NBN Co on the right track - but real risks remain. Speech to Corporate Turnaround Conference
It’s great to be here. I want to thank you for the opportunity to speak to you this morning, and thank Chris Martin especially and the Turnaround Management Association of Australia for extending the invitation. And thank you very much Michael Sloan for your kind introduction.
Many of you probably expect me to discuss the nation’s largest turnaround, the National Broadband Network. I will make some remarks about that project and its risks later in this talk, but let me begin with some reflections on corporate failures and corporate reorganisations.
In my previous career as a banker I had quite a bit of experience in this area, mostly in the media sector I might say. And indeed at one point I was retained by Westpac to restructure the Ten Network, 20 years ago. And I remember Cass O’Connor who was my right hand person on that project and certainly the best media analyst in the country at the time, had to go in to see these gloomy directors at Westpac and some from the CBA too who owned the debt, and needless to say they were pretty downcast, this was a train wreck.
You’ve all been in that situation yourselves I guess.
And I thought how do I break the ice with a joke? And Cass couldn’t think of anything funny about it, so I walked in and I said, ‘ladies and gentlemen, there is an iron law in the television industry and it is this; you have to ensure your revenues are in excess of your expenditures.’
I’m glad you laughed because none of them laughed.
They all wrote it down. I’m not kidding, they all wrote it down.
And there was one guy there who presumably had been to a tough primary school and had been taught to write very quickly and clearly. He wrote it down, he looked at it, he looked at it and he said, ‘this would apply in many industries.’
I was dying, I was absolutely dying and Cass said to me afterwards, we can never crack jokes when we are discussing insolvencies.
The simple fact that this conference not only exists but is well-attended, and I can see that the room is full, tells us something about how our economy has evolved over the past decade or so.
There was a time in Australian corporate life when workouts and reorganizations were comparatively rare, even if the business in trouble was a major listed company.
Back in the ‘70s, ‘80s or early ‘90s the typical denouement to an impending or actual crisis of liquidity or solvency was heavy-handed administration followed by a fire sale of assets. The chances of anyone other than secured creditors salvaging value ranged between none and not very much – even if such an outcome was plainly achievable and beneficial for lower-ranking creditors or shareholders, not to mention staff employed by the business.
Over the years, like you, I’ve seen a lot of shareholder value and jobs needlessly endangered or destroyed. Processes such as administration and receivership exist to protect the legitimate rights of creditors and ensure orderly resolution of company failures. But they weren’t designed to contribute value to the economy, and generally they don’t.
Thankfully business practices have changed since the early ‘90s. Creditors are more sophisticated, at least some of the time. Secondary debt markets have emerged – this is particularly important – which enable risk-averse bankers to hand off their problems to more creative and risk-tolerant hedge funds.
Faced with bad news, directors take remedial action earlier; better to confess to an embarrassing but retrievable mess than wait until it’s too late.
In the case of major corporate misadventures there is now a large and seasoned pool of advisors with the necessary skills and experience to deliver restructurings and turnarounds that preserve greater value for more parties.
On the other hand, Australia’s unusually severe insolvency laws - which deter directors from thinking about the interests of anyone other than the banks - and the ipso facto clauses found in most commercial contracts (which essentially allow them to be terminated if a counterparty is insolvent or in administration) are real impediments, as they have been for many years. Both of these make corporate reorganisations or turnarounds more difficult than they need be.
Propping up dying companies, a practise governments often find enticing, but I hope you have noticed that corporate welfare is not on the agenda of the Abbott Government, is almost always an error of judgement, and widely seen to be such. But is it any less damaging to our economy to cling to a legal construction that results in companies being prematurely extinguished, in many cases despite evidence which suggests they are capable of carrying on?
This raises the perennial question of whether there is a better alternative.
I note the recent Senate Economics Committee inquiry into ASIC considered this issue in passing, and came to a familiar conclusion. Its final report urged that, and I quote: "The Government commission a review of Australia's corporate insolvency laws to consider amendments intended to encourage and facilitate corporate turnarounds. The review should consider features of the chapter 11 regime in place in the United States of America that could be adopted in Australia.” 
Now, Chapter 11 is a complex regime backed by a large body of legal practice, with traits that could equally be interpreted as positive or negative depending upon one’s interest in a particular corporate failure.
Obviously banks, typically secured creditors, are at least at the top of priorities, are opposed to changes of this kind because they see it as weakening their leverage.
The characteristic of Chapter 11 that advocates have in mind is the opportunity it affords distressed companies to continue operating under existing management and with existing contracts protected from termination – but subject to oversight by a bankruptcy court. This greatly expands the scope for distressed companies to preserve goodwill, remain going concerns, and find solutions that minimise the losses suffered by all parties, not just creditors.
In contrast our system – which interposes a neutral administrator between creditors and directors – severely constrains directors of companies in administration from pursuing restructurings or workouts, even when options are available that potentially benefit everyone. Voluntary administration was introduced to provide more flexibility, but has had only a limited impact in practice.
Two drawbacks, it is said, to Chapter 11 are that it takes longer and is much more costly than our arrangements. Many Australians would also baulk at allowing the directors on whose watch a business stumbled to stay in place.
On balance, the best answer is probably not a wholesale re-write of our current laws in this area, so much as provisions that identify and replicate the most beneficial elements of Chapter 11 by providing a safe harbour for companies seeking to reorganise. I’m on the public record several times over the years as supporting such changes. In my view they would better equip companies facing difficulties but with genuine prospects of survival to find the least-costly resolution to their predicament.
I have no doubt that chapter 11 is one of the reasons for the resilience of American capitalism - the ability of businesses there to hit the wall, dust themselves off, restructure and keep going.
I recognise enlarging one set of rights curtails another, but on balance I believe the trade-off is worth it.
We are living through a period of volatility. Global integration, rapid productivity gains in poorer economies which allow them to converge with wealthier economies, and continued technological change are exposing companies and workers in advanced nations such as Australia to new pressures and competitors.
In 2012 Deloitte released work on the likely impact of digital technologies on various sectors of the Australian economy. The research forecast two-thirds of the economy would experience significant disruption over the next five years.  Deloitte recently updated the research and found that far from this taking five years, some 65 per cent of the economy had already experienced significant digital disruption. 
Given this backdrop, I suspect that over the next decade more Australian firms are likely to encounter turbulence, and need to reinvent themselves (or be reinvented by someone else) than in the past decade. No doubt many will do so in the face of financial distress.
The next time our intermittent debate about the merits and demerits of restructuring-friendly changes to corporate law flares (as it did in 2004 and 2010), the assistance such reforms might provide to businesses which face an increasingly volatile and competitive global economy should bolster the supporting case.
Who knows, this might even be enough to finally get this sensible change over the line.
I said at the outset that the simple fact of this an annual conference for turnaround professionals tells us something about our economy. This year the program of speakers is arguably equally revealing. Today kicks off with me, the Communications Minister. Tomorrow begins with the Chairman of NBN Co, Ziggy Switkowski.
In case anyone is still in doubt after those two hints, let there be no mistake: the National Broadband Network is the mother of all turnarounds.
That doesn’t mean it’s the only public sector business turnaround, or transformation, in town – far from it. As Minister for Communications I oversee four agencies that operate at least partly in the market sector of the economy – the Australian Broadcasting Corporation, the Special Broadcasting Service, Australia Post and NBN Co.
Each of these four is currently in the midst of major transformation:
● Australia Post, as its Chairman and CEO have made admirably clear to its shareholders, partners and customers alike, must respond to digital disruption which is destroying its century-old business model. The switch by businesses and consumers to digital messages and transactions has reduced letters volume by one billion over the past five years. Letters delivery has high fixed costs, and regulation compels the Post to deliver five days a week to 98 per cent of premises. Post lost $106 million in its latest half-year, the first loss since the 1980s.  The losses on letters have overtaken the profit on parcels and in the absence of tough but necessary reforms and organizational restructuring, Boston Consulting Group forecasts losses of $12 billion for Post from the letters business over the next decade.
● The ABC and SBS are currently working up their responses to the Government’s Budget savings and a review earlier this year by the Department of Communications assisted by Peter Lewis, former CFO of Seven West, of back of house costs (costs for activities that don’t tangibly affect programming or services). The review highlighted opportunities for both broadcasters to achieve back of house cost savings in line with commercial best practice, and provide better value to taxpayers by delivering current programming with fewer resources.
● I will say more about the NBN Co shortly but in a nutshell, after five years and $8.9 billion of funding the NBN is available at 6 per cent of Australian premises and has 255,000 users. Over the past year NBN Co has changed significantly; all but two of its Board and all but one of its senior management have been replaced by directors and executives with deep experience in telecommunications, infrastructure and finance (including Ziggy Switkowski as Chairman and Bill Morrow as CEO). The rollout is more stable, and the company is transitioning to a multi-technology model, which reduces costs by leveraging existing infrastructure. Negotiations are well progressed with Telstra and Optus to amend the NBN-related agreements struck in 2011 to align with this shift.
● Finally, since we are touring the Communications portfolio, let me note the Department of Communications itself has recently completed an extensive and difficult restructuring, being handled with considerable skill by its secretary Drew Clarke. This has seen every position progressively spilled and refilled, to achieve headcount reductions arising from program closures and accumulated efficiency dividends, and to focus more resources on policy development and analytical capabilities, including an office, for the first time, of a chief economist.
The list is a reminder that organizational transformation is just as important and prevalent in the public sector as among private companies (and arguably more challenging).
Public agencies may care less about insolvency or capital structures, but they have similar concerns as privately owned companies about financial performance, efficiency and productivity, organizational capability, internal culture and the management of change.
They often go about change in a different way. Businesses in competitive markets constantly make small improvements and adjustments in response to market forces. The cumulative effect of these incremental changes can be very, very large.
In theory Government agencies should also continuously pursue more efficient delivery of programs or services. But lack of commercial disciplines and incentives makes it harder to creatively and incrementally alter established procedures.
Consider broadcasting. A commercial broadcaster's revenues are a function of its performance - its ratings. The ABC's revenues are a function of its lobbying abilities.
Or take broadband. When the NBN was announced by Labor in 2009, after only eleven weeks of "rushed and chaotic" planning, as Bill Scales described it, it was said to be a commercial venture that would be so compelling mums and dads would be lining up to invest in it. Since then it is obvious that its IRR will do well to beat inflation. But as the economics declined its advocates simply switched to "nation building" as a justification.
As I often say, when you hear the words “nation building”, reach for your wallet.
Let me finish with a more detailed discussion of the National Broadband Network.
Today marks exactly a year since the change of government, which officially took place 11 days after the September 2013 Federal election. One year in office is long enough for me to feel qualified to offer a fresh perspective on the NBN.
Stated bluntly, the fibre to the premises NBN announced by the former Labor government in April 2009 - and I repeat after only 77 days of planning, only 77 days of planning to commit to a $43 billion Commonwealth government monopoly start-up - is the riskiest and most complex project the Australian Government has ever attempted to carry out.
There are large execution risks related to the NBN’s schedule, scope, inputs, costs and sheer complexity. These have repeatedly pushed the rollout off schedule and over budget. Make no mistake, execution risks remain significant, although the various changes to the NBN made under our Government have materially reduced them.
Separately, a number of underlying structural risks also confront the NBN in the longer term. These reflect NBN Co’s precarious economic model, the chance of adverse technology or market developments that affect its prospects, and the many stringent constraints and requirements imposed by policy. I’ll expand on the structural risks a bit later.
Together with the ‘extreme optimism’ of NBN Co’s original 2011-2013 and revised 2012-2015 Corporate Plans, it should be recognised risk and complexity were the key drivers of the poor performance of the NBN under Labor.
And that performance really was dire. By September 2013 the rollout was 462,000 premises (or 55 per cent) behind schedule, and the estimated total funding needed to complete the NBN was estimated to have blown out to be $29 billion (or 65 per cent) more than budgeted. 
Note the schedule and budget forecasts so comprehensively out of NBN Co’s reach in September 2013 were at that time 18 months old at most. They were made in NBN Co’s revised 2012-2015 Corporate Plan that was publicly released in August 2012, and presumably had been approved by the NBN Co Board and Labor Cabinet only a few months before at most.
It is fair to say that the Coalition prior to the September 2013 election underestimated the depth and breadth of the problems we would uncover inside NBN Co.
● We had no idea that after four years of construction, NBN Co didn’t know to a level of detail beyond the nearest million how many premises there were in Australia, or how many it needed to serve for the project to be finished.
● We didn’t know the address database NBN Co was using was so unreliable that the actual number of houses and businesses in an area was on average be 15 per cent fewer than the number in the database.
● We had no inkling the NBN Co Corporate Plan had underestimated demand for the NBN in rural and remote areas by a factor of 2 to 3 - meaning the company needed to serve roughly 600,000 of the most expensive users to connect, not 230,000.
● We didn’t know the Interim Satellite Service offering to RSPs was so poorly designed that overselling of capacity would degrade it to dial-up speeds – or that unless action was taken, NBN Co’s permanent satellites faced the same risk.
● We were surprised to find that nobody inside NBN Co was quite certain of the real cost per premise of its fibre rollout - the most important cost in the rollout. This was because information was siloed and the data needed to accurately calculate this cost was available for only about 30,000 premises.
● We failed to anticipate that the company had built its BSS/OSS environment - the complex IT systems which allow the network to be managed, faults logged, new services provisioned, and billing records kept - assuming no technology except fibre would ever need to be supported, or that choices had been made which limited its scalability.
● We knew the BSS/OSS was dramatically over budget. What we didn’t realise is that NBN Co had also committed to a further $1 billion of additional IT capex unrelated to those core systems.
● We sensed the company’s culture was difficult and hostile to outside ideas, but lacked a line of sight into the issues KordaMentha uncovered when they conducted employee interviews for the Strategic Review in October and November 2013.
● We knew there were many organizational flaws but had no grasp of the degraded, dysfunctional state of the company’s capacity to execute by September 2013.
All of these things came to light only after the change of government.
The Coalition’s broadband policy rested on the proposition that NBN Co’s shortcomings could be addressed by installing a high-calibre relevantly qualified CEO, Board and senior management team; relaxing Labor’s gold-plated specifications and giving NBN Co broad discretion in design and technology choices; amending the DAs to obtain access to legacy infrastructure; and running the project in a more transparent and commercial fashion.
Broadly, our program of reform has held up in practice. Since early 2014 many aspects of NBN Co’s operational performance have improved significantly, under a stronger leadership team with relevant backgrounds and expertise.
● The fibre rollout is more stable and has picked up pace year-on-year.
● New access technologies including FTTN and FTTB are being trialled, and a large-scale pilot rollout has been agreed with Telstra.
● The proportion of premises passed that are serviceable has increased, and unserviceable but ‘passed’ premises have declined from a peak of 100,000 to about 89,000.
● Relationships with key construction partners have gradually been repaired (although several commercial disputes remain unresolved).
● Significant progress has been made planning the MTM rollout, paving the way for a three-year rollout schedule to be publicly released early next year.
● As Telstra recently revealed in its annual disclosures, commercial terms have been agreed for amendment of the DAs.
● A Transformation Office has been established and a broad organizational change program is underway. This is also surfacing and addressing the cultural issues discussed earlier.
While some of the changes at NBN Co were slower than we would have liked, the turnaround we now see underway is dramatic indeed when compared to the company’s lowest ebb, which came a few months after the change of government.
I sincerely thank the board led by Ziggy Switkowski, and CEO Bill Morrow, and Greg Adcock, JB Rousselot, Jon Simon and the rest of the senior management team for their leadership, their commitment, and the extraordinary effort they’ve been willing to put into turning around the NBN. I also acknowledge and thank the remarkable contribution of my own team especially Stephen Ellis and Jon Dart and of course the team in my department led by Secretary Drew Clarke.
And I congratulate them on promising early results in what will be a long journey.
Part of the reform push has been the identification of changes which mitigate or manage execution risks related to the rollout, revenue and customer take-up:
● Increased use of non-FTTP access technologies such as fibre to the basement, node or distribution point and HFC will reduce the need to deploy lead-ins at many premises, and likewise minimise the need to enter the end users’ home or business. This downscales two of the most problematic elements of the rollout.
● NBN Co is devoting resources to ensuring a higher ratio of premises passed by fibre are ‘serviceable’ and can obtain active service once it is ordered – allowing NBN Co to reduce customer frustration and more quickly build revenues.
● NBN Co is proposing new ways of working with its contractors, where they take on a greater degree of end to end responsibility in a given area.
● Renegotiation of the DAs is likely to remove some unhelpful incentives regarding use of underground infrastructure which have added to complexity.
● Most of all, the rollout is now managed by seasoned executives who have the experience and skillset to estimate and achieve realistic targets.
● If an agreement is signed for Telstra to undertake some NBN design and construction work on a contract basis, this will further de-risk the build.
Of course even after all of these changes it would be misleading to minimise the significant risks that the project involves as it proceeds.
Costs remain a key risk, and continue to be very high. NBN Co is burning through close to $100 million a week at present and on current trends will h
have drawn down 46 per cent of its total available equity by June 2015 (when the rollout is estimated to extend to only 10 to 12 per cent of premises).
Several other operational areas continue to be of concern to the Government:
● Integration of the various multi-technology access technologies and products with NBN Co’s BSS/OSS systems has not yet been achieved. This is an area that needs to be watched.
● NBN Co’s customer ratings remain poor due to issues such as missed appointments, lengthy waits for new service and inability to activate service on the day.
● There are question marks over BSS/OSS scalability and the scalability of customer-facing functions such as service activation. Both need to ramp up to four or five times current volumes by 2015-2016, as customer acquisition accelerates.
● There is no evidence FTTP or fixed wireless costs per premise are declining.
● The timetables for finalising amendments to the Telstra DAs and the Optus HFC agreement remain a risk, and may be complicated by adverse decisions from the ACCC.
Beyond execution risks, which could be thought of as tactical in nature, are the structural risks I touched upon earlier which are more strategic - that is, grounded in the changed industry structure and whole-sale only model of NBN Co that accompany the rollout.
The fundamental issue is that the NBN as conceived by Labor – a wholesale-only open access network, built from scratch by a taxpayer-funded start-up, offering a high basic service at uniform national prices, and committed to burdensome financial obligations entered under Labor – is not able to earn genuine commercial returns.
While the financial projections in the Strategic Review assumed a much less generous revenue outlook for NBN Co than Labor’s Corporate Plans, they still indicated that if the project was built within the estimated budget envelope, it would earn a positive return.
Given the magnitude of the sums committed to by Labor under the DAs, however, the economics are always going to be challenging. This is exacerbated by the high cost of Labor’s non-FTTP capex commitments (especially to IT systems, fixed wireless, transit and satellite) and the recent ‘discovery’ of more users in regional Australia than originally forecast, all of whom have been promised a 25 Megabit per second basic service. The more customers in these areas, the harder it will become to deliver this service level without costs blowing out.
There are two final risks I want to briefly note.
The first is around technology and competition. While fibre fanatics love to scoff at anyone who dares suggest wireless will ever be competitive with fixed line access, the work of Clay Christiansen tells us (if we had not worked it out already) that often a ‘good-enough’ offering beats a technically more advanced offering because of lower cost and greater convenience. Wireless may prove a formidable competitor, perhaps sooner than expected – which speaks to the value in avoiding laying too many costly FTTP fibre lead-ins to users who don’t really need them.
Of course wireless will also potentially present opportunities for NBN Co, if it becomes a backhaul provider to owners of distributed small cell networks.
Last of all, there are risks to the NBN from inflated political and public expectations.
Fast broadband provides very large benefits for the economy and society, but it is a travesty that Labor deliberately conflated access to fast broadband with fibre, and was so irresponsible in exaggerating the impact of the NBN on people’s lives.
Sometimes I fear that every mayor in Australia thinks the project will turn their town into Silicon Valley. People with perfectly good broadband connections today – for example over HFC - have been brainwashed to believe that their world will be changed forever if they get fibre to the premises.
Yet the truth is that for the 50 or 60 per cent or so of Australians with good broadband today, the NBN will often be indistinguishable from what they already have assuming their current line speeds are sufficient to run the applications they need and value. They’ll wonder what all the fuss was about – and why the NBN is costing so much and taking so long.
Let me conclude on that sombre note. Bringing a sense of reality to a beautiful dream is never going to invite popularity, and many people remain incensed that we’ve killed that dream to save a mere $30 or $40 billion.
On the other side of the argument are people who say the project should have been shut down. Leaving aside the political dimension, we were satisfied that the cost of shutting it down was at least $15 billion and likely quite a bit more.
But I’m confident that everything we’ve seen so far tells us the Coalition's strategy is the right one and that we have the right team in place.
Anybody who argues otherwise would do well to consider the elevated level of risk that is still inherent in the NBN even after all of our work and the work of Bill Morrow and his team.
 Parliament of Australia, Senate Economics Committee – ‘Performance of the Australian Securities & Investments Commission’ – Canberra, June 2014, p.449.
 Online at:
 Australia Post – FY2014 Financial Results - Online at: http://auspost.com.au/about-us/australia-post-fy14-financial-results.html
 NBN Co – NBN Co Strategic Review – Dec 2013, pp.38-40. Note the blowout in required funding is $34 billion (or 77 per cent) if the original forecast and post-election revised outlook use the same 20 per cent capex contingency reserve.