Internode Blog

Q & A on the Internode iiNet transaction announcement

Monday, December 26th, 2011 by

This blog post is a collection of answers (an FAQ) that I’ve written on whirlpool in response to questions asked about it there.

I’m placing some of those answers here because they can easily be lost in the succession of pages there, and some of them seem to be asked repeatedly.

Hence putting them here is an exercise in trying to make them easier to find – and reducing that repetition somewhat!

I’ll add to this post as necessary if future questions of importance turn up that make sense to add into this blog post.

Regards,

Simon Hackett

What is this all about?

Its about this:

http://www.internode.on.net/news/2011/12/259.php

and this:

http://blog.internode.on.net/2011/12/23/open-letter-simon-hackett/

This is another iiNet acquisition and Internode will just disappear, right?

No, it isn’t.

As part of the transaction, I will be granted a 7.5% shareholding in the iiNet company group at the completion of the transaction. This means I’ll be a top-ten shareholder in the listed group.

This is the only time in iiNet’s history that the result of an acquisition includes the assignment of a Significant shareholding to the founder of the company concerned. It makes this a combined merger/acquisition, because I’m retaining a substantial shareholding interest at the completion of the deal. This was my choice.

Why does that matter? Because I’m retaining an ownership stake in both Internode and in the rest of the iiNet group, my financial interests are aligned with those of the group. I’m committed to its future and I’m putting (well, keeping) my money where my mouth is.

Internode will be remaining as a separate operating company within the group, with its own identity, and its own staff.

I am staying at the helm of Internode, as is the rest of the management structure of the Internode & Agile company group.

Its very much ‘business as usual’ – but better – after this transaction is completed.

While saying that, I also want to underscore that ‘business as usual’ does not mean ‘no change’. No successful company can operate without changing as market conditions change, and we fully expect Internode to continue to do so, under its new ownership structure.

Will Internode ‘use anytime’ quota plans will be removed and replaced with iiNet Peak/Offpeak plans?

Its important to appreciate that in some other significant iiNet acquisitions in the last few years (e.g. Westnet and Netspace), the plans offered by those companies at the time were structured similarly to iiNet plans already; They already were peak/offpeak quota style plans. So it make rational sense to wind up normalising the plans concerned over time.

However, in the case of Internode, our plan structures have long been offered on the basis of a ‘use anytime’ single quota. This significant difference is something that a number of our customers state as their preference.

Providing that plans are sustainable in economic terms, there is no particular driver toward forcing Internode plans to turn into carbon copies of iiNet plans.

There is no current expectation to do so in the mid term at the very least. Over the coming months and years, naturally, we will continue to assess what our customers tell us that they want and need, but right now we aren’t under any immediate pressure to change plan structures – only to ensure that they remain financially sustainable (which is obvious and necessary for any company).

Why didn’t Internode arrange an IPO (Initial Public Offering) for Internode instead of joining forces with iiNet?

I’m moving from being the major shareholder in Internode to being a 7.5% shareholder in the iiNet company group.

Also, in the process, I am personally retaining, within the company group, around the same amount of investment value that I would have retained in Internode had we listed Internode separately.

The Internet industry in this country, in a market that is now saturated, is very much a scale game. If we’d listed in our own right, we’d have had the capital we needed to be a strong market player in principle, but we would not have created the necessary scale. That path would have required us to engage in our own rounds of acquisitions to then build that scale. While a viable approach in theory, it would have taken a lot longer and been a source of substantial distraction in a formative industry period (as the NBN looms).

Instead, via the transaction that we have elected to undertaken, we gain the market capitalisation that we need to be a strong future player and we gain immediate scale. That gain in scale is also bilateral – Internode gains the benefits of scale, and iiNet gains a considerable upward step in scale due to the substantial size of Internode.

Why is the NBN a driver for this transaction?

It will cost around $20m per annum to operate an ‘empty network’ on the NBN once the NBN has all of its 121 points of interconnect deployed. That huge overhead is the outcome of an ACCC decision to break the state-by-state NBN network design up into those 121 smaller subnetworks.

That running cost is just the price of admission, the price to run an empty network, before you add a single customer to it.

For Internode, on its own, that would have consumed around 10% of our gross income, and most of our current annual operating profit, just to be a competitive market player on the NBN, concurrently with operating our existing national ADSL2+ networks.

Instead, as a part of the iiNet group, that same $20m per annum NBN baseline cost represents only a few percentage points of the total gross income of the group, and it can be easily carried by the group.

As a result, the whole group gets to efficiently use that single $20m per annum investment without causing significant negative impacts to the group performance.

That is why the NBN rewards scale – and its important to appreciate that we need to operate that new national network and its 121 points of interconnect, and their associated overhead costs in parallel to the existing national ADSL2+ deployments for ten or more years. As the NBN migrations occur, we’ll move from operating an ‘empty’ NBN network and a ‘full’ ADSL2+ network, to the inverse of that – and we won’t be able to turn off the ADSL2+ deployments in terms of their overheads, until the last customer in each applicable geographic area is migrated to the NBN.

This is just one of the reasons why this transaction makes sense – there are plenty of others, and its important to appreciate that this transaction would have made great sense had the NBN not been a factor, too. Thats because even absent of the NBN, the next decade is going to be one in which the consolidation of the market and the pressure on operating margins driven by competition will put more and more pressure on market players to be extremely efficient in terms of overheads per customer. There is only one way to do that – with very high operating scale.

I wish I could have bought shares in Internode (e.g. at an IPO)

From time to time its been pointed out by a lot of people that they’d have loved Internode to list, so they could have bought some shares in it.

One of the benefits of this transaction is that it actually provides the general public, and Internode customers in particular, with a way to do that very thing, and to do it right now – by simply buying shares in the iiNet group (ASX: IIN). That group, once the transaction is completed, will obviously include Internode. So you can buy into both Internode and iiNet, by buying iiNet shares, right now!

I’ve come across a number of people since the announcement who are rather keen about that idea :)

This transaction must have been forced by the venture capital investors in Internode who wanted their money out

Nice theory, but Internode is in fact a private company with no external investment – its never had any. This was simply the right time to make this change.

Internode will just disappear into iiNet without trace!

If you think we’re going to just disappear up the nether regions of iiNet without trace, you underestimate a number of key things:

  • The extent to which Michael Malone and I have come to know and respect each other over the last decade or two, and the extent to which we are looking forward to working with each other directly in order to kick some serious ass.
  • The strength of the Internode group, and of its people, built up over the last two decades
  • The impact of the (unique) situation where I will be a major shareholder in the iiNet group, not merely an employee of it. This has never happened in any previous iiNet acquisition (and I would be surprised if it happens again in a future one).
  • The respect in which I’m held by the iiNet board

Its hard to note the above points without it sounding like I’m just trying to blow my own trumpet, and I’m sorry about that (its not the aim).

Rather, the aim is to underscore that this is a unique alliance and it is involving a company (Internode) that I’ve spent two decades building up.

I won’t be just riding off into the sunset and leaving now. That was never the point.

Being a South Australian that means I should have a moral imperative to swap to another South Australian ISP now, right?

Ok, you’re playing the ‘SA’ card. I appreciate that another SA headquartered provider is doing that right now, in response to this news.

Lets talk about that, because its important:

Internode and Agile employ around 450 people, and the overwhelming majority are in South Australia.

They are remaining right here, and as a major SA employer (with a lot more staff employed than any other ISP in South Australia), I find the notion of moving your business away from the company employing all of those South Australians, on the very principle that you want to support South Australians, to be somewhat disingenuous at best!

Next, lets look at one more specific South Australian – me (Simon Hackett).

Post transaction, I’ll be betting a shareholding in the iiNet group worth (currently) around $32m on the future efforts of all of those South Australians, and I am remaining one of them – working in the business I founded – as well.

Adam, the other major SA Internet Provider, are an excellent company. I respect their management and staff greatly, and they’ve done a brilliant job of operating in this state, just as (I believe) that Internode and Agile have done.

A change of ownership structure in Internode (and where also I retain a significant chunk of that ownership personally after the change) doesn’t represent a change in our commitment to the state of South Australia.

Indeed, its quite the reverse. With access to far greater technical and financial resources, and the huge advantages of far greater scale, you can expect to see us achieving a great deal more for South Australians then we would have been able to do in the future, on our own.

(and importantly, the previous point would apply whether we had listed in our own right or not – its that scale thing again).

One of the many reasons this deal made sense to iiNet is because of how important Internode is within South Australia. The idea isn’t to change that – its to ramp it up!

Its also important to appreciate that no South Australian broadband company has done more for regional South Australians than the Internode and Agile group has.

With our major investments around the state in both ADSL2+ deployments, fibre networks, long haul licensed microwave backhaul systems, and our licensed regional WiMax based fixed wireless networks in the Coorong, Mallee and Yorke Peninsula areas, we have spent twenty years putting our money where South Australians live – and where others fear to tread.

Our investments in South Australia have been around the state in general, not merely in Adelaide alone.

What sort of improvements in service outcome will the transaction bring for Internode customers?

While its early days yet (the transaction isn’t officially completed yet – ETA end of Feb 2012), there are a number of obvious ways that we are expecting to fruitfully combine our strengths at a network level.

One of the most obvious ones is in the constructive interconnection of the iiNet and Internode DSLAM networks, and also in the constructive interconnection of the iiNet and Internode IP transit networks.

Internode has a great national and international network – and we fully expect it to remain a key part of the networks operated by the company group. We’re… really really good at this stuff.

But, focussing on DSLAM’s initially:

Internode and iiNet run the same ADSL2+ hardware (made by Ericsson). This is a fine instance of both companies having selected the best tool for the job back when we both did so.

But it also leads to the rather excellent opportunity that exists now, to interconnect those two DSLAM networks for the mutual benefit of both Internode and iiNet retail customers.

The intention (NB timing and details are still to be sorted out) is already the obvious one, which is to make the port coverage of each company available to the other, and to do so in a seamless manner.

That leads to the wins in both directions that we clearly expect, viz:

1) Internode customers will gain access to the much larger national footprint that iiNet has deployed using Ericsson ADSL2+ hardware.

The consequence here is that Internode customers will be able to access direct ADSL2+ ports for our Easy Naked and Easy Broadband services everywhere that iiNet has hardware deployed. That’ll massively increase the geographic reach of our ADSL2+ and fetchtv full services.

reciprocally:

2) iiNet customers will gain access to the national ADSL2+ DSLAM footprint of Internode. This will expand the iiNet retail ADSL2+ access map by around 36 more DSLAM sites.

There are other ways in which this sort of clear technical win from interconnection is available and we expect to explore and deploy a number of them over the coming months and years.

Just one more example – Voice services:

Internode and iiNet use the same vendors for their national VoIP services (Broadsoft’s Broadworks core VoIP platform and associated support infrastructure). Thats going to make it a piece of cake to interconnect the voice networks of both companies.

Likewise, and somewhat like the DSLAM situation, the licensed carrier companies of each group (Agile and Chime) both have SS7 voice interconnect and Local Number Portability established with the other major national voice players (including Telstra and Optus).

It turns out that (like the DSLAM geographic coverage maps), the places each of us have made the investments in deploying LNP are not identical.

As a result, by joining forces on this as well, we’ll be able to fill out the geographic map in terms of where LNP is available, for retail customers of both companies.

Why does that matter? Because LNP is the way that you get to keep your existing phone number when you move to a Naked DSL service and/or when you move in the future to an NBN service. So the wider combined geographic coverage will just cement our (combined) leadership position in NBN services provision.

There’s a lot of good stuff to look forward to here – these are just the first and more obvious things on a longer list.

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