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Chorus will halve dividend as part of deal with govt - analyst

UPDATED Nov 19: Forsyth Barr analyst Blair Galpin has taken his punt on Chorus.

"We expect dividend to be halved for the next two years as one of the conditions of government intervention," he writes in a research note today - ForBarr's first since Chorus' statement yesterday that it was suspending dividend guidance while EY carried out an independent review of its finances and UFB capability. EY is due to report by year's end.

Mr Galpin confims Chorus' "buy" rating, but slices its 12-month target (already trimmed from $3.25 to $3.00 last week) to $2.55. 

Last year, Chorus paid 25 cents per share or $95 million to investors.

The amount of the dividend has been a key point of contention for the Coaltion for Fair Internet Pricing (which includes Orcon and CallPlus, whose stance is supported by Vodafone). The Coalition contends that if the government over-rules the Commerce Commission's ruling for a 23% cut in copper line pricing, the money that would otherwise have been lost to Chorus will go to shareholders rather than being invested in the UFB. A Chorus pleged to temporarily halve its dividend would make a government move to over-ride the Commerce Commission more politically saleable.

Long term, pricing review will favour Chorus
The analyst is looking forward to more certainly after the EY review is complete - particularly if the government not only holds good to its promise to legislate to over-ride the Commerce, but also moves to a regulatory asset base model (as already governs NZX-listed Vector) for the company, which he sees as a positive.

But he also warns more uncertainty could be ahead. The process of challening final copper wholesale pricing could take up to two years - although ultimately he sees thngs resolving in Chorus' favour with a shift in emphasis from international benchmarking of copper pricing to the cost of a replacement network (that is, the UFB).

Election uncertainty
But there's a kicker

"In 2015 we expect the ComCom to complete its cost-based reviews and reset prices at which point we expect the company to review its dividend policy upwards," he writes.

Mr Galpin also notes, "We have an election within the next twelve months and we are yet to see the Labour Party’s telecommunications policy."

Uncertainty around the election result will impact Chorus, he says. Investors don't know at this point which reforms may be unwound by Labour, or not.

Chorus  [NZX: CNU].was up $1.05% to $1.92 in midday trading.

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Analysts sharply split after latest Chorus developments

Nov 18: What's up with the government and Chorus?

Analysts remain sharply divided after this morning's developments. Before market open today, Chorus withdrew its dividend guidance of 25.5c per share for the 2014 financial year (implying a payout to shareholders that would be again around the $100 million mark), blaming regulatory uncertainty and the outcome of the government’s independent review, announced November 7.

Shares [NZX: CNU] which traded at $3.02 as recently as August 7, have been punished by the most recent rounds of regulatory controversy, and this morning fell 5.74% to $1.89 before a partial recovery.

Is the government merely having a diplomatic pause before it inevitably steps in to over-rule the Commerce Commission's copper line price cuts (and remember commercially sensitive parts of EY's independent report - a definition that could cover most of it - will be redacted)?

Or are Key, Adams and co genuinely having second thoughts about the shape of the UFB - and if so could it lead to more state funds being injected into Chorus (already the recipient of $928 million as the government buys non-voting shares and interest-free debt securities). Or could the government go down the Tony Abbott route, and head off more cost over-runs ($300 million in Chorus' case so far) by scaling back the project from fibre-to-the-premise to fibre-to-the-node (or neighbourhood level)?

Upgraded to outperform
First NZ Capital upgraded Chorus from "neutral" to "outperform" last week.

This morning, equity research director Greg Main said the brokerage was sticking by that rating.

Mr Main said the move was no surprise, and says it's interesting that Chorus warned its dividend was at risk rather than actually suspending it while the review was being carried out (it's due to wrap up by year's end).

By First NZ Capital's analysis, Chorus would be worth $1.84 under what it sees as the worst case scenario for investors - that is , the Commerce Commission's determination for a 23% cut in copper line pricing going through,and fibre uptake is only 20% by 2020.

Does that mean you should back up the truck if Chorus falls under $1.84?

Not necessarily, Mr Main says there's risk if the company trades at a discount to $1.84, because if the ComCom's full cuts do go through, Chorus is unlikely to pay a dividend until 2021 (that is, until after the 10 year UFB rollout completes), and may need to raise another $200 million to $250 million in equity.

However, First NZ Capital's "outperform" rating clearly  states on which side of the risk/reward seesaw it's leaning.

"Clearly if the government sticks to its proposals the share price is worth at least in the high $2’s depending on dividend," Mr Main says.

Target sliced
Craigs Investment Partners kept Chorus at "hold" following a review last week, but sliced its 12-month price target from $2.63 to $2.17.

This morning, Craigs' research analyst Arie Dekker was sticking by that rating, which implies less confidence the government will come down on Chorus' side - or at least not with full force.

Echoing Mr Main, he tells NBR, "I think there was a broad expectation that the dividend for FY14 was under threat and was expecting it to be reviewed at the first half FY14 result [due end of February] at the latest."

But looking ahead, Craigs' rating and target are more pessimistic. Mr Dekker earlier told NBR it was "not encouraging" that ICT Minister Amy Adams had switched to a neutral, ambivalent line on Chorus - when up until the Commerce Commission's final price determination on October 31, she and John Key had been talking tough on how they would use new legislation to override the regulator if it took too narrow an interpretation of the Telecommunications Act.

The announcement today doesn’t change my price target, but I would expect it to impact the share price negatively given investors with an income focus may see it as confirmation that Chorus’ dividend is simply too uncertain in the near- to medium-term," he says.

Under review
Forsyth Barr telecommunications analyst Blair Galpin says he will have a new note on Chorus out later today - but streses it's not so much a case of the dividend warning sparking a review of his rating ("Buy" with a 12-month price target of $3.00 - last week trimmed from $3.25) but that fast-moving events mean Chorus has been under near-constant review over the past couple of months.

"Given the uncertainty facing Chorus it has had no choice but to withdraw dividend guidance for FY 2014," he tells NBR.

Today's development does highlight dividends will be a discussion point with the government, Mr Galpin says.

And while lobby group the Campaign for Fair Internet Pricing has claimed extra revenue from the government keeping Chorus' regulated copper line pricing high will go into the pockets of shareholders (rather than going toward the fibre rollout), the ForBarr analyst notes, "As a public company, Chorus has to offer some returns if it wants to attract investors. The decision to be made is, "What is an appropriate level?"

And the broader question to be answered is, How much will commercial vs political factors play in deciding that dividend level?

In recent comments to NBR, Mr Galpin has been perhaps the most bullish of the analyst pack.

"The UFB programme is a hallmark partnership for the government that it cannot see derailed nor will it want to be seen to back down on its previous commitment to intervene," he told NBR on November 6.

The government did not want to be seen to be simply handing Chorus money - hence the pause for a review, but "We believe this intervention will result in a favourable outcome for Chorus allowing it to continue with current dividend policies," he said.

Investors will be watching for his note later today  to see if he keeps the faith.

ckeall@nbr.co.nz

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Comments and questions
3

Fibre to the Node is already mostly complete in New Zealand, we called it "Cabinetisation". Telecom paid for that. - now appropriately claimed by Chorus.
Europe calls it FTTN to make it look like they have more fibre, and further they assume only VDSL is supplied by FTTN. In NZ we have both VDSL and ADSL in cabinets and about 50% of copper lines are FTTN.

The options to increase speeds do include using the "Node" or cabinet, but they may also use exchanges, i.e.
1 More cabinets to make them smaller and thus closer to customers to make the speeds higher, an expensive rewiring option that the Australians may have to face if they implement FTTN
2 Bonding - to deliver more than one DSL line over more than one copper line to customers wanting higher speeds, this suffers from the need to have more copper and is likely to be more expensive than fibre.

There are more options, especially wireless (e.g. LTE?) although they may be expensive and it's often difficult to get over the sharing problems.

On Monday and Tuesday, at a very constructive conference hosted in Sydney by Communications Day, the evidence presented provided a compelling case that
(a) even faster speeds are being eked out of copper all the time, via vectoring technology
(b) mobile and wireless applications are becoming ever-more capable, and are significantly lower-cost than fixed networks for areas with medium to low population density
(c) data usage is increasingly on smart phones and tablets - whilst much of this is offload via wi-fi, almost half of daily current data usage on smart devices occurs at places other than the home
(d) the application used on mobile devices is very similar to that used on fixed, including video entertainment
(e) data growth projections for the next five years (ex Cisco) show that traffic will become more asymmetric not less, as video grows in importance - this vastly outstrips projected 'cloud' -based volumes
(f) ongoing investment in compression technology means video traffic is increasingly taking up less capacity for the same end experience
(g) there is no clear and unequivocal relationship between the speed of a connection and the amount of data used
(g) the vast majority of consumers have very low willingness to pay for faster connections

Led by its Communications Minister, the Australian Industry is taking a pause to assess the evidence and the analysis to realign the direction of its government-funded network. This is a brave step, but appears to have backing from most parts of the sector. Importantly, there is a live and vibrant debate about what to do next. The opposition spokesman was the only presenter who appeared to support the 'old' Australian FTTH proposal.

Why can there not be debate of this sort in New Zealand?

The Final Pricing Principle model (FPP) does indeed require the Commerce Commission to work out the actual cost of providing the service rather than benchmarking against other jurisdictions.

However, the move to an FPP doesn't signal any "shift in emphasis" for any future determinations - the Commission process is set down in the Act and requires the Commission to benchmark against similar regulatory regimes.

The FPP approach is part of the Act and can be requested by any participant. The benchmarking determination comes into effect until the FPP price is determined in such situations and then that price is introduced and, I believe, backdated to the original date.

TUANZ supports looking at actual costs of delivery rather than a hypothetical benchmarked comparison. However, looking at the evidence already in play - CallPlus's submission on the UBA process and its representations at the UBA conference - the actual cost of delivery of UBA is dramatically less than the current determination.

Paul