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Chorus - six options for the government

Common sense has prevailed and we won’t see the government overrule the independence of the Commerce Commission any time soon.

While that's good news for the long-term interests of both customers and the industry alike, it leaves us with the question of what to do about Chorus [NZX: CNU].

First, we have to determine whether there is a problem that needs fixing.

So far, we’ve been told that Chorus “could go broke” if the price of copper wholesale comes down.

I don’t buy that, and I’ve seen little evidence of that.

The numbers we’ve run are similar to Chorus’s own pronouncements in this area – that it will reduce profit (profit, not revenue) by about $80m to $100m a year. Coincidentally, Chorus pays out about $100m a year in dividend share.

To my mind, any infrastructure company that is rolling out a once-in-a-generation network wouldn’t expect to also pay a dividend at the same time. That money could and should be ploughed into the network in the interests of long term sustainable dividend payments in the years ahead.

My first preference, in that case, would be for Chorus to concentrate on the job at hand, get on with deploying the network and worry about dividend payments once the network is in place.

But Chorus has hinted darkly that there may be more afoot. If the final determination is allowed to stand, Chorus CEO Mark Ratcliffe says there will be two outcomes:

“We would have much less cash every year to invest and we simply will not be able to borrow the sums of money we need to make up to a $3 billion investment in UFB.”

This is an extraordinary situation. How can Chorus have bet so heavily on little or no change in the regulated price of its copper lines? How can they, and their investors, not have seen the writing on the wall when Minister of Communications Steven Joyce gave them a three-year delay to the introduction in order to get their house in order? That they’ve not used that time wisely is shocking and surely won’t go down well at the next board meeting, let alone the annual general meeting.

If that’s the case, the government must do something because the UFB deployment is too important to New Zealand to allow it to founder at this point.

Option 1: Do nothing.
If we do nothing, Chorus fails to deliver on its contract and defaults.

The Network Infrastructure Project Agreement (NIPA) between Chorus and the Crown is quite clear on this – default and there are penalties in terms of cash and repayments and an agreement that Chorus will relinquish control of the project to Crown Fibre Holdings, the government agency charged with overseeing the UFB deployment.

CFH would take direct control of the company and its contractors in order to see the project through to completion.

Option 2: Give Chorus more money directly.
I would need to see some clear evidence of Chorus’s problem before even countenancing this. Chorus is a private company that has bid for a contract and won. If it’s underbid, if it’s failed to secure adequate funding, if it’s failed to consider the obvious regulatory impact, then that’s it’s problem.

If we are to give Chorus more money we would be rewarding it for poor performance. That money would have to come with serious caveats on spending and should include a radical change in management, dividend policy and possibly the board as well.

Option 3: Go back out to market.
Chorus isn’t the only game in town in the fibre deployment world. If Chorus can’t do the job, perhaps Vector might like another shot at the title.

Vector missed out to Chorus on the Auckland bid – perhaps taking Auckland off Chorus and giving it to another provider might be the answer.

If Vector isn’t keen, what about the other LFCs? They’re cracking on, doing the job quickly and within budget. You don’t see them complaining that they need hundreds of millions of dollars more each year. Maybe Northpower Fibre could extend its network deployment capability down country and run the project for CFH.

Option 4: Provide bank debt assurance.
Probably the easiest thing for the government to do now is to guarantee Chorus’s debt to the bankers. I’m no financial guru, to put it mildly, and have no idea how any of this works but I’m told it’s the simplest thing the government could do with the least risk to the country. If Chorus can’t continue and make things work from there, we own them.

Option 5: Nationalise Chorus.
The share price is at its lowest point – perhaps the government should buy the company and run Chorus’s network as an open access national network, delivering service far and wide and without prejudice.

Potentially we could see one network across most of the country delivering service to ISPs and then on to users without too much overhead and red tape.

What am I saying, governments live for red tape. Much as I would like New Zealand to own its own infrastructure, I just can’t see this working. It’s in the list as a potential option but I suspect it’s unworkable.

Option 6: Cancel the UFB.
It’s all too hard, nobody really wants it, let’s walk away from the commitment. There you are, you “user groups”, you’ve got what you wanted, we’ve canned the UFB. On your head be it.

This would be a catastrophe for the country and is the furthest thing from “what we want” as users.

The UFB is essential to both New Zealand’s economic future and our social well-being. In ten years’ time, when it’s built and we’re looking at extending it into rural areas, the UFB will be a glittering jewel in our national crown and all this discussion will be dismissed as teething troubles and that’s as it should be. To abandon the project now is unthinkable and besides, I’m sure the opposition parties would have a field day and would make building the UFB into an election issue all over again.

 I don’t know what the government will decide from here. Much of it rests on the Ernst and Young report which comes out next month. From there we should get a better picture of whether there is a problem to solve and if so just what that problem is.

There is another option of course. Chorus can stop wailing, get on with the project at hand and cut its costs to be in line with international best practice and the kinds of costs we’re seeing from the other fibre companies. They can get better at digging ditches and stringing fibre from poles and concentrate on driving cost out of the business.

We can help with that – a major part of the rollout cost is eaten up in consents and legal fees, not to mention the delays, inherent in seeking permission to connect the network to each property.

This is a national upgrade programme that replaces an old network. Telecom used to have rights of access to property to deploy and replace network gear – we should make it easier and quicker for all the LFCs to do the same.

Rights of way, driveways, easements, multi-dwelling units, gated communities, new subdivisions, apartment blocks, business parks. All should be accessible by default. That would strip a huge amount of cost out of the business of deploying the UFB and that’s clearly not a bad thing.

Paul Brislen is CEO of the Telecommunications Users Association of NZ (Tuanz)

READ ALSO: ForBarr says Chorus should consider abandoning UFB; runs sums on withdrawl

Comments and questions
40

Yes let's cut a lot of red tape and get on with the job. It is essential for the future of NZ. Changes to the RMA are way overdue. Let alone the extra council red tape that is costing us all too much.

The ever-touted RMA reform is not the panacea to this problem - in fact its hardly related. Councils have bent over backwards to fast track consenting for UFB.

The vast majority of red tape and frustrating time delays are all associated with access to private property, but I guess you wouldn't want law reform to undermine your god given private property rights now would you?

Agree Anon, the RMA is not relevant here. The key is that Chorus under cooked its costings and wants to claw value from someone.

Chorus, and indeed all the LFCs, face spending a large percentage of their costs on consents for access to build the network. I've spoken with several infrastructure companies in the past few months about this and it is a major problem for all concerned.

Councils may think they've bent over backwards but I've heard plenty of tales about LFCs being forced to bear the cost of work that should be shared among multiple players. How often have we seen roads dug up for one project only to be dug again a month or two later for another?

Costs like these are avoidable and should be minimised.

Shares from a de-merger split of a half sovereign "Telecom" that quickly went down in price.... Then waiting a year for some recovery and a dividend announcement - now this!
For those of us that try to look at opportunities in supposedly free markets like NZ. Your investment banking deal structures look either amature or very manipulated.
As for those that would question the dividend. It's always "risk verses reward" in a free market. What's happened here is exactly why it was necessary for Chorus to pay a decent dividend. Yes I did pair off some profits, yes I played the investment safe (like I do all my positions) but a free market depends on capital ownership risk taking by people like me.
Regulation is fine! I support smart regulation and realize a smaller micro economy like NZ needs to be sensitive. But for the love of God... Update your regulators and make their decisions at least relevant to the industry they are regulating!! The whole mess should be seen as an embarrassment and travesty for a government that can't make a plan and stand by it. Don't knock on my door next time you need a money raising.

Proves that this is a MINORITY National Government with only 59 out of 121 MPs?

Penny Bright

It shows at last, MMP can work when a government starts behaving like the Muldoon govt did when under FPP it had a majority of seats, but a minority of popular votes. Almost all Govts in my life time have not enjoyed a majority of the total votes cast.

Yes, to hell with the shareholders, who do they think they are? They don't deserve dividends, do they. Many have lost over half their investment already, but what does that matter? I mean why should they be rewarded for risking their capital; you'd think they owned the company.

Here's the analogy. Go and build a house, costing $300k and you have already arranged tenants at $300pw. Now along comes the regulator, says the cost of rent for an equivalent house in Sweden is only $150pw, that's all you can charge. Bang, your partially built house has just lost half its value.

The nub of the issue is that there is a disconnect between Chorus's and the ComCom's pricing. How could they all get it so wrong?

No-one forced you to invest in Chorus.

You made a bad decision and lost. You could have sold them some weeks back when the share price was higher to minimise your loses, but sounds like you gambled on John Key saving the day.

They didn't all get it wrong.... it was Chorus who got it wrong. They knew 3 years ago this day was coming.

Companies in capital intensive growth phases usually do not pay dividends, at least not in the rest of the world. We are very yield focused in NZ. SO yes shareholder's do need to wait for a yield.

Regulatory risk is a factor which investors in Chorus should have been cognisant of. It would have been fair for Govt. to get Com Com to do the price review before the share split. That would have been more even handed. Chorus knew as well as other industry players that the price for copper was over-cooked. It simply can not be the same as the price for a brand new high capacity network. I guess Chorus management did not want to lead with their chin.

Haven't we all forgotten the only reason that Chorus exists is because the regulator forced Telecom to split. So the responsiblity of this stuff-up lies squarely at the feet of the regulator, and government.
Yes shareholders should be compensated for their risk, look at any other listed regulated monopolies, who recieved a fair return on their capital.

And that's where everybody is confused.

Chorus is not in a "capital intensive growth phase".

It is in a capital intensive REPLACEMENT phase.

When the fibre network is finished, after billions have been spent, Chorus will not have hundreds of thousands of new customers.

It probably won't even have the same number as now.

And the average customer spend will be little different to now.

And that's were the problem lies. The fibre network is essentially a maintenance upgrade to keep up with the times - it won't earn them any more.

But the Comcom and everyone else wrongly considers that it is some kind of separate new business.

Here's the analogy as I see it. I hire a contractor to build my house for $300k and halfway through the project the contractor comes back and says "I'm sorry but costs in another part of my business have gone up so you'll have to pay more".

The simple answer is, no.

The Commission rules were in place from the start - changing them halfway through the project is unacceptable.

Shareholders who don't bother learning about the company in which they are investing similarly don't get much sympathy, especially when they invest in a regulated monopoly and don't expect it to be regulated.

So in your opinion, no one should have invested in fibre in the first place.

Everyone knew the company would be regulated Paul. The operative question is whether everyone knew this regulation would be based on the cost price of Sweden and Denmark. It's frankly ridiculous to compare NZ to these two countries as they have vastly different population densities and topographies to name a few key differences.

This is a seriously under researched article.
1. Crown Fibre does not have the capacity to take over the project. There are financial penalties.
2. See point 4, you are no financial guru, why are you writing this article when it is about financial capability of Chorus?
3. Ah, no the other LFCs are not within budget. Vector would want a much better deal as would others.
4. See above, why are we reading your comments again?
5. You say, "and run Chorus’s network as an open access national network, delivering service far and wide and without prejudice" Actually Chorus is a wholesaler charged with creating an open network and required to provide the contracted services to all potential ISPs at the same price, without prejudice. That is the essence of the current UFB scheme. The red tape comment is just puffery. Chorus is a commercial business unit and Government ownership would not hinder or change much. The question is why payout shareholders with cash that could be used to recapitalize Chorus and fund the UFB roll-out. Government would get a shareholding for its cash and market shareholders diluted. A rights issue underwritten by Govt could deal with any perceived inequities. But then you are not a financial guru.
6. Actually UFB is ahead of demand and few users require its capability. any or most that do on any scale had fibre before UFB started. As for house holds, there is no compelling reason to dump copper VDSL yet. So slowing down UFB could be an option. Build closer to demand.

I agree with your opening comment that the Com Com findings should stand and consumers not subsidise the UFB, Chorus shareholder wealth or dividends. Also agree that a hold on divs is appropriate when building and investors should have thought about that. But the rest of your article is uninformed and worthless. Better research next time.

I think you need to go back and read both the CFH agreement with Chorus and the separation documents that split Telecom and Chorus in two.

Both make it clear that CFH can take over the company if it misses major targets with regard to the project.

The link is in the story - section 19 has the detail.

Paul - Wrong - Crown Fibre Holdings cannot "take over" the company.

They can either impose financial penalties if the fibre project is canned (as share brokers are now suggesting they seriously consider)

Or they can temporarily put in managers for 3-6 months max for the fibre project.

They are specifically NOT allowed to take control of anything outside of the fibre project (Clause 19.10 (c) (i) and onwards)

John is correct - CFH would only be able to take temporary control of the UFB operations NOT Chorus.

The Commerce Commission copper price IS based on -

-The price people in Stockholm (living close together in apartments) pay.
- An exchange rate near a record low

The Commerce Commission copper price is NOT based on -

- what it actually costs to provide and replace the copper service in NZ, which will be mostly redundant in a few years.

Do we want people in NZ to invest in new infrastructure that will benefit NZ in the future, or do we want to screw anybody who puts their money into our country's future?

The Commerce Commission process is not decided on by the Commission but is the one spelt out in the Telco Act, written by Steven Joyce.

In it, the Commission is required to benchmark against countries that have similar regulatory regimes. There's nothing about population density or exchange rates on a daily basis (indeed, most of the Commission dealings insist on using a ten-year average of exchange rates).

The Commission is simply enforcing the rules as laid down by the Crown. For the Crown to come in at this point and try to overrule the regulator is unacceptable to TUANZ and, indeed, to the majority of the MPs in parliament it would seem.

As Peter Dunne said on the radio this morning, the precedent set by a government overruling an independent regulator is unacceptable to the investment community and would do more harm in the long run than good.

Are you the same principled Paul Brislen who when working for Vodafone successfully lobbied the Labour government to overrule the independent regulator’s recommendation to regulate mobile termination rates? Why was the government overruling the regulator back then not “unacceptable"?

There is no red tape in NZ - government departments changed to green tape decades ago. I've got a memento piece of red tape, about 12 inches long, in my briefcase.
You can buy this green tape in most large garden shops, good for tying up plants, as well as government files.

The Telecommunications Act 2001 also requires the Commerce Commission to take in to account expensive capital intensive upgrades in setting it's pricing.

It has totally failed to do this.

It has used a price, which as you say, has not considered the fact that millions of people in Sweden live close together in apartments, and has used a bizarre exchange rate (5.99 korna /NZ$) which is lower than the Krona has ever been in the last ten years.

It's a totally random way to come up with a price for NZ.

To figure out what a fair price to run a copper network in NZ, it used NO information about what it actually cost to run a copper network in NZ. None.

Absurd.

John,

The Act (Schedule 1, Part 2) requires the COmmission to set the initial UBA price as the UCLL price "plus benchmarking additional costs incurred in providing the unbundled bitstream access service against prices in comparable countries that use a forward-looking cost-based pricing method".

If you read the Commission's report you will see that problem arises because of the limited number of countries that meet that definition (eg comparable countries that use a forward-looking cost-based pricing method).Taking into account s18A doesn't provide a magic wand to waive away the words of the legislation.

It may be fair to say that is a random way to come up with a price. But it is the way the Act requires for the intitial price. The final price is cost based, and personally I think it should have started there rather than mucking around with a benchmarked initial price. But again, that isn't the choice of the Commission, it can't just ignore the process set down in the Act.

If you want someone to blame, blame the Government, minister and officials who were responsible for the legislation.

Absurd maybe but if those are the rules then we should be asking questions of the people who wrote the rule book. Steven Joyce apparently. It is not the players fault.

Option 7: allow fibre to be strung up overhead - trenching is a huge part of the cost of laying fibre, lets get rid of it

I'm still waiting for a concrete explanation on how fibre will transform NZs economy.

You will be waiting a long time because there isnt a good explanation - just airy, fairy "hope and change" stuff, with emphasis on the "hope". The reason for this whole article is because kiwis want cheap copper more than they want fibre.

The fair internet pricing groups are already admitting it is unlikely ISP prices will fall next December, data caps will probably be increased instead.
Now our outdated copper networks (circa 1940) will be subject to higher volumes, so expect appalling internet speeds in the evenings. We might not have our World class UFB network in place in time, thanks to these petty groups and regulators

Alex, you are so right. I have had, successively, ADSL, ADSL2 and VDSL. I live less than 2 km from the local exchange, with a cabinet 50m from my house. Nevertheless, I suffered all the speed degradation you mention. I switched to fibre three months ago, as soon as Telecom started offering it as an ISP. The speed improvement has to be seen to be believed. I don't care how cheap they make copper. I would never go back to it after experiencing the benefits of fibre. Why do we always settle for second best and cheap in NZ, when there is an alternative even if it is more expensive? No wonder our technological and economic progress is so poor.

John, you've failed completely to read the Telco Act which REQUIRES the Commission to do exactly what they've done. They have no leeway in this, it's written in law that the Commission will benchmark against similar regulatory regimes.

At no time was the Commission expected to figure out what it "actually cost to run a copper network in NZ". Regulatory regimes don't work like that. Instead, they're all about economic models, benchmarking and the like.

As for Section 18, which you refer to, I don't see how it's at all possible to use it in the way that's been repeated. It's one paragraph that requires the Commission consider the investment in new networks. That's hardly an overriding directive that usurps everything else in the Act.

Granted, the Act is poor in this regard. If the govt wanted the Commission to change its approach it should have been clearly spelt out. It wasn't, and the Commission is working with what it's got , as required by law.

Telecom of old (in Chorus drag) appears to lose

Get real - lots of tough talk soon to be followed by a collapse + cheque

Yawn

So how do you explain the exchange rate com com used for Krona is significantly lower than it has been at ANY time in the last ten years?

(meaning a high price in Sweden becomes a low price in NZ).

Comcom used an exchange rate of 6 krona/NZ$. Here is the exchange rate for the last ten years
http://www.dollars.com/chart/NZD-SEK?period=10y

Great article, thanks Paul. And great responses, too. Providing options is a really helpful contribution to this problem, even if some people think they're all wrong, even while they themselves are reluctant to furnish alternatives.

My money is on a combo-approach, because Chorus have erred, and nobody other than gummint can intervene.

#3 - returning to the market - is probably the most politically acceptable, depending who you talk to, but especially current Government's voters (leaving aside Chorus investors).

2 and 6 are non-starters. 1, 4 and 5 appear to me to be a matter of degree: we nationalise either Chorus, or the project, or the cost of the project.

Like Anonymous #9, I too have yet to hear solid arguments about the economically transformative powers of UFB. Although that seems to be immaterial at this point.

Paul, if your option 6 comes to pass, you and the users you represent would have learned the hard way the adage "be careful what you wish for"!

Hey NBR, just wondering if you've thought of implimenting a rating system so 'hot' articles with lots of comments could be sorted through easier? Either float them to the top after a 'like' or '+1' like youtube does, or even just a rating beside them and leave them where they are.

Awesome.

We did, but the poor thing got kicked around and abused. Hope to return it shortly.

And higher ratings off those will to provide their names, the hiding behind pseudonyms annoys me and gives no credibility to the comments

lets hope the Greens can do a better job of setting the electricity price than National has done for copper.