Anti-telco sentiment fuelling iiNet

Mark Rushworth, CEO of ihug. Picture / Richard Robinson

PERTH - Having to battle two huge telephone companies for broadband market share may seem like a daunting task, but Australia's iiNet - owner of New Zealand's ihug - is having success on both sides of the Tasman by promoting itself as a champion of the consumer.

In Australia, Telstra has been cast as the greedy, competition-stifling incumbent, while in New Zealand the role goes to Telecom. Both companies have subsidiaries on each other's turf - TelstraClear and AAPT, respectively - whose complaints of poor wholesale terms and regulations inevitably come with a tinge of hypocrisy, given that their parents are guilty of the same behaviour.

It's a situation that is turning customers off the incumbents and on to alternative providers, says Steve Dalby, iiNet's general manager of regulatory affairs.

"It just helps you to accept that they're playing games. Whatever they say, you can take with a grain of salt," he says.

The public distaste for Telstra has translated into tangible gains for iiNet. Since its founding in a garage in 1993, the company has grown to become Australia's third-largest internet service provider, after Telstra and Singapore-owned Optus.

In acquiring OzEmail last year, iiNet hit 578,000 customers, 142,000 of which are on broadband.

The company announced in February a half-year profit of A$6 million ($7.15 million), down 24 per cent from a year earlier - a decline it attributed to the costs of doubling its customer base through the OzEmail acquisition.

But revenue for the period climbed significantly, up 89 per cent to A$120 million. The company attributed the increase to customers migrating from dialup to broadband, and also to its own network: 85,000 are on iiNet's DSL infrastructure, with the remainder getting Telstra's resold service.

Profit margins on its own network are significantly higher, Dalby says, and the 90 per cent of customers will be migrated by the middle of next year.

In NZ, ihug - acquired by iiNet in 2003 - has had similar success.

Although revenue was fairly flat at $34 million for the year to last June, up slightly from adjusted revenue of $32 million a year earlier, the firm has been adding customers at a healthy clip. Ihug is the largest reseller of Telecom's DSL services, with about 25,000 subscribers on broadband and 120,000 overall customers.

Like its parent, ihug is the third-largest ISP in the country, behind Telecom and TelstraClear. The company was also named Best ISP at the NetGuide Web Awards last week.

Dalby says the secret behind both companies' success has much to do with the antagonistic behaviour of the incumbents. By jealously trying to protect their market share, Telstra and Telecom have alienated customers, united their enemies and given their respective Governments ample reasons to regulate the markets.

"What Telstra's attitude has done is driven the industry together, and it's happening in New Zealand as well. I don't know if that's good or bad, but it's a fact," he says.

Many of the smaller ISPs and telcos in Australia have banded together into an information-sharing lobby called the Coalition of Competitive Carriers.

The move has been mirrored here with the ihug-led formation of the Internet Service Providers Association last year.

iiNet is also one of the few ISPs to have taken advantage of local loop unbundling, which was introduced by the Australian Competition and Consumer Commission in 1999. The company last month announced an additional A$15 million investment in ADSL2+ technology, bringing its total investment in its next-generation network to just under A$50 million.

iiNet says the network will cover about 90 per cent of metropolitan Australia, or 4 million households, by January and provide download speeds up to 24 megabits per second - 16 times faster than Telstra's offerings and about seven times faster than Telecom's. Both Telstra and Telecom have promised to roll out similar ADSL2+ services but have yet to commit to an exact date.

The headline speeds have been attacked by both Telstra and Telecom, who say that 24 megabits is only possible for customers living close to a telephone exchange.

iiNet's chief technology officer, Greg Bader, admits this is true, but says customers still get much faster speeds than those offered by the incumbents. More than 90 per cent of ADSL2+ customers are getting speeds greater than 3.4 megabits, and more than 50 per cent are receiving better than 9.1 megabits, he says.

Unbundling Telstra's local loop has also created competition in the telephone market. iiNet has 98,000 traditional phone customers and 19,000 subscribers to its Voice Over Internet Protocol service. Phone and ADSL2+ bundled packages sell for about A$63.

With the New Zealand Government expected to initiate the unbundling of Telecom's local loop, phone and internet services similar to iiNet's are likely to arrive here through ihug.

The ISP has pledged $20 million over three years to rolling out its own ADSL2+ network.

Ihug also plans to replicate iiNet's business strategy and act as a market consolidator, with an eye to acquiring other ISPs. Just as iiNet quickly achieved size through buying OzEmail, so too would ihug, Dalby says.

"That's exactly the driver. It's all about scale."

TelstraClear and number-four provider CallPlus are likely too big to be acquired by ihug, leaving number-five ISP Orcon - which has just under 20,000 broadband customers - as a likely target.

Ihug chief executive Mark Rushworth says he would be very interested in acquiring Orcon but no overtures have yet been made.

Scott Bartlett, Orcon's general manager of regulatory affairs, declined to comment.

Not everyone expects major expansion from ihug, however.

iiNet has several issues it needs to iron out at home before it can concentrate on New Zealand, Macquarie analyst Tim Smart says.

iiNet has had problems integrating its call centre operations following the OzEmail acquisition and needs to fully complete the merger.

"Right now iiNet has got a hell of a job in terms of focusing on integration of OzEmail and all that's happening in Australia," he says.

"I'm not sure at what point they're going to be in a position to be a great big consolidator [in New Zealand]."

The Australian company is also facing an increasingly aggressive Telstra, which has signalled that it wants to boost its broadband market share from about 41 to 55 per cent, Smart says.

Telstra is also playing hardball in what it charges reseller customers such as iiNet and has threatened not to proceed with building a next-generation network unless the Government allows it to raise the rates.

Those factors are going to cause price uncertainty for some time in the market, which will weigh on iiNet's share price - indeed, the stock has plummeted in the past six months from A$2.90 to around A$1.75.

"You've always got that cloud hanging over iiNet's head," he says.

Still, ihug is well positioned to benefit from unbundling in New Zealand, he adds.

While the company's announced investment isn't huge, Telecom is sure to respond to the threat of ihug building its own network by offering it better wholesale terms.

"Even though they may not immediately go ahead and spend much more than $20 million or roll out everywhere," Smart says, "the mere fact that they're getting scale in certain exchanges [means] the equation of negotiation power with Telecom does shift. It can act as a powerful negotiation and pricing tool."

* Peter Nowak travelled to Perth courtesy of iiNet.