2.6 CityLink 18
2.7 ihug 19
2.8 Sky Network Television 20
2.9 Vector Communications, 24
2.10 CallPlus 26
2.11 IT Mainland 28
2.12 Compass Communications 30
2.13 Econet Wireless New Zealand 31
2.14 IPStar 32
2.15 Orcon 33
2.16 TeamTalk Limited 35

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Telecommunications industry investment in New Zealand xviii

2.17 Summary and Conclusions 37

3 International Comparisons 41
3.1 Industry Comparisons 41
3.2 Equivalent provider comparisons 54
3.3 NGN deployment 63

4 Investment perspectives 67
4.1 Investment Drivers and Barriers 67
4.2 Fixed Network Investment Prospects assuming regulatory status quo 73
4.3 Industry Views 78
4.4 Investor Community Views 93
4.5 Convergence of Telecommunications and Media 97
4.6 Key Conclusions 102

Annex A: Investor reports A1

587306 -
1 Introduction

This report examines telecommunications industry investment in New Zealand. We


present:

• Details of current and future industry investment (Section 2)


• International comparative information and analysis (Section 3)
• Perspectives in investment, including industry and investor views (Section 4).

The information in this report is based on the material available to us as at 17 March 2006.
Confidential material is presented in square brackets and has been removed from the public
version.

587306 -
2 Current and future industry investment

In this section we present an analysis of the size and profile of investment of


telecommunications service providers in New Zealand, covering both existing and
proposed investment.

2.1 Telecom

2.1.1 Fixed network

Telecom’s domestic fixed-network (New Zealand Wired) capex is disaggregated into three
categories:

• Growth - augmenting capability for existing services.


• Upgrades and replacements - rehabilitating capability for existing services.
• New investment - establishing capability for new services.

Actual New Zealand Wired capex for 20031, 2004 and 2005 as well as forecast capex for
2006 is presented in Exhibit 2.1 below.

1
Note: information relates to financial years. The New Zealand financial year ends on 31 March; as such information presented in
TCNZ annual reports relates to the first quarter of the year of publishing and the last three quarters of the previous year.

587306 -
Telecommunications industry investment in New Zealand 3

500
470

450 426

Capital expenditure (NZD millions)

400
348
170
350

314

202
300

Growth

161
250
New investment
165 160 Upgrades and replacements
200

102
150

111
68
100

122 140
50
81 76
0

2003 2004 2005 2006F

Exhibit 2.1: Telecom’s New Zealand Wired capex [Source: Telecom]

Exhibit 2.2 below indicates that:

• new investment capex does not appear to have increased at the expense of growth and
upgrades and replacements capex
• total New Zealand Wired capex has increased every year since 2003
• an unusually high year-on-year increase in new investment capex occurred in 2004
(+63%)
• an unusually high year-on-year increase in total capex occurred in 2005 (+22%)
• in 2005 the least and greatest year-on-year increases in capex were for new investment
(-8%) and upgrades and replacements (+61%) respectively
• in 2006 the least and greatest year-on-year increases in capex are expected for growth
(-16%) and new investment (+57%) respectively.

587306 -
Telecommunications industry investment in New Zealand 4

Increase in capex over previous year per capex category:

Year Growth New investment Upgrades and Total capex


replacement
2004 -2% +63% -6% +11%
2005 +25% -8% +61% +22%
2006 (forecast) -16% +57% +16% +10%

Exhibit 2.2: Relative change in New Zealand Wired capex [Source: Telecom]

The 25% increase in ‘growth’ capex in 2005 over that of 2004 was as a result of capex
used to:

• increase the coverage of broadband services


• purchase data centre equipment which had previously been leased
• upgrade Xtra’s email platform.

New investments capex is disaggregated into new information systems capability, new
network capability, and product development sub-categories (Exhibit 2.3). Telecom has not
made publicly available details of what capex has been allocated to each sub-category.

180
160
160

Capital expenditure (NZD millions)

140
40

120 111

102 New Information Services


capability
100
New network capability
80 64 50
68 90 Product development
60

46
40

31 42
20
5
30
17 16 10
0

2003 2004 2005 2006F

Exhibit 2.3: Telecom’s New Zealand Wired ‘New investment’ capex [Source: Telecom]

587306 -
Telecommunications industry investment in New Zealand 5

Exhibit 2.4 below indicates that in 2005:

• total new investment capex was 8% less than in 2004


• the least and greatest increases in capex over 2004 were for product development
(-8%) and new network capability (+35%) respectively.

Telecom forecasts that in 2006:

• total new investment capex will be 57% greater than in 2005


• the least and greatest increases in new investment capex over 2005 will be for new
Information Services capability (-20%) and product development (+200%)
respectively.

Increase in ‘New investment’ capex over previous year per capex sub-category:

Year New Information New network Product Total ‘new


Services capability capability development investment’ capex
2004 n.a. 2003 capex is not directly comparable to 2004 capex due to business
restructuring
2005 -22% +35% -38% -8%
2006 (forecast) -20% +114% +200% +57%

Exhibit 2.4: Relative change in Telecom’s New Zealand Wired ‘new investment’ capex

[Source: Telecom]

In 2006 Telecom claims that it will incur substantial capex in the implementation of its
NGN and in increasing its share of the broadband share.

2.1.2 Mobile network

Mobile (New Zealand Wireless) capex, unlike New Zealand Wired capex, is not
disaggregated into categories. Exhibit 2.5 illustrates that New Zealand Wireless capex:

587306 -
Telecommunications industry investment in New Zealand 6

• was 1% less in 2004 than it was in 2003


• was 31% greater in 2005 than it was in 2004.

A significant contribution of the 31% increase in New Zealand Wireless capex in 2005
over that of 2004 was the roll-out of the EV-DO network.

2006 forecast capex data is not available for New Zealand Wireless, though Telecom
expects it to incur capex in increasing its 3G market share.

Exhibit 2.5:
100
Telecom’s NZ
89
90
Wireless capex
Capital expenditure (NZD millions)

80 [Source: Telecom]
69 68
70

60

50

40

30

20

10

0
2003 2004 2005

587306 -
Telecommunications industry investment in New Zealand 7

2.1.3 Telecom’s NGN plans

Overview

In November 2001 Telecom first publicly signalled, in a press release2 stating that it had
entered into negotiations with Alcatel, its intention to build an NGN. Telecom publicly
released3 its NGN investment plan in August 2004, by which time we believe
implementation of the plan was well underway:

In June 2002 Telecom began a 5 year investment plan to implement the NGN. Initial
investment comprises a MPLS capable IP Core, enhanced DSL and Ethernet over fibre
technology with supporting operational support systems. [p. 33, 34]4.

Telecom’s August 2004 press release states the size of the investment as $1 billion over a
ten year period, though more recent press releases quote a figure of $1.4 billion. Details of
the NGN plan as presented in the press release are provided in Exhibit 2.6 below.

Capex Timeframe NGN plan element


(NZD millions)
120 5 years Deployment of fibre to the curb (FTTC) and fibre to the premises
(FTTP). Extension of fibre to 2100 roadside cabinets.
10 n.a. Fibre pilot for residential and business customers, to test
technologies and to inform decisions about the possible future
deployment of FTTP
110 3 years Enhance and to increase coverage of and capacity for services
which use Telecom’s copper access network
125 5 years Core network: capacity expansion, new backbone route
construction, transition to IP platforms.

Exhibit 2.6: Telecom’s August 2004 NGN investment plan [Source: Telecom]

2
TCNZ (2001). Telecom and Alcatel move towards strategic relationship. 13 November 2001.

3
TCNZ (2004). Telecom outlines new technology investment plans. 5 August 2004.

4
TCNZ (2003). Form 20-F for the fiscal year ended 30 June 2003. 28 November 2003.

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Telecommunications industry investment in New Zealand 8

In February 2005 Telecom5 released further details of its NGN investment plan
(Exhibit 2.7) and provided details6 of the status of completion of each of the components of
the plan (Exhibit 2.8).

2001 2002 2003 2004 2005 2006 2007 2007 2008 2009 2010
Mass PSTN Replacement
Residential Video
Residential VOIP
Residential Multiservice Access
Network VOIP for Business
Full Multiservice Access for Business
Multiservice IP Core


IP Core Development

Broadband Coverage
NGN Architecture


NGN Economics

TVR Alcatel Partnership �
Exhibit 2.7: Telecom’s high-level NGN plan [Source: Telecom]

5
TCNZ (2006). Telecom New Zealand: NZ operations. Management briefing day. 23 February 200

6
TCNZ (2005).Investment in New Zealand’s future. Rev 5.0. February 2005.

587306 -
Telecommunications industry investment in New Zealand 9

Project component Status


Alcatel partnership Completed
NGN economics Completed – but will continue to be updated
NGN architecture Completed – but will continue to be updated
Broadband coverage Completed - national coverage will reach 96% by end 2004
Ongoing - FTTC coverage being extended
Ongoing – FTTP being planned
Ongoing – fibre core transport being enhanced
IP core development Completed and now being transitioned to multi-service core
(MSC)
Multi-service core Ongoing – planned and to be completed in 2005
Full multi-service for business Completed with ‘One Office’ being released to market in
December 2005
Network VoIP for business Partially implemented – trial approved
Residential multi-service access In labs – trial being finalised for mid-2005
Residential VoIP Trial being finalised for mid-2005
Residential video Trial being finalised for mid-2005
PSTN replacement Architecture and solution finalised – voice migration planning
started
PSTN lifecycle management completed and under execution

Exhibit 2.8: Status of Telecom’s NGN as of February 2005 [Source: Telecom]

Later that year Telecom announced7 that it would invest $220 million of the $1.4 billion
total NGN capex in VoIP platforms, with the aim of migrating all of its residential
customers to VoIP between 2007 and 2012.

Telecom8 has very recently announced:

• plans to deploy ADSL2+ from June 2006


• [

7
TCNZ (2005). Telecom and Alcatel build platform for next generation voice. 30 August 2005.

8
TCNZ (2006). Delivering affordable broadband for all – the future evolution of broadband in New Zealand. To be presented to the
Minister on 20 March 2006.

587306 -
Telecommunications industry investment in New Zealand 10

Recent developments

In late March 2006 Telecom released an updated NGN rollout plan during Alcatel’s Asia-
Pacific briefing day in Sydney. The presentation material included an updated NGN
timeline (Exhibit 2.9).

Exhibit 2.9: Status of Telecom’s NGN as of March 2006 [Source: Telecom]

Comparing Exhibit 2.9 with the previous NGN timeline Exhibit 2.7 identifies that timing
for mass market NGN components including, residential multi-service access (VoIP) and
residential video services have slipped by as much as 2.5 years.

587306 -
Telecommunications industry investment in New Zealand 11

Where to from here?

[9

9
Ibid

587306 -
2.2 TelstraClear

TelstraClear is the second largest fixed network carrier in New Zealand and has been
operating in its current form since December 2001. It was formed when Telstra merged the
50% owned joint venture TelstraSaturn and CLEAR Communications. In April 2003
Telstra acquired the remaining 41.6% interest in TelstraClear for AUD25 million.

TelstraClear reports annual total revenues of $716 million (2005 Telstra Annual Report)
earned through the delivery of a range of fixed line business and residential services
including:

• Business fixed telephone, data, broadband internet and mobile (Vodafone re-sale),
claiming 35% to 40% market share in top level enterprise and government sectors in
late 2005
• Residential telephone, dial-up and broadband internet and digital cable TV, with over
62,000 residential customers in Wellington, Kapiti coast and Christchurch
• Residential HomePlan
• Wireless delivery of business access and internet services.

TelstraClear operates a nation-wide fixed network consisting of:

• inter-city fibre optic backbone utilising terrestrial and submarine cable


• fibre local networks in all major metropolitan and most regional centres
• residential telephone and cable TV access networks in Wellington, Kapiti and
Christchurch.

Beyond the reach of its own network, TelstraClear offers residential and business services
through re-seller arrangements.

During 2005, TelstraClear abandoned investment plans to build New Zealand’s third
mobile network and has clearly indicated that it will not now establish a national fixed full
service network to rival Telecom. However, TelstraClear has continued to invest in its core
and business access networks, spending $125 million capital in 2005 (Telstra Financial
report). This investment included:

587306 -
Telecommunications industry investment in New Zealand 13

• a multi-million dollar network upgrade which quadrupled its North Island backbone
design capacity from multiple 2.5 gigabits per second to multiple 10 gigabits per
second
• a $14 million project to extend the North Island upgrade into the Auckland
metropolitan area, increasing capacity of the Ethernet network from 1 gigabit per
second to 10 gigabits per second.

In a recent press release (25 January 2006), TelstraClear CEO Dr Alan Freeth announced
that TelstraClear will invest $20 million in a new-generation fibre backbone network
connecting key cities in the lower South Island. This will consist of a 950 km fibre lay,
linking Dunedin to Gore, Invercargill, Queenstown and Christchurch. Dr Freeth stated that
the network build reflects TelstraClear’s commitment to ongoing investment in New
Zealand and that in 2006 TelstraClear will spend more than $120 million extending the
network and enhancing customer services. TelstraClear is also planning high speed access
networks for the CBD areas of Invercargill, Queenstown, Timaru, Ashburton and Gore
once the backbone is completed.

The new fibre will also provide a link in New Zealand’s advanced research network, for
which TelstraClear was named preferred managed service supplier in December 2005.

According to Telstra’s annual report in 2005, TelstraClear is:

continuing to grow revenue while managing cost levels, with strong retail revenue growth
in the consumer and small business markets resulting from aggressive marketing strategies,
as well as some major corporate customer wins. Growth in the retail segment has been
partly offset by reduced wholesale revenues driven by competition and rate reductions.
Regulatory change in fiscal 2004 allowed TelstraClear the opportunity to resell residential
services to the 90% of New Zealand homes that previously had no choice of service
provider. This was a major strategic focus for TelstraClear in fiscal 2005.

Telstra states that New Zealand is a strategically important market for its trans-Tasman
customers and the combination of TelstraClear and Telstra enables it to provide customers
on both sides of the Tasman with seamless communication and IT solutions.

587306 -
Telecommunications industry investment in New Zealand 14

TelstraClear is now part of the Telstra International group which includes Telstra’s
business ventures in other Asia-Pacific countries. TelstraClear is one of the better
performing companies in this group through its renewed focus on ‘increasing revenue,
driving expense efficiencies and investing capital expenditure wisely’. In presenting
Telstra’s vision in the recent Strategic Review, the Telstra CEO confirmed that the
immediate focus for TelstraClear is to continue to ‘look for breakout opportunities and
focus on profitable operations’.

2.3 Vodafone

The Vodafone Group acquired its New Zealand business (previously known as BellSouth
New Zealand) in November 1998. At the time of purchase, Bellsouth had 138,000
customers. Vodafone is currently the largest mobile provider in New Zealand with results
for the quarter to 31 December 2005 showing in excess of two million customers, with
total revenue for 2005 at $1.2 billion. On the basis of revenue and network coverage,
Vodafone is the second largest telecommunications operator in New Zealand.

Vodafone’s base network is a 2G GSM digital mobile infrastructure which provides service
to all major centres, recreational areas and state highways in New Zealand. The network
has more than 1100 mobile sites which Vodafone claims provides coverage to over 97% of
New Zealand’s populated areas. The network has been expanded since 1998 and Vodafone
New Zealand’s capital expenditure from that time has exceeded $1.4 billion.

In May 2004 Vodafone announced that it had selected Nokia as its 3G network
infrastructure partner for both Australia and New Zealand. The 3G UMTS network was
officially launched in August 2005, providing data speeds of up to 384kbit/s. The network
was originally available in 19 metropolitan and town centres and its expansion is the key
focus of Vodafone’s capital expenditure in New Zealand. Vodafone state that the national
3G network will require investment of [ ] over [ ] years, providing internet
download speeds of around [ ] and able to meet the needs of
between [ ] of internet users within its coverage footprint over the next [ ]
years.

587306 -
Telecommunications industry investment in New Zealand 15

Vodafone has reported significant growth in data services over its mobile network,
principally TXT, PXT and Vodafone live. Future service growth is expected to come from
3G-enabled products and services, including video calling, mobile television and full music
track downloads.

Apart from expanding the range and availability of 3G services on the mobile network,
Vodafone has little current scope for further investment and growth (unless it were to
revise the Vodafone business model and purchase or build wireline network). With the
New Zealand mobile market reaching very high penetration levels (over 88%) network
growth could also come from selling cellular service into the fixed line market as a
replacement for wireline. This issue is the subject of Vodafone’s application to the
Commerce Commission for an investigation and Determination on local interconnection
with Telecom, which the Commission has recently decided to investigate.

2.4 Broadcast Communications Limited

Broadcast Communications Limited (‘BCL’) is positioned as an independent wholesale


provider of communications solutions for both broadcasting and telecommunications. The
company is a wholly owned subsidiary of the State Owned Enterprise Transmission
Holdings Limited (THL). Part of BCL’s vision is “to be the leading wholesale provider of
broadband wireless access solutions with specific emphasis on rural and provincial
markets”.

BCL, in one form or another, has been providing broadcast and telecommunications
services in New Zealand for more than 60 years. In particular, BCL has provided or is
currently providing co-location, linking and maintenance service to TVNZ, TV3, Prime
Television and Sky Television, TAB and national FM radio and network linking and a fibre
optic network for the start-up CLEAR Communications (now TelstraClear). In addition,
BCL’s broadband access product Extend forms a part of Telecom’s broadband wireless
internet offering and is used in a number of Project Probe regions.

BCL claims that its network reach takes in 99.8% of New Zealand's population, using more
than 400 transmission sites throughout the country. It is assumed that this reach refers
principally to broadcast capability rather than interactive telecommunications. The network

587306 -
Telecommunications industry investment in New Zealand 16

employs a number of technologies, including extensive use of Digital Microwave Radio


(DMR) and fibre optic transmission systems. The fibre infrastructure links all major centres
and radio systems extend coverage to provincial and regional areas. While used extensively
for broadcast service, the network is designed to meet telecommunications levels of
reliability and availability.

Although used principally as a “wireless DSL” service to deliver broadband internet, the
BCL broadband access solution is also capable of delivering high quality voice service.

In September 2005, BCL announced that it was to begin trials of WiMAX broadband
wireless access solutions. If successful, BCL intend to add this capability to its range of
access solutions. Its investment in this and other emerging technologies will be driven by
demand for wholesale service from customers, such as Telecom and ihug, wishing to
enhance service delivery capability in remote and rural areas. As it is rapidly becoming a
widely accepted industry standard, WiMAX has the potential to deliver cost effective
wireless broadband to residential customers in areas of low population density, making it
potentially well suited to New Zealand requirements.

Also in 2005, BCL began work on the commercial rollout of digital terrestrial television
(DTT) for New Zealand. According to the BCL 2005 Annual Report:

BCL initiated a major project, working with television broadcasters and the New Zealand
Television Broadcasters’ Council, to scope out options for the delivery of digital terrestrial
television (DTT) in New Zealand. DTT offers sharper pictures, more efficient use of
spectrum, greater options for broadcasters, more channels for viewers and the potential for
high definition television in the future. It also provides an opportunity to develop a cost-
effective digital television platform utilising existing broadcasting infrastructure owned by
New Zealanders. The work being done includes the development of a commercial business
case for the deployment of a DTT network that meets the requirements of New Zealand’s
television broadcasters. It will see BCL engineers undertake a thorough analysis of the
technical requirements and costs involved in a range of different deployment options to
support future decision making about the development of free-to-air digital television in
New Zealand.

587306 -
Telecommunications industry investment in New Zealand 17

2.5 Woosh

Woosh Wireless (formerly Walker Wireless) launched its broadband IP wireless access
solution in September 2003. Prior to this time, Walker Wireless provided a range of lower
speed wireless data access solutions.

The Woosh network was the first in the world to deploy a major commercial
implementation of UMTS TDD technology from supplier IP Wireless. This technology is
based on the same standards as the data capability associated with the GSM 3G service
being deployed by Vodafone. As such, it was more developed than other broadband
wireless products in 2003, allowing early market entry.

Woosh now has a broadband customer base of 20 000 customers. It is not clear how many
of these customers also subscribe to the Woosh telephone service launched in September
2005, but 500 customers were reported as signing up to Woosh phone in the first two
weeks of service and recent reports put the number of voice customers at around 1000.

Prior to raising an additional $29.2 million investment from shareholders in January 2006,
Woosh had invested $130 million (including accumulated losses) and reported sales of
$11.4 million and operating costs of $17 million per annum.

The Woosh service is available in Auckland (70% coverage), Wellington (37 000 homes
and businesses), Christchurch (18 000 homes and businesses) and parts of Southland
(10 000 homes and businesses). The Southland rollout is sponsored by a Project Probe
initiative. Woosh estimate that it has [ ] market share in the areas where it provides
coverage.

The broadband rates available from Woosh (250kbit/s and 500kbit/s download) are limited
when compared to ADSL. The service also suffers from significant latency (delay) which
makes it less suitable for real time services such as gaming and VoIP using Skype. The
user experience does seem to be variable, however, with users in some regions reporting no
problems with speed or delays. Woosh has introduced a new wireless access product (from
US broadband wireless company Trango) to provide the video-conferencing service
required for Probe initiatives.

587306 -
Telecommunications industry investment in New Zealand 18

Looking forward, Woosh confirms continued commitment to roll-out to other centres


around New Zealand. Its failure to comply with a number of Probe commitments which it
originally won may indicate that the technology has difficulty serving low density and rural
areas, where a WiMAX solution may be preferable.

[Woosh has recently indicated10

2.6 CityLink11

CityLink was formed in 1997 in Wellington as a result of a 1995 public-private partnership


(PPP) initiative which deployed a fibre-based broadband communications network in the
city. The network was designed to be:

• high bandwidth – using fibre


• low cost – using aerial cable

• open architecture – using well established technological standards.

The CityLink network has expanded rapidly, with annual growth rates of 100% (as
measured by the number of connected buildings) during the first few years of business. 350
buildings in the Wellington CBD are connected to the CityLink network which passes an
additional 300+ buildings. CityLink is currently building a similar network in Auckland. In
addition to the fibre network CityLink has wireless (Wi-Fi) hotspots in over 50 strategic
locations in Wellington and also operates five peering exchanges12.

10
Woosh (2006).

11
www.citylink.co.nz

12
The Line (2005). CityLink opens DPE and 3CIX peering exchanges. 20 July 2005.

587306 -
Telecommunications industry investment in New Zealand 19

CityLink’s main services are:

• dedicated point-to-point connectivity using dark fibre and Ethernet


• managed IP networking allowing:
– high-speed access to ISPs – 18 ISPs are connected
– business-to-business (B2B) local networking
– VLANs
– VPNs
• Wi-Fi based Internet access.

CityLink is a privately owned company and it has not publicly released any revenue figures
or details of investment plans (other than to say that it is building a network in Auckland).

2.7 ihug

Established in 1994, ihug is currently New Zealand’s third largest ISP with over 100 000
business and residential customers13. It was acquired in 2003 by iiNet Limited, Australia’s
third largest ISP, who reports ihug’s revenues as AUD31.9 million for the financial year
ended 30 June 200514.

ihug’s network consists of satellite earth stations in Auckland, Christchurch, Dunedin and
Wellington. It has interconnection agreements with Telecom, TelstraClear and Vodafone15.

Services offered by ihug include:

• Internet access via dial-up (including global roaming), ADSL Internet access using
Telecom’s commercial UBS product, Frame Relay and fibre (Ethernet) Internet
• toll calls
• domains

13
www.ihug.co.nz

14
iiNet Limited (2005). Annual report 2005. 30 September 2005.

15
Paul Budde Communication Pty Ltd (2005). 2006 Telecoms overview, statistics and analyses in New Zealand. December 2005.

587306 -
Telecommunications industry investment in New Zealand 20

• website hosting
• telehousing.

Morgan Stanley16 reports that ihug had the following subscriber numbers as of October
2005:

• broadband – 17 000
• dial-up – 56 000
• voice – 29 000

• other – 11 000.

ihug claims17 that it will invest more than $20 million in current-generation broadband
technology (ADSL2+) over three years for the provision of broadband and VoIP services if
the Government unbundles the local loop18. This investment is sufficient to cover more
than 100 000 households, 48 000 of which will be in Auckland. ihug plans to support its
LLU-driven broadband strategy by acquiring ISPs which have established subscriber bases.

2.8 Sky Network Television

Sky Network Television (‘SKY’), a publicly owned media content aggregator (MCA), was
established in 1987 following deregulation of the New Zealand broadcasting industry. It
successfully tendered for a range of UHF networks and commenced broadcasting a three-
channel subscription service in the Auckland, Hamilton and Tauranga regions in May
1990. SKY remains New Zealand’s only source of pay TV content. It had television
services revenues of $489.4 million for the financial year ending 30 June 2005.

16
Morgan Stanley (2005). iiNet Limited: a beneficiary of ULL rollout and industry consolidation. 26 October 2005.

17
ihug (2006). Letter to David Cunliffe. 1 February 2006.

18
ihug (2005). Ihug set to spend $20Mil to improve broadband. 13 December 2005. Media release available at
http://www.ihug.co.nz.

587306 -
Telecommunications industry investment in New Zealand 21

SKY gradually increased the coverage of its terrestrial UHF service and in April 1997 it
launched a nationwide analogue direct broadcasting satellite (DBS) service. This was
upgraded to a digital service in December 1998.

SKY transmits its analogue service via five UHF frequencies and its digital service via four
transponders on Optus’ B1 satellite. SKY has committed to lease transponders for up to 15
years on the B1’s replacement, the D1 which is to be launched into a 160° east position by
June 2006. The D1 satellite will allow for broadcast of HDTV and Dolby 5.1 Digital
sound. A back-up satellite, known as D1R, is scheduled to be launched in November 2006,
should there be a failure during the launch of the D1 satellite.

Optus will launch a second satellite, the D2, for SKY as a back-up to the D1 (or D1R). The
D2 will be launched into a 156° east position in 2007. To avoid having to re-align every
dish to 156° east in the event of the D1 failing SKY is now installing dual low-noise block
converters (LNBs) on each new installation and during any call-outs. These LNBs
automatically switch the dish to the 156° east position.

SKY terrestrial network infrastructure comprises:

• a 15-year-old television station which has been developed incrementally and uses tape-
based analogue technology
• satellite dishes
• decoders or the MYSKY PVR (personal video recorder).

SKY also has a resale agreement with Telecom and a retransmission agreement with
TelstraClear who:

• installs subscribers on its own network


• operates its own cable TV network
• undertakes all aspects of customer service.

SKY's digital service is capable of reaching nearly 100% of New Zealand households
while its UHF service reaches over 80% of New Zealand households.

587306 -
Telecommunications industry investment in New Zealand 22

SKY broadcasts more than 80 channels via its digital service and five channels via its UHF
service. Channels are grouped by type:

• Documentaries
• Free To Air
• Music Video
• News
• Digital Music
• Family
• Interaction
• Movies
• Pay Per View
• Radio
• Sports
• SkyBet
• Special Interest.

As of 30 June 2005, either directly or through Telecom or TelstraClear:

• 40.5% of all New Zealand households subscribed to Sky


• SKY had 636 286 subscribers, of which 562 723 were subscribed to the digital service.

SKY is currently trialling a service called MY SKY which offers subscribers greater
interactivity and functionality than the current digital service. It differs from the standard
digital service in that it includes a personal video recorder (PVR) which:

• has a 160Gbyte hard drive


• is fully integrated with SKY’s electronic program guide (EPG)
• has two decoders, allowing for the viewing of one channel while recording another
• has a 60-minute buffer, recording the channel being watched, allowing for rewind,
pause, forward etc functions.

587306 -
Telecommunications industry investment in New Zealand 23

MY SKY was initially scheduled19 for launch in December 2005. However, information on
SKY’s website indicates that the service had not been launched as of today.

SKY’s importance as an MCA within New Zealand is reflected in its involvement in IP-TV
and mobile TV developments:

• Citigroup reports20 that SKY and Telecom were trialling IP-TV as of October 2005,
combining SKY’s digital service with a joint SKY/Telecom set-top box, with enhanced
EPG and TV functions being delivered over a Telecom ADSL connection. SKY has
first right of refusal to supply content to Telecom.

• SKY has entered into agreements with Telecom and Vodafone to provide SKY video
content to mobile devices.

SKY’s proposed investments are:

• $4.5 million to extend four of its UHF network licences for ten years until 2020
• an audience measurement system to provide information on subscribers’ viewing
habits
• $50 million to upgrade its TV station for broadcast mobile TV and IP-TV.

Citigroup estimates21 that $40m of the $50m SKY’s investment in upgrading its TV station
will be incurred during the 2006 financial year. The new station will:

• be constructed over two sites (for redundancy)


• have a capacity of up to 112 standard-definition channels
• provide the capability to offer widescreen on all channels
• allow for Dolby 5.1 Digital sound encoding
• allow for HDTV format production.

19
SKY (2005). Press release SKY television leads television revolution: MY SKY launch date confirmed. 6 September 2005.

20
Citigroup (2005). Sky Network Television: holding the aces. 17 October 2005.

21
Citigroup (2005). Sky Network Television Ltd: holding the aces. 17 October 2005.

587306 -
Telecommunications industry investment in New Zealand 24

Network Strategies believes that in addition to the aforementioned investments significant


investment will be required to enter the IP-TV and mobile TV markets. SKY and Telecom
have announced that they have been trialling IP-TV since October 2005, combining SKY’s
digital service with a joint SKY/Telecom set-top box, with enhanced interactive and TV
functions being delivered over a Telecom ADSL connection.

2.9 Vector Communications22, 23

Vector Communications (‘Vector’) is a wholly owned subsidiary of Vector Limited, a


multi-utility company with revenues of $871 million for the 2004/05 financial year. Vector
Limited’s portfolio includes the following companies in addition to Vector:

• Vector Electricity and UnitedNetworks – retail and wholesale electricity distribution


network operators respectively serving Auckland and the lower North Island
• NGC – natural gas and LPG transportation; energy sales and energy metering services
• Vector Gas – wholesale natural gas distribution
• NGC Metering – energy metering services
• STREAM Information – online electricity metering for business users
• Utilitech - multi-utility training business
• Treescape - arboricultural and vegetation management organisation.

Vector owns and operates a total of 320kms of fibre (Ethernet) networks, located in ducts
parallel to Vector Limited’s electricity and gas networks in Auckland and Wellington. The
networks are designed for:

• high reliability
• flexibility for future growth
• scalable performance levels
• compatibility with business LANs.

22
Vector Limited (2005). Annual report 2005.

23
www.vectorcommunications.co.nz

587306 -
Telecommunications industry investment in New Zealand 25

It operates a wholesale business model, offering services including:

• Metro Ethernet – point-to-point and point-to-multipoint connectivity


• InterMetro – connectivity between the Auckland and Wellington networks
• Telehousing – co-location of customers’ telecommunications equipment at Vector’s
data centre.

In April 2005 Vector Limited announced24 that it had won a ‘multi-million dollar contract
to supply state-of-the-art energy [gas and electricity] and communications infrastructure’ to
the Highbrook Business Park development in East Tamaki. More specifically, Vector
Limited will install:

• an electricity network with a high-speed restoration facility


• a gas network based on a multiple-ring configuration, aiding gas system security
• a fibre communications network with a capacity of up to 10Gbit/s per fibre.

The business park is expected to cater for up to 12 000 people when completed. It will be
constructed incrementally over the next 12 to 15 years.

[Vector has indicated 25

24
Vector Limited (2005). Press release, Vector wins competitive 'triple-play' contract for major Auckland development. 8 April 2005.

25
Vector Communications (2006). Submission by Vector Communications Limited to the Hon David Cunliffe, Minister of
Communications and the Ministry of Economic Development on broadband regulation in New Zealand. 10 February 2006.

587306 -
Telecommunications industry investment in New Zealand 26

[Vector states26 :

2.10 CallPlus

CallPlus, formed in 1996 and 100% New Zealand-owned, had 2005 revenues27 of $60
million. It operates as a full service provider by reselling Telecom’s services. Business
services include:

• Calling – tailored plans, toll-free and VoIP


• Data – Ethernet over fibre and Frame Relay
• Internet – ADSL, dial-up, Ethernet, Frame Relay and ISP services including domain
names and static IP addresses
• Lines – PSTN and ISDN, centrex and supplementary services (call waiting etc).

Residential services including toll calls and broadband and dial-up Internet access are
offered under the Slingshot brand.

26
Ibid.

27
Paul Budde Communication Pty Ltd (2005). 2006 Telecoms overview, statistics and analyses in New Zealand. December 2005.

587306 -
Telecommunications industry investment in New Zealand 27

587306 -
Telecommunications industry investment in New Zealand 28

2.11 IT Mainland

IT Mainland (ITM) was incorporated in August 2005 to raise $5 million capital28 ‘to secure
the commercial advantages [its investors] see in the IndraNet Fractal Mesh Network
Technology (FraMe)’. Media reports29 indicate that IndraNet had previously tried to raise
the capital in 2005 but was unsuccessful.

FraMe is a proprietary wireless technology. A network based on FraMe technology is


meshed and consists of:

• minders (CPE) operating in 2.4GHz and 5.8GHz spectrum


• metaminders operating in 2.4GHz, 3.5Hz and 5.8GHz spectrum
• hyperminders (highest level of network with the fewest nodes) connected using fibre
and/or ‘extreme broadband wireless transmission means (such as free space optical)’30.

The number of levels of network required to provide coverage to an area is proportional to


the level of traffic and traffic density. IndraNet claims31 that the following are features of
FraMe hardware and networks:

• low power – does not require a licence


• low latency – enabling real-time communications
• point-to-point connectivity
• symmetrical 2Mbit/s bandwidth between minders – with next generation capability of
20Mbit/s
• subscriber densities of up to 1 million per km2 whereas existing 3G technologies such
as CDMA 2000 can only achieve 10 000/km2 at 2Mbit/s
• a fully-meshed, multi-layer, self-healing network.

28
IT Mainland (2006). Prospectus. 23 January 2006.

29
www.stuff.co.nz (2006). Second bid to finance wireless network dream. 23 February 2006.

30
www.indranet.co.nz

31
Ibid.

587306 -
Telecommunications industry investment in New Zealand 29

IndraNet’s website implies that the maximum distance between minders is 10 miles
(16km). However, Electricity Ashburton has deployed32 13 minders to provide a
point-to-point link between its office (assumed to be in Ashburton) and a remote substation
at Pendarves, a distance of no greater than 25km over flat terrain.

ITM’s business plan33, 34 assumes:

• an addressable market of more than 300 000 residences and businesses, 170 000 of
which are in Christchurch
• capturing 4% of the addressable market during the first three years of deployment and
25% market share at completion of year five
• achieving average per-minder costs (including operating costs) and returns of $1000
and $1200 respectively per annum by the end of 2008
• installing 1405 minders and an estimated nine metaminders
• an installation fee of $165 per minder.

ITM initially plans35 to offer the following services in the short-term:

• Specialised iPN Services: autonomous and secure networks that are configured over
each local FraMe network, reserved for a customer’s exclusive purposes, and leased to
that customer. Examples of such services include power grid management, security
systems, traffic management systems, and private networks between branches of a
business.

• Broadband ISP Services (BSP): during the first twelve months of operation of a FraMe,
the focus is planned to be on Internet connectivity for Internet Service Provider (ISP)
services. ISP services are to be tailored to end-user profiles.

• Voice: VoIP is planned to be introduced after the FraMe network is established.

32
www.computerworld.com (2003). Ashburton point-to-point link 'vast' improvement. 29 July 2003.

33
IT Mainland (2006). Prospectus. 23 January 2006.

34
IT Mainland (2006). Investment statement for offer of shares. 23 January 2006.

35
Ibid.

587306 -
Telecommunications industry investment in New Zealand 30

Services planned for long-term deployment include video on demand, videophone and
teleconferencing.

Network Strategies views ITM’s technology as innovative and its deployment plan as
commendable. However we have serious reservations about its ability to achieve its goals
for the following reasons:

• The bandwidth is currently relatively low – only 2Mbit/s symmetrical.


• IndraNet’s/IT Mainland’s repeated equity raising without having achieved any
apparent commercial deployment.
• The technology is proprietary. This decreases its marketability and potential uptake and
leads to higher unit costs than if the technology was standards-based.
• The technology appears to address the problem of how to deliver real-time and
non-real time services over the same data stream by throwing bandwidth at it as
opposed to adopting priority-based traffic management.
• IndraNet and ITM literature presents ambiguous, inconsistent and vague information
pertaining to the status of IndraNet’s technology and network deployment.
• It is not clear whether the technology can interface with PSTN switches, an important
consideration for the delivery of PSTN-grade VoIP services.

2.12 Compass Communications36

Established in 1995, Compass Communications (‘Compass’) provides fixed


telecommunications and Internet services to over 25 000 business and residential customers
throughout New Zealand, as follows:

• Internet access – ADSL, dial-up, Frame Relay, ISDN, wireless and website hosting.
• telephone lines – POTS, ISDN, value added services, Centrex and redirection service.
• phones systems
• direct dial service – tailored national and international calling plans

36
www.compass.net.nz

Paul Budde Communication Pty Ltd (2005). 2006 Telecoms overview, statistics and analyses in New Zealand. December 2005.

587306 -
Telecommunications industry investment in New Zealand 31

• wireless – Internet access in Auckland, Christchurch, Palmerston North, Queenstown,


Rotorua and Whangarei.
• data networks
• fax broadcast.

Network Strategies understands that Compass has switches in Auckland, Christchurch and
Wellington, and further PoPs in Dunedin, Hamilton, Napier, New Plymouth, Palmerston
North, Rotorua, Tauranga and Whangarei.

Compass has not publicly released details of any proposed investments.

2.13 Econet Wireless New Zealand37

Econet Wireless New Zealand (‘EWNZ’) was established in New Zealand in 2000. It is
100% owned by the Econet Wireless Group which has offices and operations in Botswana,
Lesotho, Kenya, Nigeria, the UK and Zimbabwe.

Network Strategies understands that EWNZ has no network infrastructure, though it has
access to 2.5G and 3G spectrum:

• 2.5G spectrum – held by EWNZ.


• 3G spectrum – held by a Hautaki Ltd on behalf of all Maori in New Zealand.

Goldman Sachs JBWere38 believes that ‘there is a realistic prospect of a [GSM] network
being developed by Econet with the backing of Huawei’. However it also states that
Econet’s decision to invest will be based on the Government’s decision on whether to
create a more favourable current regulatory environment, including ‘more favourable
roaming rules ... and improved cell-site co-location rules’ before it invests in New Zealand.

37
www.ewnz.co.nz

www.econetwireless.com

38
Goldman Sachs JBWere (2006). Telecom Corporation of New Zealand: Econet resurrects the 3rd entrant risk – ball’s now in the
Government’s court. 10 January 2006

587306 -
Telecommunications industry investment in New Zealand 32

2.14 IPStar39

IPSTAR New Zealand Limited (IPNZ) is a wholly owned subsidiary of the Shin
Corporation of Thailand, a company with a market capitalisation of over USD8 billion.

IPNZ operates using an Auckland-based gateway and its NSS-5 satellite, allowing for
IP-based communications with a bandwidth per user of up to 4Mbit/s downstream and
2Mbit/s upstream. This satellite is to be supplemented with the IPSTAR-1 satellite which
was launched on 11 August 2005 but which does not appear to be fully operational.
Important specifications of IPSTAR-1 include:

• service life of 12 years


• three spot beams for New Zealand, each with approx. bandwidth of 200Mbit/s
• per user bandwidth of up to 8Mbit/s downstream and 2.5Mbit/s upstream.
• 178Mbit/s broadcast capacity.

CPE consists of a two-way satellite dish and a modem.

IPNZ offers the following services via a wholesale business model:

• broadband Internet access


• Internet access for business multi-tenant units (MTUs), residential multi-dwelling units
(MDU) and hotspots (hotels, Internet cafes, airports etc)
• VoIP
• video-conferencing
• intranet and extranet solutions.

IPNZ has also stated its intention to offer IPTV.

39
IPSTAR (2005). Presentation to David Cunliffe. Overview: IPSTAR system. 13 June 2005.

www.ipstar.co.nz

www.iconz.co.nz

587306 -
Telecommunications industry investment in New Zealand 33

The services are available to anyone in New Zealand with a clear line of sight to either
satellite. As of June 2005 IPNZ had 300 customers on the NSS-5 satellite:

• Probe schools
• Landcorp
• Fonterra farmers.

IPNZ’s deployment target is 50 000 by end of 2008. Network Strategies views this target
as optimistic due to the increasing popularity of IEEE802.xx technologies. However we
view IPNZ’s intention to offer IPTV services as a very significant threat to SKY’s
operations, provided IPNZ can access content. IPNZ has not publicly released any
investment figures.

2.15 Orcon

Orcon, a 100% New Zealand-owned ISP, has been40 operating since 1997 from an Internet
data centre and its Internet Head Office, both based on the North Shore. It has 85 full and
part-time staff.

Network Strategies understands that Orcon has PoPs in most cities to re-sell Telecom’s
ADSL.

Orcon offers a wide range of business and residential-focussed services:

• business Internet access – dial-up, ADSL, fibre, Frame Relay and ATM
• residential Internet access – dial-up and ADSL
• domains
• email
• toll calls
• website hosting – including co-location
• ISP/Enterprise services – bandwidth, wholesale dial-up and DSL, ISP billing and
CRM.

40
Presentation to Minister

587306 -
Telecommunications industry investment in New Zealand 34

Orcon’s customer base is:

• 54 000 dial-up users


• 13 500 broadband users

Orcon has made the following statement concerning future investment:

It is our intention to invest heavily in the New Zealand Telecommunications market, given
the appropriate environment. This investment will include the following:

Significant investment in DSLAMS and related LLU technologies. Initially in Auckland,


but a nationwide rollout will follow given appropriate customer density (in conjunction
with other LLU players). At this stage however, Orcon does not have the required margins
on our existing products to afford the capital requirements of installing enough DSLAMS
to cover our Auckland customer base.

On-going investment in the latest SPAM, VIRUS, ADWARE and filtering protection
technologies.

Investment in wireless technologies for the delivery of both data and voice; both WIFI and
WiMAX.

Investment in VoIP hardware and software to lower the cost of calling for the New Zealand
public and businesses.

Investment in online website business ventures to realize the full potential of broadband in
New Zealand; including media portals, community forums, video delivery, voice services
etc.

587306 -
Telecommunications industry investment in New Zealand 35

2.16 TeamTalk Limited41

TeamTalk Limited (‘TeamTalk’s) is New Zealand’s only nationwide trunked mobile radio
network operator, operating since 1994. Its capital expenditure and revenue for the
financial year ended 30 June 2005 were $1.3 and $20 million respectively, and as of March
2006 it had a full time staff of 37.

TeamTalk operates nationwide using two overlapping mobile radio networks – one which
grew incrementally and one which was bought from Telecom in May 2001, providing local
mobile radio services from 247 sites. It owns all the mobile radio equipment required to
operate its services and has access to the sites on which its transmission assets are situated
through co-siting agreements with Telecom and BCL.

The following voice and data services form the core of TeamTalk’s portfolio:

• radio-to-radio calls
• toll calls
• data transport
• remote alarm monitoring
• portable panic alarms using GPS.

TeamTalk’s customer base of about 4500 is drawn largely from the following industries:

• ambulance services
• rescue helicopters
• courier companies
• security services personnel
• local authorities and civil defence
• utility companies
• local and long distance road carriers
• taxi companies

41
TeamTalk (2004). Investment statement & prospectus. 2 April 2004.

www.teamtalk.co.nz

587306 -
Telecommunications industry investment in New Zealand 36

• contractors.

In 2004 TeamTalk purchased all of the equipment it requires to increase network capacity
and coverage over the next few years. As such it does not expect to make any significant
investments in capital over the next few years. It does plan however to acquire companies
which:

• can operate complex mission-critical telecommunications networks


• have effective distribution channels into its key blue-collar markets
• have a loyal customer base whose telecommunications needs are well understood
• have an efficient, low-cost operating model.

TeamTalk has not indicated that it plans to enter the mainstream residential data or voice
telephony markets.

587306 -
Telecommunications industry investment in New Zealand 37

2.17 Summary and Conclusions

Wireline

Service provider Proposed investment Regulatory sensitivity


of investment decision
CallPlus [ ] [ ]
Compass None proposed n.a.
1 2
ihug ADSL2+ - $20m+ capex over three years. LLU
Telecom $470m (estimate) wireline investment in 2006, $160m Regulatory status quo
of which is for ‘new investment’. Investment areas continuing
include broadband, ICT and ‘triple play’ – voice, video
3
and data .
4
ADSL2+ deployment Regulatory status quo
continuing
4]
Backhaul, NGN (WiMax, Sky TV etc) Regulatory status quo
continuing
5
TelstraClear More than $120m for ‘extending and enhancing None specified
services for customers throughout the country’. $20m
of this will be for a backbone network linking
Christchurch, Dunedin, Gore, Invercargill and
Queenstown. It expects to establish access networks in
the CBDs of Ashburton, Gore, Invercargill, Timaru and
Queenstown.

1. ihug (2006). Letter to David Cunliffe. 1 February 2006.

2. ihug (2006). Improving broadband uptake in NZ.: growth hormones for a healthy dwarf.

3. Telecom New Zealand (2005). Annual report 2005. 24 August 2005.

4. Telecom New Zealand (2006). Update on industry issues. 31 January 2006.

5. TelstraClear (2006). TelstraClear to invest $20m and create choice in South Island. Media release, 25 January 2006.

Exhibit 2.10: Wireline operators’ investment plans and conditions [Source: Operators]

587306 -
Telecommunications industry investment in New Zealand 38

Service provider Proposed investment Regulatory sensitivity


of investment decision
Vector ‘Multi-million dollar’ contract to supply energy and None specified
communications infrastructure to Highbrook Business
6
Park in East Tamaki
[ [
]

7
]

6. Vector Limited (2005). Annual report 2005.

7. [Vector Communications (2006). Submission by Vector Communications Limited to the Hon David Cunliffe, Minister of
Communications and the Ministry of Economic Development on broadband regulation in New Zealand. 10 February 2006.]

Exhibit 2.10 (cont.): Wireline operators’ investment plans and conditions [Source: Operators]

587306 -
Telecommunications industry investment in New Zealand 39

Wireless

Service provider Proposed investment Regulatory sensitivity


of investment decision
1
BCL DTT (digital terrestrial television) network None Specified
2
Extension of EXTEND broadband wireless network None Specified
CallPlus [ ] No conditions
Compass None proposed n.a.
Econet In a national GSM network Regulated roaming
and cell-site co-
location.
IPSTAR None proposed n.a.
IT Mainland
Sky Network Sky’s latest annual report (2005) does not contain n.a.
Television specific information regarding future capital
investments.
TeamTalk Continued expansion of mobile radio network n.a.
3
Telecom $90m (estimate) for investment in mobile in 2006 No conditions
4
Vodafone 3G network roll-out, first phase estimated at $300m Regulation of MTR
[ TSO reform
]
5
Woosh Wireless Woosh has ordered 180 UMTS TDD base stations from None Specified
IPWireless to ‘further consolidate its network in
Auckland and extend the company’s network in other
centres around New Zealand’
[ ] [
]

1. Transmission Holdings Limited (2005). Annual report 2005. June 2005.

2. BCL (2003). Regional broadband wireless network rollout running to schedule. Media release, 3 October 2003.

3. Telecom New Zealand (2005). Annual report 2005. 24 August 2005.

4. Vodafone (2006). Letter to David Cunliffe: Priorities for telecommunications policy in 2006. 24 January 2006.

5. Blast Public Relations (2005). Woosh continues its network expansion. 15 April 2005, via email.

Exhibit 2.11: Wireless operators’ investment plans and conditions [Source: Blast PR,

Operators]

In some cases service providers’ investment strategies are related to the future regulatory
environment. We note too that there is strong emphasis on metropolitan and regional
centres in investment plans. This is not unexpected, given the fact that typically

587306 -
Telecommunications industry investment in New Zealand 40

telecommunications spending distributions are highly skewed – in other words, a large


proportion of spend is generated by a relatively small number of customers. This influences
planned geographic coverage, and there may be a trade-off between targeting large
customers and broad market coverage. This issue is discussed further in the next section.

587306 -
3 International Comparisons

3.1 Industry Comparisons

Much criticism of the New Zealand communications sector’s performance is based on


comparisons with other OECD countries. In this section we review a selection of key
comparative statistics over time to see where New Zealand ranks in comparison to selected
countries. We have included as much as possible countries with smaller population bases
(such as Ireland and Scandinavian countries).

It is well established that income is a key driver for take-up of telecommunications


services. Thus an important reference point is New Zealand’s GDP per capita compared to
the income of the other sample countries. From 1998 to 2004 New Zealand’s income per
capita has remained substantially below that of all other sample countries (Exhibit 3.1).

587306 -
Telecommunications industry investment in New Zealand 42

55
Australia
50
Austria
45
Denmark
GDP per capita (USD 000s)

Finland

40 France
35
Germany
Iceland

30 Ireland
25
New Zealand
Norway

20
Sweden

15 United Kingdom
United States
10
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.1: GDP per capita - selected countries [Source: World Bank]

New Zealand’s fixed and mobile penetration has consistently remained at comparatively
low levels compared to other sample countries over time (Exhibit 3.2 and Exhibit 3.3).

587306 -
Telecommunications industry investment in New Zealand 43

80
Australia

75
Austria
Main lines per 100 inhabitants

Denmark
70
Finland
65
France
Germany

60
Iceland
Ireland
55 New Zealand
Norway
50
Sweden

45
United Kingdom
United States
40
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.2: Main lines per 100 inhabitants over time – selected countries [Source: ITU]

120
Australia
Cellular subscribers per 100 inhabitants

Austria
100
Denmark
Finland
80 France
Germany
60 Iceland
Ireland
40 New Zealand
Norway
Sweden
20
United Kingdom
United States
0
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.3: Cellular subscribers per 100 inhabitants over time [Source: ITU]

587306 -
Telecommunications industry investment in New Zealand 44

As a general rule we would expect telecommunications penetration to be higher in higher-


income countries than lower income countries. Indeed, Exhibit 3.4 illustrates this trend and
correspondingly New Zealand performs poorly in comparison with most of the other
countries in 2004. New Zealand’s position in relation to the trend line indicates that for a
country with New Zealand’s level of income we would expect cellular penetration to be
higher.

110
Sweden
Cellular subscribers per 100 inhabitants

105
United Kingdom
100 Iceland
Austria
95 Denmark
Finland Ireland Norway
90
Germany
85
Australia
80
75 New Zealand France
70
65
United States
60
20 000 25 000 30 000 35 000 40 000 45 000 50 000 55 000
GDP per capita (USD)

Exhibit 3.4: Cellular subscribers per 100 inhabitants - selected countries 2004 [Source: ITU,

World Bank]

Internet usage in New Zealand has been accelerating rapidly over time and by 2004 there
were more internet users in New Zealand per 100 inhabitants than in any of the other
sample countries. This illustrates a widespread ability and willingness to engage in a
service enabled by computer and communications technology even though in most cases
access is via dial-up (Exhibit 3.6). In terms of broadband take-up New Zealand is at the
very lowest level compared to the other sample countries. Our view is that this is a direct
result of relatively high prices and data caps. Although it is possible to obtain reasonably
priced broadband in New Zealand at very low usage levels, this is not the case for higher

587306 -
Telecommunications industry investment in New Zealand 45

usage levels. Telecom’s ADSL plans have relatively low data caps beyond which excess
usage charges are incurred. We note too that usage-based plans are far less prevalent in
countries with better developed broadband markets than New Zealand.

90
Australia
80
Austria
Internet users per 100 inhabitants

70 Denmark
Finland
60 France
50 Germany
Iceland
40 Ireland
30 New Zealand
Norway
20 Sweden

10 United Kingdom
United States
0
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.5: Internet users per 100 inhabitants over time - selected countries [Source: ITU]

587306 -
Telecommunications industry investment in New Zealand 46

20
Australia
Broadband subscribers per 100 inhabitants
18
Austria
16 Denmark
14 Finland
France
12
Germany

10
Iceland
Ireland
8
New Zealand
6 Norway
4 Sweden
United Kingdom
2
United States
0
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.6: Broadband subscribers per 100 inhabitants over time – selected countries

[Source: ITU]

Despite the relatively low broadband, fixed and mobile penetration in comparison with
OECD counterparts, New Zealanders are comparatively large spenders on
telecommunications. In 2003 telecommunications revenue as a proportion of GDP was
almost 4% for New Zealand, one of the highest in our sample (Exhibit 3.7). The OECD
report that the OECD average for 2003 was 3.2% of national income, having grown from
2.3% in 1995. Naturally the relatively high result for New Zealand over time could be due
to a number of factors, including:

• high (possibly monopolistic) prices


• high costs
• increasing usage as prices decline
• inefficiencies caused by a lack of competition in the market.

587306 -
Telecommunications industry investment in New Zealand 47

5.0%
Australia
4.5% Austria
Telecoms revenue as a % of GDP

Denmark
4.0% Finland
France
3.5% Germany
Iceland
3.0% Ireland
New Zealand
2.5% Norway
Sweden
2.0% United Kingdom
United States
1.5%
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.7: Telecoms revenue as % of GDP – selected countries [Source:ITU, World Bank]

1.4%
Australia
Telecoms investment as a % of GDP

Austria
1.2%
Denmark
Finland
1.0% France

Germany

0.8%
Iceland
Ireland
0.6%
New Zealand
Norway

Sweden
0.4%
United Kingdom
United States
0.2%
1998 1999 2000 2001 2002 2003 2004

Exhibit 3.8: Telecoms investment as % of GDP – selected countries [Source: ITU, World

Bank]

587306 -
Telecommunications industry investment in New Zealand 48

In relative terms investment per channel appears to be consistently low in New Zealand
(Exhibit 3.8). It is clear that levels of investment in the OECD declined between 2000 and
2001. Prior to 2000 investment had been growing at record levels due to42:

• roll out of second generation (2G) mobile networks


• new entrants to the local access market
• investment in national and international backbone infrastructure
• expectations of the ‘dot.com bubble’.

During 2001 a combination of the downturn in the telecommunication market and the
completion of 2G networks lead to a decline in investment levels. The exaggerated
expectations during the hype of the ‘dot.com bubble’ caused overinvestment and poor
management decisions, which left companies with high levels of debt. A number of new
entrants pulled out of the market, while others cut back on investment.

New Zealand is ranked 8th out of the 30 OECD countries for public telecommunication
investment per access channel in 2003, but appears to have exhibited a consistently low
average investment across the six years from 1997 to 2003. In 2001 New Zealand was
ranked 22nd (Exhibit 3.9).

42
OECD (2003) Communications Outlook 2003.

587306 -
Telecommunications industry investment in New Zealand 49

Austria
United Kingdom
Japan
Czech Republic
Switzerland
Ireland
Italy
New Zealand
Slovak Republic
Australia
Denmark
United States
Sweden
Spain 2003
OECD 2001
1999
Portugal
1997
Greece
Korea
Canada
Netherlands
Hungary
Iceland
Norway
Belgium
Finland
Mexico
France
Turkey
Poland
Germany
Luxembourg

0 100 200 300 400 500 600 700 800 900


Telecoms investment per access channel (USD)

Exhibit 3.9: Telecoms investment per access channel for 1997, 1999, 2001 and 2003

[Source: OECD]

587306 -
Telecommunications industry investment in New Zealand 50

700
Telecoms investment per access channel (USD)
Australia
600 Austria
Denmark
500 Finland
France
400 Germany
Iceland
300 Ireland
New Zealand
200 Norway
Sweden
100 United Kingdom
United States
0
1997 1998 1999 2000 2001 2002 2003

Exhibit 3.10: Telecoms investment per access channel - selected countries [Source: OECD]

New Zealand telecommunications investment as a percentage of revenue also appears to be


consistently low when compared to the “peaky” nature of investment in other OECD
countries (Exhibit 3.11).

587306 -
Telecommunications industry investment in New Zealand 51

60
Australia
Telecoms investment as % of revenue

Austria
50
Denmark
Finland
40 France

Germany

30
Iceland
Ireland
20
New Zealand
Norway

Sweden
10
United Kingdom
United States
0
1997 1998 1999 2000 2001 2002 2003

Exhibit 3.11: Telecoms investment as % of revenue - selected countries: OECD]

Exhibit 3.12 below illustrates, as expected, that total investment levels are lower in New
Zealand than in many other OECD nations. Norway in particular has experienced
consistently higher levels of investment than New Zealand even though it has a similar
population.

587306 -
Telecommunications industry investment in New Zealand 52

16 000

Australia
14 000
Telecoms investment (USD millions)

Austria

12 000
Denmark
Finland
10 000 France
Germany
8 000
Iceland
6 000 Ireland
New Zealand
4 000 Norway
Sweden
2 000
United Kingdom

1997 1998 1999 2000 2001 2002 2003

Exhibit 3.12: Telecoms investment - selected countries [Source: OECD]

The factors that may cause variations in public telecommunication investment per access
channel include43:

• vendor financing – the introduction of this practice may increase investment levels by
allowing more operators to invest larger amounts

• capabilities of technology – an upgrade to new and improved technology causes the


unit cost of servicing customers to decline. In some cases the public
telecommunication investment per access channel may be lower even though the total
investment overall is higher.

These factors can cause variations in public telecommunication investment per access
channel over time and across countries.

43
OECD (2003) Communications Outlook 2003.

587306 -
Telecommunications industry investment in New Zealand 53

New Zealand’s public telecommunication investment per access channel (Exhibit 3.13)
was lower than the OECD median during the period 1997-2001. It exceeded the OECD
median in 2002 and the gap increased in 2003 so as to be nearly equal to the declining
OECD third quartile.

900

Telecoms investment per access channel (USD)

800

700

600 Maximum
Third quartile
500 Median
400 New Zealand
First quartile
300 Minimum

200

100

0
1997 1998 1999 2000 2001 2002 2003

Exhibit 3.13: Comparing New Zealand’s telecoms investment per access channel with the

OECD countries [Source: OECD, Network Strategies]

Over the short term we see clear evidence that public telecommunication investment per
access channel fluctuates from year to year. An examination of smoothed data (such as
short term averages) would provide a better indication of medium term trends in
investment levels.

Based on three-year average investment data, Exhibit 3.14 indicates that over the periods
1988 - 1999 and 2001-200344:

44
2000 data has been omitted to allow for the inclusion of the most recent (2003) OECD data

587306 -
Telecommunications industry investment in New Zealand 54

• the OECD median level of investment varied little


• New Zealand investment declined relative to the OECD median and fell below the
OECD median during 1994-1996.
Telecoms investment per access channel (USD)

900

800

700

600 Maximum
Third quartile
500 Median
400 New Zealand
First quartile
300
Minimum
200

100

0
Average Average Average Average Average
1988-90 1991-93 1994-96 1997-99 2001-2003

Exhibit 3.14: Three year average telecoms investment per access channel [Source: OECD,

Network Strategies]

3.2 Equivalent provider comparisons

In this section our objective is to benchmark the relative performance of Telecom and
Telecom Mobile against other comparable FNOs and MNOs internationally. We discuss
our approach and results below.

587306 -
Telecommunications industry investment in New Zealand 55

3.2.1 Approach

We have selected a benchmark sample of FNOs and MNOs in countries with some
similarities to New Zealand. All benchmark countries are developed countries in the
process of deploying NGN. Denmark, Ireland, Norway and Sweden have relatively small
population bases, like New Zealand. While Australia and the UK represent much large
population bases, comparative data is useful particularly with the state of development of
NGN plans in these countries. Overseas operators were chosen on the basis of having the
greatest market share in their respective markets. An exception to this rule was necessary
for MNOs in Ireland and in the UK, where only O2 reports all of the required financial
information.

Country Fixed Mobile


Australia Telstra Telstra Mobile
Denmark TDC TDC Mobil
Ireland eircom O2
NZ Telecom Telecom Mobile
Norway Telenor Telenor Mobil
Sweden TeliaSonera TeliaSonera Mobile
UK BT O2

Exhibit 3.15: Companies included in Network Strategies’ sample [Source: Network Strategies]

Financial and operational data for a period of not less than three years was sourced from
official company reports. Network Strategies has compared operators on the basis of the
following metrics:

• annual fixed capex per fixed access line


• annual mobile capex per mobile subscriber
• annual fixed capex per annual fixed revenue
• annual mobile capex per annual mobile revenue
• annual fixed capex per capita
• annual mobile access per capita.

587306 -
Telecommunications industry investment in New Zealand 56

Network Strategies’ analysis used both yearly average nominal and PPP exchange rates in
its comparisons. The reason for this is that a large proportion of capex may be locally
sourced. In this case to assume nominal rates in comparisons would be misleading as only
the imported content is affected by market exchange rates. At the same time use of PPP
may be inappropriate in circumstances where capex is dominated by imported content.

While we have attempted to compare FNOs with FNOs and MNOs with MNOs on a
like-with-like basis we introduce the caveat that the validity of our comparisons is affected
by:

• operators’ practice of changing the definitions of terms used in annual reports


• the different accounting standards adopted by each country
• the differing degrees of structural separation of each operator.

3.2.2 Results

FNO benchmarking

The results of Network Strategies’ benchmarking analysis of FNOs, notwithstanding the


caveat stated in section 3.2.1, suggest that:

• Telecom’s fixed capex per access line increased yearly between 2003 and 2005 and is
the third and second highest of the sample in 2005 when determined using nominal
yearly average (Exhibit 3.16) and PPP exchange rates (Exhibit 3.17) respectively.
Telstra has the highest fixed capex per access line as determined using either exchange
rate. Note that a high capex per access line figure does not imply high investment in
new infrastructure – it may reflect capex required to maintain an inefficient network.

• Telecom’s fixed capex as a proportion of fixed revenue increased yearly between 2003
and 2005. It is the second highest in the sample, behind Australia (Exhibit 3.18).

587306 -
Telecommunications industry investment in New Zealand 57

• Telecom’s fixed capex per capita increased yearly between 2003 and 2005 and is the
third highest of the sample in 2005 when determined using nominal (Exhibit 3.19) or
PPP exchange rates (Exhibit 3.20). Telstra is in first place, followed by eircom.
Fixed capex per fixed access line (NZD - nominal)

350

300

BT
250 eircom
TDC
200 Telecom
Telenor
150 TeliaSonera
Telstra

100

50

2002 2003 2004 2005

Exhibit 3.16: Fixed capex (NZD – nominal) per fixed access line for FNOs in Network

Strategies’ sample [Source: Network Strategies, Operators]

587306 -
Telecommunications industry investment in New Zealand 58

350
Fixed capex per fixed access line (NZD - PPP)

300

BT
250 eircom
TDC
200 Telecom
Telenor
150 TeliaSonera
Telstra

100

50
2002 2003 2004 2005

Exhibit 3.17: Fixed capex (NZD – PPP)) per fixed access line for FNOs in Network Strategies’

sample [Source: Network Strategies, Operators]

18%
Fixed capex as a proportion of fixed revenue

16%

BT
14% eircom
TDC
12% Telecom
Telenor
10% TeliaSonera
Telstra

8%

6%
2002 2003 2004 2005

Exhibit 3.18: Fixed capex as a proportion of fixed revenue for FNOs in Network Strategies’

sample [Source: Network Strategies, Operators]

587306 -
Telecommunications industry investment in New Zealand 59

180
Fixed capex per capita (NZD - nominal)

160

BT
140 eircom
TDC
120 Telecom
Telenor
100 TeliaSonera
Telstra

80

60
2002 2003 2004 2005

Exhibit 3.19: Fixed capex per capita (NZD – nominal) for FNOs in Network Strategies’ sample

[Source: Network Strategies, Operators]

160
Fixed capex per capita (NZD - PPP)

140

BT
120 eircom
TDC
100 Telecom
Telenor
80 TeliaSonera
Telstra

60

40
2002 2003 2004 2005

Exhibit 3.20: Fixed capex per capita (NZD – PPP) for FNOs in Network Strategies’ sample

[Source: Network Strategies, Operators]

587306 -
Telecommunications industry investment in New Zealand 60

MNO benchmarking

The results of Network Strategies’ benchmarking analysis of MNOs, notwithstanding the


caveat stated in section 3.2.1, suggest that:

• Telecom Mobile’s capex per subscriber has stayed almost constant over the period
2003-2005 and is relatively low using nominal (Exhibit 3.21) or PPP exchange rates
(Exhibit 3.22) – fifth out of the seven MNOs in 2005. O2 in Ireland has the highest
capex per subscriber using either exchange rate conversion.

• Telecom Mobile’s capex per unit revenue has varied little over the period 2003-2005
and is the median of the sample in 2005. O2 in Ireland has the highest capex per unit
revenue (Exhibit 3.23).

• Telecom Mobile’s capex per capita is relatively low – fifth out of the seven MNOs,
using nominal (Exhibit 3.24) or PPP exchange rates (Exhibit 3.25). O2 in Ireland has
the highest capex per capita using either exchange rate conversion.
Mobile capex per mobile subscriber (NZD - nominal)

180

160

140
O2 (Ireland)
120
O2 (UK)
TDC Mobil

100
Telecom Mobile
Telenor Mobil
80 TeliaSonera Mobile
Telstra Mobile
60

40

20

2002 2003 2004 2005

Exhibit 3.21: Mobile capex (NZD – nominal) per mobile subscriber for MNOs in Network

Strategies’ sample [Source: Network Strategies, Operators]

587306 -
Telecommunications industry investment in New Zealand 61

160
Mobile capex per mobile subscriber (NZD - PPP)
140

120
O2 (Ireland)
100 O2 (UK)
TDC Mobil
80 Telecom Mobile
Telenor Mobil
60 TeliaSonera Mobile
Telstra Mobile
40

20

2002 2003 2004 2005

Exhibit 3.22: Mobile capex (NZD – PPP) per mobile subscriber for MNOs in Network

Strategies’ sample [Source: Network Strategies, Operators]

18%
Mobile capex as a proportion of mobile revenue

16%

14%
O2 (Ireland)
12% O2 (UK)
TDC Mobil
10% Telecom Mobile
Telenor Mobil
8% TeliaSonera Mobile
Telstra Mobile
6%

4%

2%
2002 2003 2004 2005

Exhibit 3.23: Mobile capex as a proportion of mobile revenue for MNOs in Network Strategies’

sample [Source: Network Strategies, Operators]

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70
Mobile capex per capita (NZD - nominal)

60

50 O2 (Ireland)
O2 (UK)
40 TDC Mobil
Telecom Mobile
30 Telenor Mobil
TeliaSonera Mobile
20 Telstra Mobile

10

0
2002 2003 2004 2005

Exhibit 3.24: Mobile capex per capita (NZD – nominal) for MNOs in Network Strategies’ sample

[Source: Network Strategies, Operators]

60
Mobile capex per capita (NZD - PPP)

50

O2 (Ireland)
40 O2 (UK)
TDC Mobil
30 Telecom Mobile
Telenor Mobil
20 TeliaSonera Mobile
Telstra Mobile

10

0
2002 2003 2004 2005

Exhibit 3.25: Mobile capex per capita (NZD – PPP) for MNOs in Network Strategies’ sample

[Source: Network Strategies, Operators]

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3.3 NGN deployment

Australia45

Telstra’s NGN plan is presented in Exhibit 3.26 below.

Exhibit 3.26: Telstra’s high-level NGN plan [Source: Telstra]

Telstra states that work on the IP core is progressing. It took delivery of its first IP
DSLAMs at the end of February 2006. Roll-out of the fibre-to-the-node (FTTN) network
has been put on-hold because of regulatory uncertainty over local loop unbundling.

45
Telstra (2006). Goldman Sachs JBWere Australasian Investment Forum – New York. 7 March 2006.

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Denmark

TDC has not publicly released details of any NGN plans though it states46 that:

Our research and development activities currently focus on next-generation services and
network platforms in the landline and mobile sectors. This includes development of
broadband applications and services, as well as IP-based and UMTS network platforms,
and wireless LAN capabilities.

Ireland

eircom envisages47 rolling-out an NGN:

We continually monitor and test new generations of network technology to identify


opportunities to lower our costs and introduce new services. To this end we are replacing
our international switches with "Next Generation Network" nodes. We anticipate that in the
future, voice and data services will be transported across a single, fully integrated network
platform, or "Next Generation Network". Such technology is now developed to the point
where we consider the cost savings and revenue opportunities sufficient to justify the
investment, and we are planning a migration to a Next Generation Network over the
coming years.

NGN capex will be released48 with end of financial year results

46
TDC (2005). Form 20-F for the fiscal year ended December 31 2004.

47
eircom (2005). 20-F for the fiscal year ended 31 March 2005.

48
eircom (2006). Third quarter results. 16 February 2006.

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Norway

Telenor, in conjunction with Siemens and Juniper, is currently upgrading49 its entire
network to an IP-based MPLS network. Network Strategies believes that Telenor has not
publicly released a timeframe for the project.

Sweden

In May 2003 TeliaSonera publicly announced its intention to migrate to an all IP network
within 10 years. Network Strategies believes that it has not publicly released any NGN
plans.

UK

BT announced50 a five-year £10 billion plan to build an end-to-end IP-based NGN - its 21st
century network (21CN) –in June 2004. Preferred technology suppliers were announced in
April 2005. 350 000 customers in Wales are currently being migrated to the 21CN. The
results of this migration will inform BT’s 21CN deployment. BT expects more than 50% of
annual PSTN service traffic to be IP-based by 2008.

49
Telenor (2005). Joint press release from Telenor ASA, Juniper Networks and Siemens Communications. 1 July 2005.

50
http://www.btplc.com/21CN/Theroadto21CN/Keymilestones/Keymilestones.htm

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Exhibit 3.27: BT’s high-level NGN plan [Source: BT]

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4 Investment perspectives

4.1 Investment Drivers and Barriers

Key factors that affect the initial and ongoing investment decisions of alternate providers
are as follows:

• Market issues, including substitutability, demand location and distribution


• Macroeconomic factors
• The economics of infrastructure roll-out
• The regulatory environment
• Financial constraints
• Ownership structure

4.1.1 Market issues

Clearly the characteristics of the market are a key element to the business case for alternate
service providers. Important aspects include the number and location of potential
customers, spending patterns, loyalty to existing network providers, and any technical
constraints that customers may have. Typically telecommunications spending distributions
are highly skewed – in other words, a large proportion of spend is generated by a relatively
small number of customers. This fact will certainly influence planned geographic coverage,
and there may be a trade-off between targeting large customers and broad market coverage.

Another key market issue is the substitutability of services and facilities. For example,
fixed and mobile services may not (as yet) be perfect substitutes yet there is certainly a

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high degree of substitutability. Thus the existence of one particular service limits the
market for another. Often the cheaper service will be preferred, even if the functionality of
this service is less than the other.

A further consideration for alternate network providers in devising strategies is the likely
reaction of the incumbent and other market players, and the availability and timeliness of
regulatory solutions should disputes arise.

4.1.2 Macroeconomic factors

A two-way relationship exists between investment and economic growth. While clearly
investment and innovation drives economic growth, at the same time economic growth and
structural change in the economy constitute key drivers for increasing the level of
telecommunications expenditure and investment. Sustained economic growth therefore
would be expected to produce over time a strong increase in telecommunications
expenditure in real terms and simultaneously investment. Sectoral influences may also be
important as telecommunications is an intermediate good – in other words, it serves as an
input to all economic sectors. In the case of New Zealand our geographical remoteness
from overseas markets makes telecommunications a particularly important input for many
sectors of the economy.

Economic uncertainty can be a major inhibitor of investment, and this is particularly so in


the case of the large investments that may be required to commence operations as an
alternate network provider. At the point of writing, the New Zealand dollar remains at high
levels and unemployment is low, but there are numerous predictions of economic downturn
in the short to medium term. Such economic predictions increase uncertainty and act as a
further barrier to investment commitments.

4.1.3 The economics of infrastructure roll-out

There are wide differences in the economics of infrastructure roll-out from one technology
to the next. For example the economics of deploying fibre-based systems are quite different
from those of broadband wireless systems. For fibre the break-even point will occur at high

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penetration while for broadband wireless there may be a lower break-even point but higher
long-term costs.

Both mass market and niche market alternative providers are commercially driven initially
to target high spending customers in areas which can be serviced at least cost. A new
entrant does not benefit from economies of scale that enable an incumbent provider to
support cross-subsidisation between high and low customer density areas. This means that
in many cases it makes economic sense for new ventures to focus on high-density areas
populated by key target customers. Often this will mean rolling out new access network
infrastructure in key cities to win business voice and data contracts. However typically
connection will be required beyond the city footprint (for example, to connect with branch
offices) which means that wholesale services (from Telecom) will of necessity form part of
the business plan.

4.1.4 Regulatory regime

Regulation is a key factor affecting alternate network providers. ECTA emphasizes the
importance of effective regulation in advancing telecoms investment. From its Regulatory
Scorecard51 ECTA finds

…across 16 EU countries investment in telecoms has suffered where regulation has failed
to tackle dominant companies, whilst countries that have opened their markets to
competition by improving effective regulation have stormed ahead.

Numerous barriers to market entry may be minimised or removed through effective


regulation, which typically includes the need to address the following issues:

• High interconnection fees


• Access to facilities and infrastructure (including co-location agreements)
• Disputes with the incumbent
• Spectrum availability
• Number portability.

51
See Jones Day and SPC Network, ECTA Regulatory Scorecard 2005.

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In addition new investment is impeded in circumstances of regulatory uncertainty. This


includes uncertainty regarding regulatory conditions, rules and the timing and nature of any
likely regulatory intervention. All of these factors introduce an additional element of risk in
undertaking new or further investment.

The OECD attributes the recent rapid expansion in broadband penetration in many
countries to successful regulatory action, specifically with the opening of local loops
despite sustained resistance from incumbents.

Although regulators in some countries took hesitant steps in the early days to fully
implement local loop unbundling, now most countries have well established policies for
unbundling. Only Mexico, New Zealand and Switzerland have not yet implemented
unbundling – in New Zealand bitstream access was introduced in September 2004, while in
Switzerland the federal government has placed a proposal before Parliament to change the
existing law on telecommunications to allow unbundling …In many countries delays in the
full implementation of unbundling occurred because it was necessary to put in place
effective policies for collocation and agree on cost-oriented wholesale prices for unbundled
local loops. …As a result of unbundling, broadband has shown significant growth …
Unbundling has not only delivered on the promise of lower prices through competition in
the retail market, but has resulted in new entrants providing increasingly higher speeds and
bundled services including the provision of television programming on xDSL.52

The OECD implies that there has in general been a transition now from bitstream to
unbundling. This suggests a progression to full investment guided by the ladder of
investment concept:

• Resale
• Wholesale
• Bitstream
• Unbundling
• Infrastructure investment.

52
See page 36, OECD Communications Outlook 2005.

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The notion of the ladder is that the regulator sets the environment so that alternate
operators and service providers gradually move along this ladder, investing more over time
in order to deliver a wider range of services and products over different platforms.
However current statistics from the OECD do not indicate that the stage has been reached
yet where substantial investment is occurring. Furthermore, in general new entrants appear
to have very localised goals.

That is not to say that new entry is still not occurring but it tends to have more of a local or
regional focus (e.g. fixed wireless ISPs) rather than trying to enter the market as a national
service provider.53

4.1.5 Financial constraints

Funding for small new entrants is often very difficult to obtain. For investors the incumbent
will generally seem a far safer option. Furthermore, in many instances significant funding
is required early in the venture, at a stage when the perceived market opportunity is
unproven. The size of the initial financial commitment may determine the incremental cost
of extending a network. Consequently a limited initial financial investment may inhibit the
number of economically viable options.

Government can play a role in assisting infrastructure roll-out by involvement at the market
entry stage. This assistance can take various forms, including the provision of seed funding
right through to subsidies.

The use of subsidies to provide investment incentives has been used in Australia. As at 30
June 2005, the Australian Communications and Media Authority (ACMA) reported that
there were 132 licensed carriers in Australia, with 40 new licences being issued through the
year 2004-05. ACMA attributes54 the increase in carriers being due to:

53
Ibid, page 99.

54
Australian Communications and Media Authority (2005) Telecommunications Performance Report 2004-05, 17 November 2005.

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• the rollout of wireless local area network base stations, influenced by the availability of
subsidies through the Australian Government’s Higher Bandwidth Incentive Scheme
(HiBIS) – ACMA understands that many new carriers intend to use wireless networks
to provide high-speed Internet access55

• a significant reduction in the carrier licence application charge and the fixed
component of the annual licence charge, making it easier for smaller players to enter
the market.

Network Strategies’ view is that it is preferable for the Government to avoid direct
subsidies, but encourage investment through taking more of a facilitator role. The
Government’s Digital Strategy initiative is an excellent example of this. The Strategy
includes, for example, the Broadband Challenge with the aim of enabling affordable
broadband roll-out based on competitive open access principles. With a focus on regional
and smaller communities, seed funding will be provided to groups that can demonstrate
robust business plans and the ability to implement the plans.

4.1.6 Ownership structure

The ownership structure of alternate service providers will have a significant impact on
investment behaviour. New entrants typically will require sustained and often major
investment over an extended time-period prior to generating a positive cashflow. During
this critical period, a major objective of the entrant’s management will be to ensure that the
shareholders are satisfied with progress and continue to support the venture. The existing
interests of the shareholders may also constrain the range of activities or the coverage of
the new venture; this is especially true of shareholders already in the telecoms industry,
who may insist that the new venture must not compete with certain operators or that it
favours particular suppliers. Changes in the shareholders’ financial position or views may
alter funding and there may even be a change in ownership before the venture has
established a stable business base. This may in turn lead to changes in management and
objectives.

55
Note that carrier licences in Australia are technology neutral.

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There are a number of examples of this in New Zealand: in particular, the changing
ownership of the venture that originally commenced operations in the early 1990s as
CLEAR Communications Limited.

4.2 Fixed Network Investment Prospects assuming regulatory status quo

In this section we examine the prospects for fixed network investment by different
operators in New Zealand. We consider the core network and the access network
(including fibre-to-the-node and fibre-to-the-home).

4.2.1 Core Network

While Telecom has the only ubiquitous full service network in New Zealand, Network
Strategies believes that a level of competition exists in the transport of voice and data
traffic over core networks. Alternative core network operators include:

• BCL – national coverage, focusing on wholesale access to rural and regional areas
• TelstraClear – mainly North Island and inter-city. South Island coverage to be extended
as per Exhibit 2.10 and in conjunction with future work
• Vodafone – national mobile coverage with significant self provision of national
backhaul capacity.

Network Strategies understands that there is substantial capacity and a range of diverse
routes in New Zealand’s national terrestrial and submarine fibre optic networks. Additional
capacity can be added when required in a cost effective manner by upgrading transmission
system optical and electronic systems and through commissioning of spare fibres.
Additional fibre routes continue to be added, particularly for the support of data backhaul
generated by broadband services in regional areas.

• The business case for provision of alternative core network capability is therefore
usually regional or community focused, such as the Network Tasman initiative
providing capacity between Nelson and Blenheim and to be re-sold by TelstraClear.

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4.2.2 Access Network

Existing alternative access network operators are summarised in Exhibit 4.1 below.

ANO Services provided and network Footprint


BCL Business and residential data and Nationwide with focus on rural and
voice provincial areas
CityLink Business-focussed data services Auckland and Wellington CBDs
up to 1Gbit/s and dark fibre network
Hamilton City Council Dark fibre campus style network Hamilton CBD
TelstraClear Business and residential data, Christchurch, Kapiti and Wellington
cable TV and telephony siamese
cable TV network
Business-focussed data services Business districts nationwide
over fibre network
Vector Communications [ [ ]
]
[ [ ]
]
Woosh Wireless Residential and SME-focussed Auckland, Wellington, Christchurch,
voice and data using UMTS and Southland
network

Exhibit 4.1: Alternative ANOs in New Zealand [Source: Network Strategies, Operators]

As expected, Exhibit 4.1 indicates that the market for business service access is more
competitive than that for residential services, at least in the major cities. With respect to
residential broadband services, competition only exists where Telecom, TelstraClear and/or
Woosh have overlapping access networks.

Although CBD areas appear competitive from the point of view of business data and voice,
alternative operators often need to supplement their network coverage with re-sale services
to reach their clients’ outlying branch offices and home workers. The ability of competitive
CBD network operators to service clients who require more than simple campus-style or
dark fibre data connection between metropolitan offices is therefore highly reliant on the
existence of an effective wholesale regime. Although this exists to some extent in the form
of UPC and UBS, these services are currently limited to non-NGN capabilities, meaning
that alternative CBD operators are limited in their ability to use wholesale services to

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compete for business with customers requiring widespread availability of advanced


services.

An outcome of the current regulatory regime is that operators with limited access network
reach (i.e. all alternative operators) who wish to provide advanced (innovative) business
services must often factor at least part of the costs of building additional alternative
infrastructure into their commercial bids for the business of high value customers. The
absence of a “ladder of investment” from re-sale to infrastructure build for advanced
network capabilities restricts the range of business that alternative providers can generally
win without high risk investments for individual customers.

The business case for alternate residential access networks is highly dependent on revenues
which can be derived from the traditional range of voice, ISP and ADSL services and
forecasts for future “triple play” bundles of service. Observing the recent experience of
TelstraClear in New Zealand, current and forecast residential revenues are unlikely to
result in a viable business case for extensive residential fixed access network rollout. Key
factors contributing to the risk of fixed residential investment are:

• declining fixed voice revenues and the likelihood of substitution with mobile and VoIP
• uncertainty over potential regulatory action on unbundling or unconstrained bitstream
services
• uncertainty around the value to network operators in the delivery of future content
based services.

It is also clear from the Commerce Commission’s TSO net cost calculations for 2001
through to 2003 that, in many remote and lower customer density areas of New Zealand,
the revenues generated by traditional residential telecommunications services do not cover
the economic costs of providing a conventional fixed wireline or wireless connection. This
is equivalent to saying that there is no viable business case for serving these customers with
a new network based on conventional fixed line technologies, unless significant new
revenue streams can also be generated.

In the short term, assuming the regulatory status quo, widespread infrastructure based
competition for residential service requires a breakthrough technology which:

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• has sufficiently low per line costs that it is cost effective in supplying basic residential
services
• is sufficiently future proof that it will be able to compete in the delivery of broadband
triple play services

At this time, Woosh is the only wide-spread network with technology which could
potentially meet the above requirements (although the currently constrained quality and
bandwidth raises questions over its suitability for more than Internet grade broadband
service). ISP and campus-style networks operating WiFi systems could also provide a cost-
effective local service, but these operate using unlicensed public spectrum and may be
subject to interference and unmanageable quality of service issues.

Future versions of the Woosh technology or equivalent WiMAX operators may be viable in
competing for residential voice services outside the metropolitan areas. Within
metropolitan areas, fixed fibre and copper networks are likely to remain the most cost
effective means of service delivery.

4.2.3 Fibre to the node

An important component of NGN network build is the reduction of copper line distances to
allow the introduction of high speed xDSL services, such as ADSL2+ which can operate at
up to 24Mbit/s. This is often achieved by replacing copper line systems between telephone
exchange buildings and copper distribution cabinets (nodes) with broadband fibre optic
systems. This is commonly referred to as “fibre to the node”.

In addition to installing a fibre optic cable, the conventional distribution cabinet is also
replaced with a cabinet based remote DSLAM system. Telecom has announced plans to
replace around 1000 conventional cabinets with remote fibre systems over the next five
years.

A competing access provider could potentially make use of fibre to the node systems if it
installed remote DSLAM cabinets (connected to its own core networks) adjacent to
Telecom cabinets and accessed short unbundled copper loops at that point (commonly
referred to as sub-loop unbundling). It has been suggested that this form of unbundling

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would be impractical in New Zealand because of the difficulties in obtaining resource


consents to place additional cabinets in public areas.

A second form of access would be to require facilities to co-locate an access seeker’s


remote DSLAM equipment in a Telecom cabinet.

4.2.4 Fibre to the home

Fibre to the home (FTTH) has long been viewed as the ultimate broadband solution but has
been difficult to cost-justify, even in new infrastructure build projects, due to the additional
costs of network and customer premises equipment. This cost equation has changed
considerably over recent years with the advent of fibre based switched Ethernet systems,
originally designed for high speed LANs, but used by companies such as Wired Country
(Counties Power) in reticulating new suburbs in the Auckland region. Although, with the
sale of its telecommunications business, Wired Country appears to have been unsuccessful,
other utilities such as [

4.2.5 Conclusion

Based on the analysis in this section, we make the following conclusions on the scope for
fixed network competition in New Zealand, assuming the current regulatory status quo:

• there appear to be good prospects for fixed infrastructure based network competition in
the Auckland region, possibly extending to wide-spread FTTH
• there will need to be a technology price breakthrough for alternative providers to
deliver cost effective innovative NGN business and residential services to customers
outside Auckland and other metropolitan centres.

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4.3 Industry Views

Existing players in the telecommunications market claim that there are some features of the
current regulatory regime that hinder or impede investment. In this section we discuss these
issues and explain their influence on investment by alternate providers.

4.3.1 Telecom

In its submission to the Minister on investment and regulatory issues, 30 January 2006,
Telecom stresses the importance of continued investment in Next Generation Networks and
Next Generation Business models to the economic interests of business and residential
users of broadband services. Telecom states that its planned investment matches
Government broadband objectives through delivering:

a world-class IP network able to deliver in a logical sense multiple services with differing
service qualities;

delivery of a range of voice, internet and video services (triple play) over this network; and

a fundamental overhaul of IT systems and processes

To support its continued ability to invest in the rollout of an NGN for New Zealand,
Telecom proposes that the Government’s framework for regulation should adopt clear
principles and suggests:

1. Regulation should be about encouraging investment in infrastructure.

2. Regulatory access to bottleneck facilities to facilitate competition should be balanced


against (1.) and should be designed such that investment incentives should not be
undermined.

In support of these principles, Telecom offers an improved wholesale charter which


focuses on improved speed to market, fairness and transparency of wholesale services.

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Telecom contends that the NGN constitutes a “step change” in the telecommunications
industry and to achieve this change successfully requires a no-surprises regulatory
environment. Specifically, Telecom asks for assurances from the Government and
regulator that any revisiting of unbundling and other major regulatory interventions be
taken off the agenda for the medium term.

4.3.2 TelstraClear

In its submission to the Minister on review of the Telecommunications Regime,


TelstraClear has provided a prioritised list of regulatory issues which it believes should be
addressed in the review. In order of priority, these are:

• Local loop unbundling (LLU)


• Equivalence rules for effective wholesale competition
• Future proofing of the UBS service, including removal of the 128kbit/s upstream limit
• Regulation of UPCs and future proofing of the service description
• IP interconnection, and
• Reform of the TSO.

Local loop unbundling

Following the Commerce Commission’s advice to government recommending that New


Zealand does not unbundle local loops (December 2003), TelstraClear has continued to
argue that the decision should be reviewed as a matter of urgency. The issue remains of key
importance to TelstraClear despite its recently granted wholesale access to Telecom lines
for phone service and the subsequent commercial agreement with Telecom on bitstream
services.

TelstraClear argues that LLU is vital for investment and innovation allowing, for example,
an access seeker to implement ADSL2+ or VDSL independently of Telecom’s choice of
broadband technology in a region. Further to this, it now estimates that TelstraClear could
cost-effectively deploy DSLAM infrastructure to [ ] of Telecom’s exchanges,
corresponding to around [ ] dwellings. TelstraClear’s willingness and commitment to

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enter the LLU market is a key factor in any cost-benefit analysis of unbundling and the
data provided above may have altered the Commission’s analysis if presented during the
investigation in 2003.

TelstraClear states that many of the difficulties with LLU encountered overseas have now
been overcome with improved processes and codes of conduct that could be adapted for
New Zealand. Also, equipment costs have fallen considerably, resulting in the recent rapid
rollout of LLU in a number of countries (France, Italy, Scandinavia, and Japan).

TelstraClear suggests that LLU be introduced using legislation rather than a further section
3 investigation by the Commission, which it believes would be a lengthy process.

Putting TelstraClear’s LLU position in context, its ability to invest in alternative network
technologies has been severely limited by Telstra’s strategy for New Zealand. It must focus
on “breakout” investment opportunities and this is clearly considered to be the most
important of those. Other investment ($120 million planned for 2006) is considered to be
“business as usual” and will occur without LLU.

If implemented, the success of LLU in New Zealand will hinge on the development of a
fair and workable operating environment and TelstraClear’s commitment to rollout service
under the conditions set. TelstraClear does not expand on how or if its investment could
grow beyond LLU into other forms of alternative access infrastructure.

Equivalence rules for effective wholesale competition

TelstraClear argue that effective downstream competition can only occur if access seekers
obtain service on the same terms and within the same timeframes available to Telecom’s
retail arm. It claims that, although the Act’s pricing principles encapsulate non­
discriminatory principles, they have little effect on Telecom’s actual behaviour.

To counter this TelstraClear asks for clear ex ante rules guaranteeing equivalent treatment,
along the lines of those in the UK and Australia, enforceable with penalties and
compensation incentives.

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This issue is second priority for TelstraClear simply because, without LLU, it is vital that
the wholesale regime works effectively. While this, and other lower priority issues, do not
directly affect TelstraClear’s investment decisions, they do argue for a more favourable
wholesale regime in the absence of investment in alternative infrastructure.

Future proofing of the UBS service, including removal of the 128kbit/s upstream limit

Removing the limits from the UBS service is seen by TelstraClear as essential for allowing
use of bitstream for the provision of services similar to those provided over its own
network. TelstraClear suggests that the reason for imposing the 128kbit/s upstream limit is
no longer valid now that Telecom have initiated the NGN rollout.

In designing the bitstream service the Commerce Commission intended to limit the use of
“real time” services, thereby protecting Telecom’s incentive to invest in widespread
business and residential NGN. Telecom had previously pointed out that without this
protection, NGN rollout might be limited to metropolitan areas only.

Telecom is now advancing in its NGN rollout. The analysis earlier in this report indicates
that Telecom is planning fibre rollout to around 1000 cabinet areas and a PSTN
replacement using NGN switches scheduled to be complete in 2012. In general, there does
not appear to be much evidence of plans for widespread residential NGN deployment. The
recently accelerated ADSL broadband rollout is not equivalent to NGN as many of the
connections counted as broadband have the 128kbit/s upstream limitation and are therefore
incapable of NGN service. On this basis there seems to be some credibility to
TelstraClear’s argument to remove the upstream limitation.

Regulation of UPCs and future proofing of the service description

TelstraClear has noted that Telecom has begun to deliver high value business data services
using broadband Ethernet at significantly lower cost than wholesale UPC data tails.
TelstraClear argues that the UPC service definition should be brought up to date to match
current practice through a schedule 3 investigation.

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In defining and setting prices for the UPC service, the Commission deliberately addressed
legacy TDM based services. It was not intended that access to high bandwidth symmetrical
NGN data services be regulated at that time. The issue of whether this should now be the
subject of a section 3 investigation would depend on the evidence of market failure,
bottleneck issues etc. At least within metropolitan areas, it is clear that there are many
alternative providers, including TelstraClear, delivering Ethernet based services similar to
the Telecom product.

IP interconnection

This service is defined by TelstraClear to be a bitstream-like access to Telecom’s


DSLAMS, but with facilities for the access seeker to set and control all aspects of the
bitstream service (speed, quality etc) on a customer by customer basis. TelstraClear argues
that this is equivalent to letting the access seeker have as much control as Telecom does for
its retail services.

The operation and management of DSLAM and many other network devices is not
standardised and, unlike PSTN interconnect with Signalling System #7, they are not always
designed to allow limited or partitioned control to interconnecting parties. It is possible that
the complexity and cost of providing this service might outweigh the benefits provided.

TelstraClear has not indicated how the current Act or future changes to the Act should deal
with implementation of IP interconnection.

Reform of the TSO

TelstraClear calls for the ability for Telecom to adjust the residential line price cap such
that currently non-viable customers become viable and that in all other areas of the network
Telecom is limited to earning only normal profits from line rentals.

This position is predicated on the belief that Telecom makes monopoly rents from its TSO
business and that, overall, the TSO is a highly profitable venture for Telecom. The
implication is that line rentals in metropolitan areas would fall to a fraction of their current

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price if Telecom were limited to earning a normal margin over cost. Network Strategies
own cost modelling of rural and urban lines in other countries confirms that LRIC per line
costs in cities are significantly lower than those in sparse, remote areas of the network.

TelstraClear also calls for all providers of telecommunications services to contribute to any
remaining TSO cost, including wholesalers, VoIP application providers and ISPs.

4.3.3 Vodafone

In his letter to the Minister on “Priorities for telecommunications policy in 2006” Vodafone
CEO Russell Stanners identifies four priorities for Vodafone over the next year:

• Mobile Broadband
• Avoid regulation that distorts the market
• Encourage network building
• Deal with the risk of getting it wrong.

In general, Vodafone emphasises the reality and benefits of the convergence of services
and platforms and encourage a regulatory regime which supports this.

Mobile Broadband

Vodafone points out that the only recent alternative investment in broadband in New
Zealand is wireless broadband access. It asks for leadership from the government to
encourage wireless broadband solutions which provide competition, choice and value to
customers.

Although not specifically mentioning LLU, Vodafone’s argument would lead the
government to steer away from re-opening the LLU debate and concentrate instead on
mechanisms to deliver alternative wireless solutions. It is necessary to review this
argument from the following perspectives:

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• To what extent has the emphasis on wireless access investment been driven by
unavailability of LLU? and
• Why has there also been significant investment in fibre metro broadband access?

The answer to the second question is well understood as wired infrastructure often has
significant cost benefits over wireless in areas of high line density. The importance of
wireless broadband access in New Zealand cannot be discounted, but from a cost-benefit
perspective, it is not clear that it should be preferred in all circumstances.

Avoid regulation that distorts the market

Vodafone argues that current regulation distorts the market and inhibits its ability to invest
in New Zealand. In particular it is disadvantaged by:

• The current investigation into mobile termination rates (MTR) which Vodafone claim
will strip $250m off its profit over five years, and result in Telecom gaining
significantly unless passthrough is mandated
• The TSO for which Vodafone attracts the largest cost of all the alternate providers due
to its relatively high liable revenues.

The MTR debate is a complex economic argument in which assumptions of passthrough


strongly affect the projected benefits of regulation.

Vodafone’s total capital investment in New Zealand is approximately $2 billion, quoted as


“investment in New Zealand”.

Vodafone’s situation with the TSO comes about through interpretation of the wording
describing TSO liable revenues in the Act. This issue could be addressed in the review of
the Act. The situation has been in place since 2003 and does not yet seem to have affected
Vodafone’s investment in 3G.

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Encourage network building

Vodafone is of the view that regulation should encourage network builders as “regulation
alone will not deliver broadband services”. Again it is emphasised that an unfavourable
MTR decision from the Commission will slow Vodafone’s investment in 3G and argued
that network builders require certainty that their investments will be safe from regulation.

This position is equivalent to Telecom’s fixed network NGN argument.

Deal with the risk of getting it wrong

Vodafone expresses concern at the lack of review mechanisms available for government
and parties to test the reasonableness and substance of Commission decisions. There is a
call for an independent expert body to perform this function, with powers that extend
beyond the Commission’s current final Determination and review period.

This comment is likely to have been triggered by Vodafone’s experience with missing the
legal review window for the 2001/2002 TSO Determination. The request for review of
regulatory decisions at any time after their implementation, however, does not mesh well
with Vodafone’s previous call for regulatory certainty to encourage network building.

Local Interconnect

The Commerce Commission is currently investigating Vodafone’s request for a


determined price for interconnection of Vodafone’s cellular network (hosting local
numbers) with Telecom’s fixed PSTN. Under this scheme, Vodafone customers would be
able to make free local calls to PSTN numbers within their local calling areas and would
receive PSTN calls to their Vodafone “local number” if they were within their home
calling zone. Outside of the zone, the customer could have local number calls diverted to
voice mail or to a regular mobile service.

Telecom argues that this is no different to normal mobile termination, except that the
mobile phone is using what has traditionally been a geographically zoned number.

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Success in this business is key to Vodafone’s ability to drive the future replacement of
fixed line voice service in New Zealand with mobile. The combination of large PSTN free
calling areas and high mobile termination rates currently makes mobile a premium service,
rather than a consumer’s first choice for voice calling.

In supplying a combined fixed – mobile service, Vodafone is foregoing call termination


revenue for calls to local numbers hosted on a Vodafone cellular connection. However,
Vodafone will gain new revenue from the equivalent of a fixed “line rental”.

4.3.4 BCL

Network Strategies has not been supplied with specific comment from BCL, but note that
the company has previously positioned itself as an independent wholesale provider of
communications solutions. As a wholesale only operator it has avoided most regulatory
issues to date. TelstraClear has submitted that BCL and all other operator types should be
liable for TSO payments, although this is currently prevented by the Commission’s
interpretation of TSO liable revenues.

BCL has previously argued against LLU, particularly where it could be interpreted that
components of its access network being re-sold by Telecom could fall under the
unbundling regime.

4.3.5 Woosh

Woosh has submitted that they require a stable, predictable regulatory environment for
them to continue to attract investment. They encourage the Government to:

• avoid “over zealous” regulation as it would reduce the chance of infrastructure based
competition
• do not “regulate profits out of infrastructure and into the hands of resellers”
• directly encourage infrastructure competition through assisting with co-location,
roaming, and ensuring easy access to road-side reserve for wireless installations
through enforcing the provisions of the Telecommunications Act

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• remove the TSO levy


• ensure that key spectrum rights are renewed

We note from the material provided by TelstraClear and ihug that take-up of LLU would
be likely to directly target the key Woosh market areas of central Auckland, Wellington
and Christchurch. Ongoing difficulties with the Woosh service in some of these areas could
see customers migrating to higher quality unbundled loops, The unique capability of
Woosh to provide limited mobility will continue to retain and attract new customers, but it
is questionable whether this would be sufficient to ensure the viability of the company in
an environment with increasingly competitively priced fixed broadband.

4.3.6 ihug

ihug is a strong advocate of LLU and has expressed clear views on how the Government
should progress to a fully unbundled environment and eventual infrastructure based
competition. The key steps envisioned by ihug are:

• provide ability for access seekers to differentiate broadband access products through
fully unconstrained UBS. This would include speeds and service qualities suitable for
interactive services such as VoIP at a wholesale price which allows for profitable re­
sale
• Naked DSL – unconstrained UBS without the need to purchase PSTN service from
Telecom. It is assumed that the customer now buys VoIP service from an ISP
• Full unbundling
• Last mile infrastructure build.

ihug does not believe that the current regulatory wholesale model is sustainable and
operators require LLU to obtain control over their costs. It also states that only the larger
operators and ISPs will be able to capitalise on LLU (due to the higher investment
required) and this may lead to consolidation of the broadband ISP market.

ihug presents a phased investment plan for LLU, leading eventually to more that $20m
capital investment over three years. This would involve deployment of ADSL2+ DSLAMS
capable of downstream speeds of 24Mbit/s. It is not clear whether the investment plan

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relies on the previous availability of unconstrained UBS or whether LLU investment may
be delayed if unconstrained UBS were available.

Experience in overseas markets suggests that ihug and other access seeker will only invest
in DSLAM infrastructure when their volume of UBS traffic at a particular site reaches an
economic threshold. Where there is little or no differentiation by service between UBS and
LLU, this threshold is set by the relative costs of the UBS service weighed against the costs
of unbundled loops, DSLAM equipment, co-location, backhaul etc.

If unconstrained UBS were not available, LLU would provide significantly more service
differentiation which would be likely to drive more intensive investment and rapid take-up
of LLU.

4.3.7 Vector

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4.3.8 TUANZ

In its recent submission to the Minister, TUANZ has stressed again the economic
importance of an open and competitive ICT sector for New Zealand, delivering “world
leading” high speed internet capability to business and residential customers. TUANZ
considers that the combination of Telecom’s dominant position and a light handed
regulatory regime are responsible for New Zealand’s low ranking in many OECD
telecommunications measures.

TUANZ refers to the “ladder of competition” concept through which re-sellers develop
into infrastructure owners with the unbundling of local loops. This is considered to be a
cornerstone principle in the development of competition and the reason that unbundling has
been a success in overseas regulatory regimes.

TUANZ considers that Telecom’s copper access network will remain the most cost
effective delivery mechanism for broadband for the next five to ten years, as evidenced by
Telecom winning most of the Project Probe funding.

In addition to issues raised by alternative carriers, TUANZ also notes that:

• The Telecommunications Carriers Forum is cumbersome and has been ineffective in


developing industry standards and practices (partly due to the Commission’s
“enforceability” issue). Delays surrounding number portability are an example of this.

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• Being part of the Commerce Commission, the Telecommunications Commissioner


may be constrained by positions and precedents which have been set in non-
telecommunications aspects of the Commission’s work
• The Commission is poorly resourced in comparison to Telecom’s regulatory group.

TUANZ favours a strengthened Telecommunications Act which includes new rules


concerning the timely provision of wholesale services (similar to TelstraClear’s
equivalence principle), LLU and provision of the “ladder of investment” for new entrants.
In addition TUANZ would like the Government to address options for voluntary and
enforced separation of Telecom’s wholesale and retail arms.

Although advocating the “ladder of investment” it is clear that TUANZ does not consider
that alternative access network infrastructure build is viable in New Zealand in the short to
medium term – as Telecom’s copper network remains the most cost effective broadband
delivery platform, even in rural Project Probe regions. This implies that the extent of access
seeker investment is likely to be DSLAM and backhaul infrastructure for LLU. Due to the
timing of the Probe projects, it is probable that developing WiMAX wireless access
products were not factored into operators’ bids for regions. These could alter the
copper/wireless cost equation, at least in areas of lower line density.

4.3.9 Internet NZ

Internet NZ, or the Internet Society of New Zealand, is the not-for-profit organisation
which manages the .nz Internet domain space. Its submission on regulatory issues,
“Advancing Telecommunications for New Zealand in the 21st Century” is based on the
outcomes of meetings held with members during January 2006. Members of Internet NZ
include ISPs, telecommunications operators, web host operators and a range of other
parties generally interested in the development of the Internet in New Zealand.

In general, Internet NZ members support:

re-focus (of) regulation toward swifter remedies to tackle anti-competitive behaviour with a
structure of real penalties and incentives

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Its recommendation to government is summarised in the following table which was


included in the executive summary of its report:

Year Local loop network Other proposals


2006 Initiate a Schedule 3 investigation of a true Increase funding for the Digital Strategy’s
UBS Broadband Challenge
Full Local Loop Unbundling reconsidered by Public Sector telecommunications
the Cabinet, and implemented by legislation investment review
(or by Schedule 3 investigation)
Investigate TCNZ wholesale / retail services Spectrum utilization review to support
separation options community broadband wireless initiatives
2007 Implement TCNZ wholesale / retail services Implementation of spectrum utilization and
separation Public Sector telecommunications
investment reviews
National FTTH Task Force
2008-2015 TCNZ structural separation National FTTH/FTTN rollout

Exhibit 4.2: Regulatory recommendations [Source: Internet NZ]

4.3.10 Summary and Conclusions

The outcome of the review of the regulatory positions of operators and industry groups is
summarised in Exhibit 4.3 below:

Organisation LLU Effective Upgrade Upgrade IP/Data TSO TNZ


Wholesale UBS UPC Interconnect Reform Structural
Separation
TelstraClear Support Support Support Support Support Support
Ihug, Support Support Support
CallPlus,
Orcon
Internet NZ Support Support Support Support
TUANZ Support Support Support Support
Vodafone Oppose Support
BCL Oppose
Woosh Oppose
[ ] Oppose Oppose Oppose

Exhibit 4.3: Regulatory Positions [Source: Operators and Industry Bodies]

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This summary identifies two clearly defined groups of operator opinion on the need for
regulatory reform. In broad terms these groups can be described as:

• operators with national advanced network aspirations that support reform as the only
practical means to achieve their goals (TelstraClear, ihug and Internet NZ representing
other ISPs and community based networks)
• operators that have achieved national coverage or are currently investing in advanced
network capabilities and see some aspects of regulatory reform as a threat to their
investment (Vodafone, BCL, Woosh).

Clearly there are individual exceptions to the above categorisations. However, even the ISP
Orcon which has publicly opposed LLU, but supported improved wholesaling in the past,
has now moved support to unbundling and even structural separation for Telecom.

In addition to the operators, TUANZ, representing retail users of telecommunications


services, has positioned itself strongly in favour of significant regulatory reform. This
suggests that the retail users represented by TUANZ do not receive or recognise the
benefits of there already being alternative national networks and advanced service
providers. In particular:

• Vodafone may still be perceived as a specialist mobile operator, currently unable to


provide the full range of fixed and mobile services required by modern business
• wholesale only operators (such as BCL and localised providers of fibre capacity) are
largely invisible to retail customers and the existence of their networks has not enabled
TelstraClear (for example) to compete effectively with Telecom’s national coverage
• Woosh and other wireless and satellite operators, although developing, have limited
coverage and service capability

TUANZ appears to prefer an environment in which credible full service operators can
directly compete for its members’ national and international telecommunications business.

Recent experience in overseas markets has demonstrated that efficient investment in


alternative access technologies can still be successful in an environment with high
penetration of unbundled local loops and competitive wholesale. An example is Unwired
Australia, a wireless broadband provider in Sydney and Melbourne providing internet and

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VoIP using early implementations of WiMAX technology. Its service is similar to that
provided by Woosh, appealing to apartment dwellers who do not have (or want) fixed
PSTN access from Telstra and who also find it useful to access their broadband account in
more than one location. The Unwired service does not therefore compete directly with
ADSL broadband, but has developed its own growing market niche.

4.4 Investor Community Views

We reviewed a number of recent brokers’ reports (see Annex) to find the longer-term view
of investors in alternate providers. Our main findings are presented below.

4.4.1 ABN AMRO

Telecom Corporation: local access fillip. January 2006.

ABN AMRO advises investors to hold Telecom shares but does not presents the authors’
views on investment in New Zealand.

4.4.2 Citigroup

The New Zealand telecom sector: scoping the opportunities. December 2005.

Citigroup indicates that a number of emerging services are being considered for launch in
New Zealand though it does not mention associated investment (Exhibit 4.4).

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Product Service provider Launch date Exhibit 4.4:


IP-TV Sky and Telecom January 2007 at the Emerging services
earliest
in NZ [Source:
Real-time mobile TV Sky and mobile July 2006 at the
operators earliest Citigroup]
Converged services Telecom Unknown
VoIP Telecom Early 2007

Citigroup estimates that the annual telecom capex market in New Zealand is between $0.8
billion - $1.2 billion (Exhibit 4.5).

Capex ($ millions)

Operator Fixed Wireless Systems & Total capex


Applications
Telecom NZ 350 – 400 50 – 100 100 – 150 500 - 650
Vodafone NZ n.a. 150 – 200 50 – 100 200 – 300
TelstraClear 70 n.a. 50 120

Exhibit 4.5: Estimates for the NZ annual capex market [Source: Citigroup]

Sky Network Television Ltd: holding the aces. October 2005.

This report contains much information pertaining to the valuation of Sky’s share price but
says very little about proposed investments. However we infer from Citigroup’s
assumption that Sky will enter the IPTV and mobile TV markets that significant investment
will be required.

Citigroup estimates that in New Zealand Sky will invest $50 million capex for a new
programming platform, $40 million of which will be incurred during the 2006 financial
year.

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Telecom Corporation of NZ: assessing the swing factors for TEL. July 2005.

Citigroup’s valuation of Telecom’s share price assumes scenarios for the New Zealand
market, each of which has a different probability. The scenario with the highest probability
(20%) involves TelstraClear investing $158m in WLL access network and switching
between 2006 to 2009 to provide coverage for 600 000 SMEs and homes in the Auckland
and Hamilton region. Another scenario, the introduction of a third national mobile, has a
probability of 5%. This scenario would result in $472 million of investment in New
Zealand between 2006 and 2009. The low probability ascribed to this scenario is due to the
report author’s belief that Telstra’s priorities do not lie with TelstraClear’s operations, the
latter being the most likely new entrant mobile operator at that time. The author of the
report believes that Telstra ‘would be better off scaling down its investment in New
Zealand and reinvesting capex into the Australian market’ instead of financing
TelstraClear’s roll-out of a third national mobile network.

Citigroup estimates that Telecom’s capex will be between $750 million and $775 million
for the 2006 and 2007 financial years respectively, though this estimate is superseded by
that in its December 2005 report.

Economics of broadband: quantifying the need, the need for speed. February 2005.

In this report Citigroup discusses four scenarios for the evolution of New Zealand’s
broadband market. However it does not present the capex assumptions pertaining to the
most likely scenario.

Fixed to mobile substitution: quantifying the risks. October 2004.

Citigroup’s capex predictions for Telecom are presented below (Exhibit 4.6).

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Telecom capex ($ millions) Exhibit 4.6:


Capex 2006 2007 Predicted Telecom
3G mobile 200 250 capex [Source:
Other NZ capex 472 468
Citigroup]

4.4.3 Goldman Sachs JBWere (GSJBW)

Telecom Corporation of New Zealand: 2006 outlook – we expect regulation to dominate.


January 2006.

GSJBW believes that Telecom:

... will be compelled to deploy a national GSM-based 3G network (UMTS) in NZ within


the next two years. Our forecast incorporates ~ $450m capex over FY07 to FY09 for this
investment although we note that this is not a consensus assumption.

The author believes that the following are risks are associated with such an investment:

• a further round of subsidised handset upgrades/technology migration


• a mixed marketing message – Vodafone’s technology is now Telecom’s preferred
technology
• inefficiencies of running multiple networks
• potential fast-tracking of the project with the capex spread over a shorter period than
the author assumes.

GSJBW believes that Econet ‘will want more favourable roaming rules ... and improved
cell-site co-location rules’ before it invests in New Zealand.

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Telecom Corporation of New Zealand: Econet resurrects the 3rd entrant risk – ball’s now
in the Government’s court. January 2006.

GSJBW believes that ‘there is a realistic prospect of a network being developed by Econet
with the backing of Huawei’. However it also states that Econet’s decision to invest will be
based on the Government’s decision on whether to create a more favourable current
regulatory environment.

4.4.4 Summary

The investors focus primarily on Telecom including competition scenarios and planned
capital expenditure and forecasts. Alternative providers, other than TelstraClear, constitute
a very small proportion of the market and are not discussed as a serious threat to Telecom’s
market share.

4.5 Convergence of Telecommunications and Media

In this section we consider the role of media content aggregators in telecommunications


companies’ provision of communications/content/entertainment services and the likely
relationship with and impact on telecommunications companies.

Technological advancements in content compression, broadband, set-top boxes, 3G mobile


and partnerships with media content aggregators (MCAs) such as Sky have made possible
the mass-market delivery of media content to consumers by fixed network operators
(FNOs) and mobile network operators (MNOs). IP-TV and broadcast mobile TV (BMTV)
(for fixed and mobile network operators respectively) in particular are emerging services in
which MCAs play a vital role. IP-TV is broadcast quality multi-channel TV delivered to
consumers’ PCs or to set-top boxes for viewing on a TV. Similarly, BMTV is broadcast
quality multi-channel TV delivered to consumers’ mobile devices.

Below we discuss IP-TV, BMTV and the role of MCAs in delivering these services.

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4.5.1 IP-TV

IP-TV is being offered by fixed network operators (FNOs) over copper (ADSL-enabled)
and fibre local loops in a number of jurisdictions including France, Hong Kong SAR, Italy,
Sweden, Thailand, the UK and the US. The size of the IP-TV market is expected to
increase from 500 000 subscribers as of July 2005 to nearly 20 million by 201056.
Exhibit 4.7 below illustrates an IP-TV business model for an FNO.

Satellite broadcasting
MCA’s content

MCA’s electronic
programming
guide (EPG) and
MCA’s satellite receiver
pay-per view
FNO’s ADSL (PPV) servers
TV
modem

FNO/MCA set-top box


FNO’s network

Phone
PC

Exhibit 4.7: FNO’s IP-TV business model [Source: Citigroup]

Network Strategies believes that the following factors are the most important determinants
of success for an FNO wishing to roll-out IP-TV:

• The size of the task – there is a physical limit to the number of customers an FNO can
sign up per given period.
• Network concentration – FNOs wishing to offer IP-TV over ADSL require relatively
short, high quality local loops.

56
Citigroup (2005). IP TV: stay tuned. 22 July 2005.

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• Affordability of IP-TV – the service must be affordable to the target audience. This
will be affected by the extent of competition from existing and potential TV operators.
• The upgrade cycle of set-top boxes – the uncertainty of standards to be deployed in
set-top boxes may warrant a cautious approach to IP-TV deployment.
• Digital rights management is required to prevent content leakage.
• Access to affordable backhaul.
• Quality – the FNO’s IP-TV offering must at least match the level of quality of
competitors’ offerings.
• Integration of IP-TV systems including operational support systems (OSS) with telco
systems is required to enable converged ‘triple-play’ offerings.
• Access to content – FNO’s must secure access to attractive content.

The last point above is discussed in more detail in section 4.5.3.

4.5.2 Broadcast mobile TV

The BMTV market is very young – the only commercial deployment to date is by MobiTV
in the US and the UK. However, MobiTV’s service uses valuable existing mobile network
capacity and the frame rate is too low for it to be classed as broadcast quality. True
broadcast quality mobile TV requires MNOs to deploy networks which support mobile-
device specific broadcasting technology standards. Such networks are currently being
trialled internationally. A number of competing standards exist. Adoption of these
standards requires additional spectrum, much of which may be currently utilised. The first
broadcast quality mobile TV service is expected to be launched in Italy in September 2006.

Network Strategies’ view is that the most significant obstacles to the deployment of BMTV
services are:

• choices of broadcast technology standard


• choice of business model
• access to content.

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The broadcast technology standard adopted affects, among other things, spectrum
requirements and bandwidth. The choice of business model for BMTV is important as it
will affect subscribers take-up and behaviour. Possible business models include:

• monthly flat rate subscription


• advertiser supported
• per minute charging
• monthly cap with excess usage charges.

MobiTV has adopted the former business model.

As with an FNO’s IP-TV deployment, MNO’s must secure access to attractive content.
This issue is discussed in more detail in section 4.5.3 below.

The value of the mobile TV market is expected to be worth USD3.5 billion by 200957.

4.5.3 The role of MCAs

MCAs are of particular relevance to IP-TV and BMTV deployments due to their:

• access to premium content including the latest movies releases and sports events
• expertise in digital rights management.

4.5.4 New Zealand

In New Zealand the key players in any potential IP-TV and BMTV deployment are the
FNOs, MNOs and MCAs. MCAs in the unregulated New Zealand content market are:

• TV1 and TV2 (owned by TVNZ)


• TV3 and C4 (owned by Mediaworks)
• Prime TV (owned by SKY)

57
FT.com (2006). Mobile TV standards vye for acceptance. February 16 2006.

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• SKY.

Of these MCAs SKY’s position is unrivalled due to its ownership of TV rights to:

• International and domestic rugby


• National Rugby League (Australia)
• International and domestic cricket
• Movies and television series from the top six Hollywood studios.

Citigroup notes58 that:

It would be extremely challenging for any start-up to achieve a critical mass of


“blockbuster content” (in a short space of time) that would attract customers away from the
SKT [SKY TV] franchise.

SKY’s importance within New Zealand is reflected in its involvement in IP-TV and mobile
TV developments:

• Citigroup reports59 that SKY and Telecom were trialling IP-TV as of October 2005,
combining SKY’s digital service with a joint SKY/Telecom set-top box, with enhanced
EPG and TV functions being delivered over a Telecom ADSL connection. SKY has
first right of refusal to supply content to Telecom.

• SKY has entered into agreements with Telecom and Vodafone to provide SKY video
content to mobile devices.

Citigroup believes60 that risks to SKY’s business could result from:

• The rise of digital FTA operators, leading to segmentation in the market and reducing
the uptake take of SKY’s service

58
Citigroup (2005). Sky Network Television: holding the aces. 17 October 2005.

59
Citigroup (2005). Sky Network Television: holding the aces. 17 October 2005.

60
[to be completed]

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• LLU could allow an independent IP-TV operator to enter the market


• Possible regulation of content – in New Zealand at present there is no legislation that
provides preferential treatment to FTA operators for content which is of ‘national
interest’.
• The emergence of online distribution channels (e.g. business to consumer, as in the
music industry).

However, given SKY’s dominant position Citigroup expects BMTV and IP-TV to present
opportunities rather than threats. This view is reflected in its valuation of SKY, with the
highest probability future scenario being that where SKY wholesales content to Telecom
whilst maintaining ARPU (average revenue per user) growth (Exhibit 4.8).

Scenario Probability Scenario description


1 – “Not your 5% Telecom and an independent IP-TV operator enter the NZ
night” pay-TV market. Content is not sourced from SKY.
2 – “A pair” 10% Telecom is the only pay-TV challenger to SKY, sourcing its
own content. Telecom also launches a mobile TV service with
own content.
3 – “Three of a 60% Telecom re-transmits SKY broadcast content as an IP-TV
kind” service over DSL.
4 – “Flush” 25% Telecom re-transmits SKY broadcast content as an IP-TV
service over DSL and sources non-compete on-demand
content from SKY for both IP-TV and mobile TV.

Exhibit 4.8: Scenarios considered in valuation of SKY [Source: Citigroup]

4.6 Key Conclusions

Access Networks

• there appear to be some prospects for fixed infrastructure based network competition in
the Auckland region, possibly extending to wide-spread FTTH
• there is active investment and competition for advanced business services in main
centres from independent and regionally sponsored fibre network providers

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• there will need to be a technology price breakthrough for alternative providers to


deliver cost effective innovative NGN business and residential services to customers
outside Auckland and other metropolitan centres.

Core Networks

• there is significant alternative provider investment in core networks linking main and
regional centres
• operators will continue to upgrade bandwidth on core network links and add coverage
when required for backhaul or advanced service capability
• some provincial linking and backhaul capacity will result from regional and
community based projects.

Impact of regulatory settings on alternative operator investment

There are two clearly defined groups of operator opinion on the need for regulatory reform:

• operators with national advanced network aspirations that support reform as the only
practical means to achieve their goals (TelstraClear, ihug and Internet NZ representing
other ISPs and community based networks)
• operators that have achieved national coverage or are currently investing in advanced
network capabilities and see some aspects of regulatory reform as a threat to their
investment (Vodafone, BCL, Woosh).

The key barriers to infrastructure investment are seen to be:

• uncertainty regarding the regulatory environment (particularly in the short-term - with


the first major Government review since the Telecommunications Act was passed in
2001), rules and the timing and nature of any likely regulatory intervention
• potential slowdown of the New Zealand economy
• technological uncertainty
• high cost of access network deployment and the concomitant need to engage in
wholesaling arrangements

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• size and demographics of the New Zealand market.

Convergence of telecommunications and media

• advanced broadband service provision to residential users is likely to provide access to


a range of content services. Based on current customer preferences, a key service is
likely to be access to content controlled by SKY, including live sport events
• rights to access SKY content via fixed broadband access are currently held by Telecom
on an exclusive basis for most geographic areas, and TelstraClear for areas where it has
cable TV infrastructure

Investor viewpoint

• The focus of investors is primarily on Telecom, which is regarded internationally as a


good investment prospect

International comparisons

• From 1998 to 2004 New Zealand’s income per capita has remained substantially below
that of all our sample countries
• New Zealand’s fixed and mobile penetration has consistently remained at
comparatively low levels compared to other sample countries over time
• Internet usage in New Zealand has been accelerating rapidly over time and by 2004
there were more internet users in New Zealand per 100 inhabitants than in any of the
other sample countries. A recent Statistics New Zealand survey (late 2005) reveals that
there are currently 1.24m internet subscribers which corresponds to around 30 per 100
inhabitants.
• Despite the relatively low broadband, fixed and mobile penetration in comparison with
OECD counterparts, New Zealanders are comparatively large spenders on
telecommunications. This may be due to high (possibly monopolistic) prices, high
costs, high usage or inefficiencies caused by a lack of competition in the market.

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• New Zealand telecommunications investment per line and as a percentage of revenue


appears to be consistently low when compared to the “peaky” nature of investment in
other OECD countries.

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Annex A: Investor reports

Report author Date published Report title


ABN AMRO 11 January 2006 Telecom Corporation: local access fillip
Citigroup December 2005 The NZ Telecom sector: scoping the opportunities
17 October 2005 Sky Network Television Ltd: holding the aces
28 July 2005 Telecom Corporation of NZ: assessing the swing factors for
TEL
22 July 2005 IP TV: stay tuned
22 June 2005 Telstra Corporation & Telecom Corporation of NZ: a third
mobile network in NZ?
1 February 2005 Economics of broadband: quantifying the need, the need for
speed

11 October 2004 Fixed to mobile substitution: quantifying the risks


Goldman Sachs 10 January 2006 Telecom Corporation of New Zealand: 2006 outlook – we
JBWere expect regulation to dominate
10 January 2006 Telecom Corporation of New Zealand: Econet resurrects the
3rd entrant risk – ball’s now in the Government’s court
15 November Telecom Corporation of New Zealand: key implications of
2005 Telstra’s strategy for Telecom
Morgan Stanley 26 October 2005 iiNet Limited. A beneficiary of ULL rollout and industry
consolidation

Exhibit A.1: Research reports [Source: ABN AMRO, Citigroup, Goldman Sachs JBWere,

Morgan Stanley]

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