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Where to for Chorus?

The decision by every other party and MP in Parliament (and the Conservatives outside it) to oppose legislating to overturn the  decision on the price of copper  was both bad and good for the Government.

The bad is that legislation was obviously a preferred option for the Government, even though the Telecommunications Review was only a discussion document. It is true that they had some weeks ago started to back off that route, and look at other options, but their statements up until then had quite strongly been in support of legislation.

I think it is a fair criticism that the Government should have talked to other parties at an earlier stage about whether they would support legislation, rather than fairly forcefully support it, and then realise you can’t do it.

So while the political management hasn’t been optimal, the upside is that having Parliament assert its right to say no to the Government, does actually assist the Government. It removes the legislative option off the table, and will I believe lead to more constructive dialogue between all parties on where to go from now. The members of the Coalition for Fair Internet Pricing (Kiwiblog is a member) will I believe be keen to engage constructively not that the risk of over-riding the independent regulator is gone, and  can’t demand the Government do something it is clearly incapable of doing.

The decision by Amy Adams to have an independent financial review of Chorus was an excellent one (and something I had called for), and the way I see it is there are four steps ahead of us on resolving this issue They are:

  1. Does Chorus have financial problems under the current settings, and the Commerce Commission determination?
  2. If the answer to 1 is yes, Are there changes Chorus can make to solve those problems themselves?
  3. If the answer to 2 is no, then what are the factors that got Chorus into this state?
  4. If the answer to 2 is no, then taking account of 3, what options are open to the Government, and which are preferred

We will soon get the answer to No 1. I am sure it will be a comprehensive report. I’ve had a financial modelling expert take me through what they expect the report will find, and that it will conclude on current settings Chorus will breach their debt financing agreements – specifically the acceptable ratio of debt to EBITDA. The Commerce Commission determination will increase debt and decrease EBITDA and this means the banks could withdraw their loans to Chorus which could plunge it into an Air New Zealand type situation.

Note that this does not mean Chorus will be bankrupt or even unprofitable. The report could well conclude that over the next six years or so Chorus will still make small profits, and even have marginally positive cashflow. The issue is likely to be mainly around debt and timing of cash requirements.

So if the answer to 1 is yes as the Prime Minister has (correctly it seems) warned, then we get to whether Chorus can make changes themselves to prevent a breach of their debt agreements, or can renegotiate their financing.

Obviously one change is a reduction of dividends. I say this with sadness as a Chorus shareholder, but if you have a debt problem, then you can’t expect to pay out dividends. Once you are getting the full benefits of the  investments, then they would resume I expect. I note Chorus has already started to head down this path by saying their proposed dividends are likely to be reduced.

It is unlikely that change would be enough. So the report needs to also look at whether other changes will be enough to prevent a debt default. Can opex be reduced. Can capex be delayed.  With that in mind we note the story yesterday:

Network company Chorus is flying about 200 staff from Wellington to Auckland today for an annual get- together – despite “crying poverty”.

Mr Bonnar said Chorus had twice been recognised as one of the best employers in Australasia, “and a big part of that is once a year we get all our people together”.

“It’s to hear from the senior people in the business where the organisation is at, where it’s going, what its strategy is and how what they do fits in with it.”

Now I don’t have a problem with Chorus doing this as a private company. But if you are sticking your hand out for Government assistance, then decisions like this will face public scrutiny. The cost is minimal to their overall opex, but taxpayers will expect Chorus to be as fiscally frugal as possible, before any additional taxpayer money is considered.

But what happens if the report concludes that Chorus does both have a debt problem, and can’t solve it internally. Well then I think you need to identify the factors that got Chorus into this state. I don’t mean a blame game, but identifying what contributed. Obviously the Commerce Commission determination is a significant factor, but is it the only factor? Have there been UFB cost over-runs? Was Chorus too close to the debt rations anyway, regardless of the determination?

Then after you have identified the factors involved, do you look at potential outcomes for the Government and Chorus. Off the top of my head, they include:

  • Chorus defaults on its debt (highly undesirable)
  • Chorus defaults on the UFB build (highly undesirable)
  • Chorus renegotiates the debt (would banks agree?)
  • The Government guarantees the debt for Chorus (the banks may call it in immediately)
  • The Government makes the repayment schedule for the UFB build financing longer (will it make much difference?)
  • The Government loans Chorus more money
  • The Government slows down the UFB build (undesirable)
  • The Government takes a stake in Chorus

I’m not against the last option. In fact the Government already has some preference shares in Chorus as part of the UFB contract. When it comes to commercial trading companies, I believe the Government shouldn’t own any shares at all. I’d sell 100% of the power companies etc. However just as I can accept the state should own Transpower as the national electricity grid, there is a case that the national fibre and telecommunications grid should be a government utility also.

Put it like this, if you were back in 1987, knowing what you know now, you would have split NZ Post telecommunications division into a Telecom and a Chorus on day 1, and have sold Telecom and kept Chorus. You sell off the competitive elements and own and regulate the monopoly.

So I’m not ideologically against the Government taking a stake in Chorus. It also would mean that both current Chorus shareholders and the Government would both share in the pain of getting Chorus out of its debt problems – which is preferable to it being just the Government (or worse Internet users as originally mooted).

To a degree, I’m getting ahead of myself. Let’s see what the report says on 1, 2 and 3. Then we can focus on the “least bad” option for ensuring Chorus can deliver on the UFB project and 75% of New Zealand homes get fibre access to ultrafast broadband.

Political commentator David Farrar posts at Kiwiblog and a member of Coalition for Fair Internet Pricing

Comments and questions

Government bailout in 2014 is inevitable. National can't afford to let UFB election promise go down.

Give chorus investors a plaster, the bleeding just won't stop!!

The other essential element is an independent review of the regulatory arrangements that allowed this mess to arise in the first place. 'Fixing' the UFB investment doesn't alter the fact that the whole regulatory scheme is in taters given that fibre only covers 70% of the country, but one copper price rules all markets. Under the current scenario., it is impossible to get the regulatory settings 'right' for both areas where copper-fibre substitution is occurring and investment in new technologies on copper (e.g. vectoring) in areas that will never get fibre.

You make the assumption that only Chorus can deliver UFB - a couple of years ago there were numerous companies vying to deliver fibre in their geographic areas. If Chorus can't deliver then the existing LFC's (that seem to be happily getting on with the job) should step in, or bring in some of the other companies that probably have stronger balance sheets.

You missed out two major possible scenarios (both of which are now in play)

1/ The High Court overturns the Comcom pricing because they failed to adhere to the direction from Section 18 (2a) of the Telecommunications Act 2001.

2/ The Comcom overturn their own pricing, when they are required to calculate what it ACTUALLY costs to build and run a network, rather than using a random price from apartment dwelling people in another country then convert to NZ$ using a dodgy exchange rate.

If either of these results in a realistic copper price for Chorus, then the witch hunt can be called off.

"when they are required to calculate what it ACTUALLY costs to run a network".

Fixed that for you, with respect to copper. The bulk of the copper build has been done through upgrades over the years and the cabinetisation programme. The cost of a copper tail is largely opex now.

Chorus run an internet and phone network. You are making the same error as everyone else, and think the fibre network is some brand new business.

It is not.

It won't attract a new set of customers. Every customer on fibre is a customer leaving copper.

Just as Chorus put half a billion dollars into upgrading the network in the last few years, they are doing the same again now. That the material used happens to be different, doesn't mean that suddenly it's a whole new business.

Hence, the Commerce Commission are now required to set a price for building and operating a network, INCLUDING factoring in it's replacement over time.

There are potentially 50,000 or more customers who will move off wireless tails and onto fibre directly as it becomes available. Moving off wireless to ADSL is a retrograde step, in many cases due tot he upload limitation.

Telecom/Chorus made the wrong bet with cabinetisation, wrongly assuming that FTTN would suffice. You can't keep making mistakes of that magnitude (and underbidding UFB by $400 million was another) and stay in business.

Receivership is a good outcome.

Three ways to fix the EBITDA ratio - increase revenues (hard to do thanks to ComCom - maybe sell more fibre customers), cut costs (one suspects this is a real option - maybe as you point out no more trips to Auckland) or reduce debt.

The obvious option that you have missed in this regard - raise more equity and pays down the debt. you have suggested the government as an option but why not the private sector. People are buying Chorus shares today - so do a rights issue, approach a strategic investor etc.

air NZ could have done this but the government stepped in (and made a lot of money), Haier stepped into Fisher & Paykel and made good money, Bright Foods into Synliat. Lots of cases of investors going into a destressed asset and making money - simply by making the position more sustainable.

Would the banks re-negoitate with Chorus - probably, but might mean a few changes in the management which of course they will not want (i.e. the management).

There seems to be a classic misunderstanding of the terminology here. UFB does not stand for Ultra Fast Fibre (otherwise it would read UFF). In fact people, UFB stands for Ultra Fast Broadband. Which, as anyone who cares to do a little research would know, can be delivered by any of three means. Those being copper, wireless, or fibre-optic. Instead of bemoaning the fact that we could all have our access to UFB delayed due to the seeming inability of Chorus to deliver on their extravagant promise, maybe we should be asking why the NZ government aren't considering other means of delivering the UFB, as the Abbott government in Australia are doing right now.