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Tech trends 2014: Chorus goes nuclear

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.

ckeall@nbr.co.nz

More by Chris Keall

Comments and questions
37

How dare Chorus threaten the NZ public in this way.

They should bridge the $250m "gap" by means of a rights issue at 50c. Management and board can explain to shareholders how they got it all so wrong.

A rights issue is possible, but would be a tough sell with the two-year dividend suspension, halved dividend after that; a possible debt load-up ahead; continuing regulatory uncertainty and political uncertainty as this year's election approaches. But if the price is right ...

I don't know if Chorus has made the nuclear option threat or not. I've noted that independent market researcher IDC has said that it is a possibility (in an NBR guest editorial), and that Chorus has refused to rule it out when questioned by NBR.

I'm sure, if pursued, that Chorus would call it a legitimate negotiating tactic rather than a threat. The UFB process has a history of robust negotiation and stand-offs, going pack to former Telecom CEO Paul Reynolds' threat to cherry pick the most commercial fibre business if his company (then including Chorus) did not win significant UFB business, including Auckland.

If it's a tough sell at 50c then let's make it 10c with the rights tradeable. People that believe in Chorus will pile in and take up their rights, others will be dilluted or get out and cut their losses.

Shareholders will not be happy and with good reason. They should demand explanations from the board and can get a new board and new management if they feel others would do a better job (and I am sure they would).

Chorus management are ex Telecom and they didn't do very well managing rataions with the regulators and government there so why are people surprised at the current fiasco.

Dear Anon,

The board including the CEO are voted in by the shareholders, so it is the current shareholders who get a say in what to do in responding to this price drop. If the shareholders want to cut service to get raped less by the price drop rather than raise money through new issues, no one else's say matter in this. Just open your eyes, price control never worked in history, Chorus is currently providing more than what is required because there are some competition from mobile and satellite broadband, this price cut means even less competition, so of course Chorus would cut service, might not be to 32kb, but might be 128kb.

Yes of course it's up to the shareholders to decide what they do. They could start by having a long hard look at the board and their "world class" ex Telecom management.

NBR, 5 years in the future: "So back in the "bad" old days we had dial up it worked as fast as the phone lines would allow it. Now we have DSL working at a 10th of its actual speed and the question is why?

The answer sadly involves layer upon layer of government meddling and over regulation. Instead of making fibre cheaper to lay (trenching is one of the biggest costs for fibre), the government created a crazily complex system that sent Chorus shareholders to the poor house.

Sadder still is the fact that fibre has not transformed the NZ economy like so many said it would. How could this have been avoided?

Its a bit early to say that fibre hasn't transformed the ecomomy. We are only into the 3rd year of an 8 year rollout. Thats a bit like saying mobile phones were a flop in 1990...

Why should the burden of paying for the UFB roll out be placed onto the shareholders of Chorus when the roll out has been so thoroughly screwed up by the regulators, the Government and the ISPs? It's not their job to be subsidising the government's infrastructure initiatives or the ISP's bottom line.

The Coalition for Fair Internet Pricing argues that Telecom (then including Chorus) bid for its UFB contract in the full knowledge that the Telecommunications (TSO, Broadband, and Other Matters) Amendment Act - the 2011 legislation that set the stage for the demerger of Chorus and the UFB - had a provision a Commerce Commission-regulated move from retail minus to internationally-benchmarked cost-plus pricing after three years. It says the move to cost-plus pricing was always going to lead to a copper line price chop.

The government and Chorus have argued the Commission and the Coalition have misinterpreted the Act. They put the focus on pegging copper line pricing to the cost of a replacement network (that is, the UFB). Chorus has taken the Commission to the High Court in a bid to prove its point. Including appeals, that case could take years, if previous telecommunications regulatory cases are anything to go buy (the 0867 case took more than a decade).

Chorus management got it wrong. They misinterpreted the rules and/or failed to get sufficient clarification of the regulatory environment and government policy.

Management are selected by the board and the board elected by shareholders, so blunders by management end up costing the shareholders money. That is how it works. If shareholders are unhappy they should get a new board and some better management.

Thanks for this article, well-written and highly informative.

Yes, this article is most informative. Well done NBR and Mr Keall.

The whole UFB thing is simply a giant scam whereby taxpayers money is given to big business.

When we can already download a movie in under 30 minutes using copper, or stream high def, I really question what benefits most of us will see with fibre. Factor into that the fact that speeds over copper are increasing at a very fast rate, and its a solution in search of a problem.

If there was really a massive market for fibre, businesses would be investing in it themselves.

All business computing is becoming cloud computing - and for full-blooded, two-way cloud computing, you need fibre (I agree the fastest form of copper, VDSL, is great. But unlike fibre, copper bandwidth degrades with distance, and many aren't close enough to the nearest cabinet or exchange to get the full effect, or any effect. Fibre is also more reliable, and far less suspectible to contention, or peak--time jam).

I think the government has made a dog's breakfast of managing the UFB.

But I agree with its overall philosophy: that fibre is good for business, and that left to its own devices the old Telecom would have taken forever (for perfectly sound commercial reasons) to upgrade its network. It's a strategic Crown intervention for the greater good of business.

There are also potential big gains in the health and education sectors.

And in the consumer space, fibre provides intriguing possibilities for busting Sky's monopoly over key sports and US pay TV content, which the Commerce Commission recently said inhibited new market entrants. Sadly, for people who love consumer choice, neither the regulator nor the government has any stomach for taking on Sky.

So install a closer cabinet to those businesses that need it. Much cheaper than fibre to everybody (the taxpayer) and wouldnt have led to trashing Chorus. It wouldn't have been as sexy though, would it?

Who is now going to invest in Chorus and why, when they know a faceless bureaucrat can suddenly announce that you must compete with prices in high density Scandanavia? What is the bureaucrat going to come up with next?

Maybe they should just nationalise Chorus and get it over with. I imagine the Green government in November will anyway.

The consistency of service achievable on fibre makes VDSL look silly.
ADSL and VDSL services on copper are short-term technological dead-ends.

The future must be fibre with symmetric speeds. Those who advocated point-to-point Ethernat dark fibre were correct; GPON is also a technological red herring.

Crown Fibre Holdings has been rolled by Chorus and cannot adequately manage the outcome. In an election year where broadband will be an issue, the obvious and simple, yet wrong, solution is to throw more money at Chorus. That solution will also fail.

I'm sorry OneTrack - Scandinavia's population density across urban and rural looks a lot more like New Zealand than you seem to think. In fact, New Zealand is and long has been more urbanised than any of Sweden, Denmark, Norway or Finland. BTW the bureaucrat is doing only and exactly what the law tells him to - it is more accurately an expression of a policy disconnect. I do of course defend to the death your right to have an opinion even if you are factually incorrect.

I'm sorry too Scandanavian. My copy of google says that Oslo is the only urban capital with a similar density to Auckland. Copenhagan and Stockholm are listed as five times as dense as Auckland (based on city densities). Which indicates to me that two of those three were not appropriate comparisons to use for setting Kiwi copper prices.

You might be right regarding overall density but I expect most of their populations are concentrated in the big cities, which is no doubt were the pricing came from.

So, I am still sceptical about importing pricing models from those countries to NZ.

And 4k movies and video calls? That's what the norm will be soon enough, and CES was full of 4K equipment.

We need to build infrastructure for future requirements, not for the past.

Compared to satellite, fibre would be a practical, cost-efficient way to deliver 4K (ultra high definition) ondemand movies and TV content.

Crown Fibre Holdings has TV and movie content sorted on a technical level. As we saw with Vodafone's October UFB launch, which included a Digital TV Recorder, every UFB contract holder (including Chorus) is required by Crown Fibre Holdings to deliver a multicast service. That is, TV and movie content arrives over a (in virtual terms) separate piece of fibre. The content doesn't count toward your monthly data cap, and it doesn't affect the quality of your broadband connection if it's being used for other things (even if you're on a 30Mbit/s plan, TV delivered over multicast can be delivered over up to 100Mbit/s bandwidth if necessary).

But on the political front, the government and Commerce Commission have no stomach for taking on Sky TV's near-monopoly, which the Commission recently said inhibited new market entrants.

There is a massive market for fibre , but not at the business fibre prices Chorus and other fibre providers ask for. There is already business fibre or fibre facilities in the ground in many business areas, but chorus et all do not want to make it available. Instead on waiting for the state funded cheap UFB to offer it a realistic prices.

UFB amounts to a subsidy. Subsidies never work, they damage the marketplace. The net long term effect of any subsidy when you take the whole economy into account is that you end up in a poorer position than when you started. All you are doing is favouring one section of society over another, and killing competition in the process. The money invested in UFB cannot be invested in health, education, or roading.

There is no question that we live in a connected world, and to take advantage of it, we need to be better connected. I appreciate that Crown FIbre Holdings et all, are trying to do the best with what they have. No-one doubts the sincerity of those that put the UFB project together. However when you live in an imperfect world, very few decisions will be perfect.

The problem that we have is the lack of competition, and the Telco industry is no different. Govt has it's part to play with stifling competition with over-regulation.

Maybe they should focus more on reducing bureaucracy, than trying to continually correct the market with subsidies.

Comparing to Australia, New Zealanders are getting a much better deal in terms of future fibre broadband pricing, initial investment cost and future speed. Australia have 20 million people, and the government is spending $20-30 billions, while New Zealand have 4 million people and the government is only spending $1.35billions. Not to mention our rollout is ahead of schedule and their one is behind. This fibre broadband is going to transform so many kiwis live, with speed of up to 100 times of the best copper networks. At this speed, having a computer any where on the fibre network is the same as having it in front of you, there would be little need of downloading. Building useful basic infrastructure with reasonable cost can always pay for itself many times over. So let's not let Labour and communist lobby group screw every New Zealanders over

(as it paid out $95 million of its $171 million net income to shareholders)

Says it all who else but a monopoly or Govt sanctioned tax gorging machine, can pay dividends like this in a development phase.
As said here by others the board and management got it wrong ,but there solution is demand handouts, who wouldn't when it's been there norm for excessive charging to pay for there capital investment not there own profits and borrowings as applies to those denied access to there trough. Frankly why the media pandering, to there threats.

If Chorus get into a game of brinkmanship with Govt. they will soon discover that Govt. can legislate anything they wish and Chorus will always be on the losing end of the legislation. Ig Chorus push too hard/too far then Govt. can simply nationalised. I have zero time for monopolies that take advantage of their customers.

Two points here:

National originally planned to over-rule the Commerce Commission by changing the law, but could not muster enough support (read: ACT, United oppose Chorus 'copper tax', sealing anti-govt majority).

I don't think the government will nationalise Chorus.

The Crown is already in the process of investing $929 million in Chorus (50% in non-voting shares, 50% in interest-free debt to be repaid between 2025 and 2036). That's already a stark contrast to the govt's ongoing partial privatisation programe. It's hard to see National making it any starker in an election year.

I don't think a Labour-Greens govt would push to privatise Chorus, either. Labour's broadband plan, when last in power, was only about a third of the UFB's $1.35 billion budget. David Cunliffe has taken over ICT. Last time he was ICT minister he made a good fist of using regulation to increase market competition with the operational separation of Telecom. I suspect he would favour a similarly nuanced approach if he wins power in November. Labour has already said it favours a single broadcasting and telecommunications regulator, which hints at coming at the UFB from a fresh angle - e.g. unbundling some of Sky TV's programming for over-the-top providers of content over fibre, making video the killer app to goose uptake. Accelerating fibre uptake would change the picture for Chorus as more money comes in the door, sooner from the new network. (Context: Labour has yet to publish a detailed broadband policy; whatever it turns out to be, it will face leftward pressure from the Greens). 

This is the Labour party that have already announced they intend to fully price control the power market, effectively nationalising all the power companies, right? Why do you think they wont do the same thing or similar to Chorus (and the ISPs), especially if Chorus is about to fall over (or is rate controlling speeds). They are "critical" infrastructure arent they ie "assets"? What do you think Finance Minister Norman's opinion will be on this?

Guess price control never worked and never will, and everyone is going to be worse off in this blood bath, except Vodafone, Labour, Green and those communist lobby groups (why don't they just go to North Korean and they would be happy!!!). Chorus have over $2 billions of asset and is investing another $3 billions (from borrowing) into the fibre. $171 million profit is only 3% of $5 billions, that is like inflation. New Zealanders are getting a much cheaper price than Australian, and the roll out is ahead of schedule, and the Labour, Green, Vodafone and other lobby group thinks Kiwis are getting too good of a deal and want to ruin it for us all, by dress up as a helper to get our support and get a job in the process.

They want to bring North Korea to you.

On Twitter, Auckland man @juhasaarinen has commented, "Wouldn't such a move anger the government and bring on further regulation?"

I don't think so.

If it went nuclear, Chorus could say, "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."

And for the government, it would conveniently fill the remaining $250m funding gap (assuming Chorus follows EY's other measures). If customers complain, it can say, "Well, we were ready to change the Telecommunications Act and over-rule the Commerce Commission. but ACT and UnitedFuture wouldn't support us."

Chris, thanks for bringing this appalling situation back into the foreground. Chorus and their investors have been royally screwed over by the Commerce Commission and their abstract and selective interpretation of inadequate legislation. It's notable that the former Telecommunications Commissioner even described it as "not fit for purpose". http://www.nbr.co.nz/article/chorus-rolls-out-ex-telco-commissioner-patterson-press-regulatory-overhaul-bd-145962

The Commission itself should now also be thoroughly scrutinised and required to prove just how "independent" they really are. What are the personal and family trust investment interests of the Commissioners, their advisers and the analysts? What has their trading activity been. Who has been lobbying the decision makers? What personal or former employment connections are there between the lobbyists and Commission decision makers?

Chorus is being treated with contempt by the industry, and vast tracts of the mis-informed population, but there has been scant regard for the brilliant work being done by the people in the trenches (figuratively and literally). If Chorus is going to treat others in the same way they are being treated, then NZ needs to stand by for disaster at the end of 2014. UFB won't happen for free, and NZ consumers and ISPs will have to suck it up and pay for it one way or another. Chorus is already doing more than has been asked of them.

I dont see why that action wouldn't prompt immediate regulation, even from National. If National didnt react, they would be dog tucker at the next election.

It would be absolutely stupid for Chorus to take that approach. Oh, wait...

So, it's one law for the regulators, and a different law for those being regulated? Everyone screamed blue murder when the govt suggested re-regulating to fix the current idiotic legislation. But when the one being regulated wants to play by the same rules in the same idiotic way as the regulator, then it's somehow suddenly OK to change the legislation to prevent that from happening? That's blatant hypocrisy. And if TUANZ and CFFIP want to pull that one they will make themselves look like complete muppets.

Just roll our fibre in Auckland and flag the rest of the country. Given the lions share of the economy that Auckland represents and the geographically small area it covers for the cost/benefit I think it would be a great.. There seems little benefit to paying a fortune to install fibre in far flung New Zealand towns..

Ben, a lot of those remote towns are in Northland or Waikato/King Country/Taranaki and are being installed by companies other than Chorus, who don't appear to be having any financial difficulties as a result.

But those other companies havent had a regulator coming in and screwing with their other revenue streams. Hopefully they all get finished before NZ Power comes into being, or there will be more pain.

Yeah that's right Ben Auckland generates all the money - ever heard of the dairy industry or tourism? Services? Typical Auckland-centric idiot...

Not all the money ... just most of it.