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Telecom to Chorus: cut costs without cutting service

Telecom says Chorus should "put forward a constructive proposal to resolve its funding issues and achieve industry pricing certainty that does not involve eroding the current network and service levels across its monopoly copper network."

Telecom says it is concerned that the Ernst & Young report into Chorus' financial position, released yesterday, indicates Chorus' funding gap could be partially closed by $400-450 million of "cash flow savings initiatives" suggested by Chorus management.

Although the EY report does not detail these initiatives, it indicates they may have adverse effects on Chorus customers and consumers, including:  a reduction in current service levels, which others have speculated could mean artificially reducing copper broadband speed (the so-called "nuclear option" canvassed by IDC and Tuanz); an increase in network fault rates as Chorus moves to a reactive rather than proactive approach to network maintenance; longer lead times to repair faults; and an increase in the number of businesses and consumers who can't get a telco connection, with Chorus only agreeing to new connections on a 'full cost recovery basis'.

Actions such as these will penalise many consumers and businesses and represent a degrading of the high-quality telecommunications infrastructure enjoyed today by New Zealanders.  Eroding the quality of the current telco network and service levels is not an appropriate way for Chorus to resolve its current financial difficulties, Telecom says.

Telecom says it has consistently taken the view that a collective industry solution, which appropriately balances the needs of Chorus, its customers (the retail service providers), consumers and taxpayers is the best way to resolve the current uncertainty affecting Chorus' UFB fibre rollout and the wholesale pricing of telecommunications services over the existing copper network.

Telecom says it played a lead role in industry discussions earlier this year that sought to put a collective proposal before government.

The results of the Commerce Commission-brokered discussions between Chorus and retail ISPs were not made public. But leaks indicate ISPs pushed for steep copper wholesale pricing cuts, which were rejected by Chorus.

Although those discussions failed, Telecom says it remains willing to engage with Chorus, other RSPs and other interested parties in reaching a solution that ensures the country will reap the significant economic benefits from the new fibre network whilst maintaining the integrity of the existing copper network, upon which the vast majority of New Zealanders still rely.

Ball in Chorus' court
"It's good to see one of the country's largest telcos point this out," Telecommunications Users Association (Tuanz) CEO Paul Brislen told NBR this afternoon.

(Telecom holds around 50% of the retail ISP market. It has not always made life easy for the Coalition for Fair Internet Pricing, of which Tuanz is a member - notably with its refusal to give a clear-cut answer to the question of whether it will pass on wholesale Chorus price cuts to customers - vacillation the government and Chorus supporters have seized on.)

"The ball is firmly in Chorus's court now with regard to how it reduces its deficit and the risk is it will throw its toys out of the cot and do something that damages the industry as a whole," Mr Brislen says.

"Telecom is indicating that it would welcome Chorus looking at more realistic options and the unstated threat is that Telecom will be able to unbundle next year. While it might not want to, if Chorus cuts its service levels the Telecom will have no choice.

"Fortunately as Lance Wiggs points out today, Chorus has plenty of options that don't include self destructive behaviour."

Chorus has already entered discussions with Crown Fibre Holdings over potential cost-cutting moves, and says it is open to new discussions with ISPs.

However, its multipronged strategy also involves a High Court appeal against the  Commerce Commission's copper price cut ruling, which is due to kick in in December 2014. Other regulatory cases in the sector have stretched through years of appeals.

Chorus has also exercised its right to a final pricing principles review by the Commission - a process the regulator says could take two years.

Cunliffe: no bailout
Separately, Labour leader David Cunliffe said the government should not put any more money into Chorus.

Through Crown Fibre Holdiings, the government is already committed to a $929 million investment in Chorus (half in non-voting shares, half in interest-free debt).

Mr Cunliffe says the EY measures that close the UFB "funding gap" from $1 billion to $200 million to $250 million (or $40 million to $50 million a year until 2020) could be taken further. He suggests deeper dividend cuts beyond those suggested by EY.

In its report released yesterday, the consultancy suggested a two-year "dividend holiday" followed by the dividend being reduced from 24 cents a share (which saw $95 million of a $271 million net profit paid out to shareholders last year) to 12.75c until 2020.

The government should not buy more shares in Chorus, or otherwise bail out the company, Mr Cunliffe says.

Some pundits will note the irony of Labour pushing for National to back away from investing more in Chorus, while at the same time fighting against the government sale of shares in power companies.

Comments and questions
8

Telecom is the ultimate jilted ex-girlfriend here: "Hey love, you might want to stop going out 3 nights a week instead of just 1 and maybe let that flash convertible go as well...If you'd stuck with me babe, we'd still be sweet"

This is getting a bit like soap drama.

The solution is simple,
The government has forked out good amount of money toward Chorus ultra-fast broadband. This means the government has good leverage to pressure Chorus to price its ultra-fast broadband fairly to all NZrs.
However the government needs to take into account that a listed company like Chorus has to also show good return to its shareholders, otherwise no investor would be interested in it.

If the government wants ultra-fast broadband set a price that isn’t profitable to the company, then why can’t the government take on the project by itself?

Cheers
Adam

The government can't take it on itself because then people will scream government interference and nationalisation even more so than is already happening.

There are also practical considerations in that at this stage it would most likely cost far more and take longer for a poorer outcome, as the government doesn't currently contain the required knowledge and expertise. Better to let companies handle it. Of course, if the major company that's handling the contract is this incompetent, then it probably doesn't matter who is actually handling the rollout.

Exactly who in Government is going to do this? With what capability and infrastructure? See later comment below for the solution. No need to cut service or wreck the network through poor asset management. Chorus and jus needs to act like a real business and stop complaining.

I would have thought Cunliffe would be all for the Government buying back shares in an ex state asset - or is he only interested in assets that National sold and not assets that labour sold

Nationalisation is the only logical move and at the existing share price
Total monopolies are dangerous creatures
This shows you the arrogence monopolies are
They are starting to throw their toys out of the cot

Cunliffe's comments should alarm shareholders in every company providing a regulated service in NZ. He is saying "screw the shareholders". Is that why analysts are advising caution about investing in NZ while there is a risk of a Labour/Greens government next year?

This ain't that complicated.
1. Negotiate with CFH to slow down the build, allowing Chorus to focus on more profitable areas first.
2. Bring cash funding from CFH forward to increase NPV.
(these two move will allow Chorus to "recycle"the cash better)
3. Stop paying dividends completely.

When companies bite off more than they can chew the first thing to go are dividends. Ask any business owner who has had to spend time in the 'bad bank". Yes that is a pity for shareholders. So be it. The essence of capitalism is risk and reward. Everyone loves to stag shares and feel clever that they made a profit. But when they back a company that happens to make a bad business judgement, they complain.

To Lindsay Fergusson and others who bitch about the poor shareholders. Capitalism = market = risk and reward. Shareholders bought equity, not secured debenture stock. They took a risk, hoping for a reward, a tidy tax free capital profit on the shares with a dividend stream in the interim. But the company's management made a bad judgement call on pricing and the risk has come home to roost. Actually the com com decision is partly a smoke screen. UFB is costing way more than budget for all players and uptake has been way below budget. That is the real issue here. So Chorus and its shareholders have to swallow the hard pill. That's the market.
And don't hammer Cunnliffe. He is taking a pure market approach. No bail out.
Finally, perhaps read the Chorus prospectus in full. Any mention of risks around future regulatory pricing???? Maybe there's something for the next AGM…..