Tech trends 2014: Chorus goes nuclear
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Chorus [NZX: CNU] could well take the so-called "nuclear option" in 2014, degrading its copper broadband service to force ISPs (and their customers) to pay more for decent speed - or at least use it as a bargaining chip during talks with the government.
It goes like this.
December saw the release of the independent EY Australia report on Chorus' finances, its ability fund the Ultrafast Broadband (UFB) fibre project if Commerce Commission-mandated price cuts to copper broadband pricing go through (and as things stand, they will in December).
The report backed up the government's claim that Chorus' UFB capability would be in question if the cuts go through, and Chorus' claim that said cuts would blow a $1 billion hole in its revenue - inhibiting its ability to complete the fibre rollout (Chorus has said the ComCom cuts will slice $160 million from its ebitda - which was $663 million last year. It has never specified how the cuts would impact its net profit, which was $171 million in 2013).
But contrary to the Prime Minister John Key's assertion "there's a chance Chorus will go broke" with the copper price cut, EY said there are a number of straightforward ways to close most of the $1 billion gap.
These included a two-year "dividend holiday", followed by halved dividends until 2020, raising more debt, and cutting costs - which EY says could well mean cutting jobs.
EY implies none of its measures are that radical. There is a lot of debt headroom before Chorus bumps the ceiling on its banking covenants. And Chorus dividend yield of 10.7%, as of June 30, 2013 (the end of its 2013 financial year) compares with 4.3% average dividend yield for NZ peers and 6.7% tor Australian, EY says.
Still, EY's prescription leaves a shortfall of $200 million to $250 million.
How to close it?
An equity issue would be a tough sell.
The government has repeatedly said it will not tip in any more taxpayer cash beyond the $1.35 billion already allocated to the UFB ($929 million of which is earmarked for Chorus; 50% in the form of non-voting Chorus shares, 50% in interest-free debt securities).
And ICT Minister Amy Adams has ruled out making the UFB a designated service under the Resource Management Act (a key Chorus demand for easing costly consents).
Ms Adams has also underlined that it will remain a fibre-to-the-home (or business or hospital or school) rollout so NZ can enjoy the full economic competitiveness benefits (unlike across the Tasman, where the Abbott government is scaling back the National Broadband Network in many areas, keeping copper for the last leg).
The nuclear option
One option, from Chorus standpoint, is to reduce copper broadband levels to its the minimum contacturally-required speed - which is actually a super-sluggish, barely-usuable 32Kbit/s (that is, the sort of bandwidth you got in the dial-up era). At the moment we're delivering a much faster, better copper broadband than the committed information rate (CIR) required in our contract. But if the Commission's going to push us around on pricing, we'll play to the letter of the law
ISPs would have to pay extra for decent copper broadband speed - and in turn would pass that cost on to customers. This "nuclear option" is a back-door way for Chorus to immediately reverse the Commerce Commission-mandated 18% wholesale price cut when it kicks in December.
Notably, Chorus refused to rule out the nuclear option when questioned by NBR. So expect it to at least be on the table during the company's current discussions with Crown Fibre Holdings.
Broadband users will also pay in other ways.
EY's report lists risk factors including
- The cost and capital savings may result in some redundancies [According to its 2013 annual report, Chorus now employs 763 permanent and fixed term employees directly - 248 earning more than $100,000. A further 4434 are employed by by service partners Downer, Transfied, Visionstream and others].
- There could be negative brand damage for Chorus as consumers receive a service level that could be lower than that provided today.
- Network fault rates could increase as Chorus implement a reactive rather than proactive maintenance strategy resulting in reduced network performance and increased consumer complaints.
At the end of the day, broadband users are likely going to end up paying for the shortfall - if not from more taxpayer cash going to Chorus, or the company being given another soft loan, then through missing out on copper broadband price cuts as the nuclear option is taken, and shelling out more to Chorus for service calls as broadband faults increase.
And there's another issue. In November 2012, the government leaned on Chorus to chip in $20 million for free "non-standard" installs - a broad category that includes anyone whose house is more than 5m from the curb, whose home is down a right-of-way or who lives in an apartment.
But that money will run out by the end of 2015, Chorus estimates. And given the hostility it's faced from regulators and now also effectively the government as UnitedFuture and ACT refuse to support a law change to overrule the Commerce Commission, Chorus is unlikely to volunteer further funds for free installs. That will mean steep install costs for many households, which will retard UFB uptake just at the point it should be taking off.
There's also uncertainty over November's election. Labour has yet to reveal its broadband policy.
And Chorus is playing for time with two multi-year stalling tactics, requesting a final pricing principles (FPP) review by the Commission, and filing a High Court appeal against the regulator's price cut determination. Look for CEO Mark Ratcliffe to come out fighting in the broadband brawl of 2014.
Meanwhile, ISPs have been their own worst enemy.
Vodafone was one of the most articulate critics of Chorus with its "corporate welfare" attack.
But Vodafone (29% market share) and Telecom (50% market share) dithering over whether they will pass on the Commerce Commission's wholesale price cuts to consumers has undermined the otherwise successful "axe the copper tax" campaign.