RAW DATA: Chorus letter to shareholders
Chorus [NZX: CNU] posted the following letter to shareholders today, and filed it with the NZX:
In recent weeks the value of Chorus shares has fallen dramatically and we feel that you should hear from us directly about what has transpired and perhaps more importantly what your Board and management team is doing to preserve and restore value in Chorus.
The chronology of recent events is as follows:
In December 2012 the Commerce Commission (Commission) announced a final decision reducing the price of copper line services (UCLL) and a draft proposal to reduce copper broadband prices (UBA) by around 65%;
In February this year the Government announced that it would review the regulatory policy and issued a Discussion Document in August. This proposed three options for higher prices than proposed by the Commission but lower than today’s prices and indicated that Government may legislate to implement one of those options;
On 5 November this year the Commission announced its final price for the copper broadband service (UBA) which saw a reduction of around 50%. This reduction would take place on 1 December 2014;
Chorus advised the market that this could mean around $142 million per annum EBITDA impact and around $1 billion funding shortfall for the remainder of the ultra fast broadband (UFB) build period;
The Government announced an independent review by Ernst & Young (EY) to look at those impacts; and
Subsequently it became clear that the Government did not have the political support to implement any of its proposed pricing realignment options through legislation.
We understand that many of you are questioning whether Chorus should continue to invest in the rollout of ultra-fast broadband (UFB), given what appears to be a backwards step in New Zealand’s incentives for investment in regulated telecommunications services, or indeed any other, significant investment.
Chorus’ Board and management continue to believe that improving our network infrastructure and enabling high quality broadband – ultimately through a fibre network in a large part of the country - is the best long term option for New Zealand.
While it has become apparent that the Government does not appear to have the political support required to see through its proposed realignment of prices it remains unclear whether there is support for other legislative change needed to realign the policy settings and update the current regulatory framework. It is clear that the implementation of the 2011 legislative reforms has not delivered on the policy intent to transition to fibre and that this still needs to be addressed. There have been many statements by Chorus, other UFB partners and Government Ministers that what has played out is not what was expected by anyone at the time.
We believe the Commission’s interpretation and application of the current regulatory framework has clearly undermined the principle of a fair return on investment by investors. The policy expectations at the time of demerger was not to deliver significant wholesale price savings to the largest two retail service providers (RSPs) with smaller amounts to other RSPs but rather to create a neutral open access wholesaler and a transition to fibre over time.
However, there is no certainty the policy environment will be adjusted so Chorus has applied to the Commission for a final pricing principle review of its initial 5 November 2013 decision on the price Chorus can charge for its copper broadband (UBA) service. This follows a similar review that Chorus requested in respect of the Commission’s December 2012 decision on Chorus’ copper line pricing (UCLL) services. Essentially this review process means that the Commission will undertake economic cost modelling to determine the price for Chorus’ services rather than simply benchmarking prices against services in other countries.
Cost modelling is complex, highly technical and may take years to complete. While there are no certainties, as the current regulatory situation illustrates, we do believe that a credible review when completed could mean that for the combination of services regulated by the Commission, Chorus could charge prices around or even above current levels, significantly above the results from the Commission’s initial benchmarking approach.
Nevertheless, absent policy clarity, in parallel with the Commission process, Chorus is also asking the High Court to determine whether the Commission was correct to rely on pricing from just two countries when setting the initial UBA price and whether s18(2A) of the Telecommunications Act was considered as intended.
Chorus’ reputation and New Zealand’s as a good place to invest has been severely tarnished as a consequence of the broken regulatory framework and the political drama that it has given rise to. The politics appear to have stymied a policy intervention to date even though the Commission’s decisions are a symptom of regulations that simply do not align with the Government’s policy of a transition to fibre.
There are many regulatory issues that will continue to be addressed over the remainder of the build period. Bringing coherence and removing as much uncertainty as possible remains in everyone’s interests. No Government, industry players, investors or lenders wish to go through another episode like the current one in coming years.
We await next steps on whether the Government’s policy reviews will continue even without the pricing intervention proposed in August.
You will also be aware that the Government has commissioned Ernst & Young Australia to conduct an independent assessment of Chorus’ ability to meet its obligations under the UFB and RBI contracts.
Based on the Minister’s statement on 5 December 2013 it appears Ernst & Young has confirmed statements by Chorus and Government that there is a significant funding shortfall.
The Government has asked us to now immediately begin discussions with Crown Fibre Holdings (CFH) our partner in the UFB Public/Private Partnership, to find ways to address the funding gap with a mix of changes that can be made to the UFB contract alongside changes to Chorus’ own business model. Those discussions are underway.
The Government has said at this time there will be no increase in public funding so we need to work within the existing envelope. This will be challenging but we are confident that there will be a solution between us.
For our part we are acutely conscious of the importance of balancing the needs of investors and those of our customers and indeed New Zealand.
We believe that as the owner and operator of a critical piece of New Zealand’s infrastructure and in an environment of a transition to fibre New Zealand deserves the best quality communications network. We are aware that there could be suggestions made that we have been providing significantly greater value to our customers than is strictly required. Our telecommunications network - despite New Zealand’s challenging geography and weather - is regarded as an example of best practice around the world. The suggestion of “over delivery” is one that we will accept.
While we have not been privy to any of the reports from Ernst & Young we have provided them with all the information they required including where we have the opportunity to cut costs and re-design pricing and service levels for various products.
Our immediate focus is on assessing all options that may be available to us within our own control and in discussions that are underway with Crown Fibre Holdings to maximise a timely and sustainable position for Chorus’ shareholders and lenders. While discussions continue with Crown Fibre Holdings, we cannot finalise our medium term strategy. At this stage it is likely Chorus will need to cut all discretionary activity, including growth-related capital investment, re-price most of its commercial services, and generally manage for cash until the Commission’s final price review outcomes are resolved. We are also continuing to assess capital management options that might be appropriate.
We appreciate that these are challenging times for shareholders. If you wish to make your views known on the above, we would welcome it. We have also provided a summary on our website to address some of the misinformation you may have read or heard in recent weeks.
Chairman Chorus Limited