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PM says chance Chorus could go broke

Sept 16: Prime Minister John Key hinted this morning his government may not step in to over-ride the Commerce Commission on Chorus pricing - but only if its final pricing determination, due October 31, is in line with his government's thinking.

Mr Key said on Breakfast the regulator had used too narrow a legal definition when it recommended a 25% drop in copper broadband pricing (in part, the Commission benchmarked NZ against similar countries overseas).

"The Commerce Commission may well come up with a new determination, and we may well accept that," the PM said.

Mr Key said the process was partly about determining the cost of a replacement network - i.e. UFB fibre - and that we know that now.

I'd agree with a public submission made Friday by 2degrees founder Tex Edwards that we don't know the true price of the UFB.

All that we know is that the government and Chorus (which has upped its estimate by $300 million so far) estimated it way too low.

Mr Edwards suggests the Commission's next task is to establish the true cost of the rollout. Good idea.

Then the government should get on with the key problem: spurring demand for fibre so Chorus (and Enable, Ultrafast Fibre and Northpower) can start making some money off it and stop trying to sweating copper.

Another development today saw the Coalition for Fair Internet Pricing call for an NZX inquiry into Chorus' "conflicting statements about its financial viability."

It's a little mischievous, but sparked by the PM's earlier comment that Chorus could go broke if the wholesale price of copper is set too low (see below) and Chorus' own comments about its ability to pay a dividend (also below).

On TV3’s The Nation over the weekend, Mr Ratcliffe would not endorse Mr Key’s comments but said there were “some really challenging scenarios” if the draft Commerce Commission recommendation was accepted. This morning on Breakfast, Mr Key moderated his "broke" comment from Friday to say the Commerce Commission recommendation would "pressure" Chorus.

Mr Key says the Coalition in part reflects a commercial battle.

And it does. Members Orcon and CallPlus would like to pay less for Chorus copper (although they are now pledging to pass on price cuts, after some helpful prodding from NBR). But it's hard to say other members, like Consumer NZ, do anything but play things straight down the line.

A final note: I'm uneasy about the PM changing the UFB rules all the time, but it's barely unprecedented. When the Commerce Commission initially balked at lowering mobile termination rates (wholesale mobile network interconnection charges) while Steve Joyce was ICT Minister, Mr Joyce sent its final determination back for a rethink. The Commission obligingly changed its mind. The Drop The Rate Mate campaign (which includes many of the same members of today's Fair Internet Pricing Coalition, didn't complain.*


Sept 14: Yesterday, John Key made the extraordinary claim that, "Basically if the Commerce Commission ruling stands there's a chance Chorus will go broke, in which case the Ultra Fast Broadband (UFB) won't be rolled out."

Last year, the Commerce Commission recommended the price of copper broadband be cut by up to $12.50 a month or around 25%, saving households $150 per year. It says it arrived at the figure by comparing NZ pricing to that in similar countries.

The government has over-ridden the regulator, saying it will implement a cut of $2.50 to $7.50 instead.

A new lobby group, the Coalition for Fair Internet Pricing, says the difference between the two amounts will generate extra revenue of $588 million for Chorus up to 2020. Covec, the economic research company that created this estimate, says it's conservative. The group says it's effectively a tax because the extra revenue from copper lines (or at, least, a lower reduction than expected) is being used to subsidise the public-private Ultrafast Broadband (UFB) fibre rollout.

Is there a chance Chorus will go broke, had the government doesn't go through with its proposal over-rule the Commerce Commission? (As outlined in a discussion document issued by ICT Minister Any Adams; public submissions closed yesterday).

NBR put the PM's could-go-broke theory to Chorus.

Spokesman Ian Bonnar came back with the anodyne, "Chorus has been very clear on multiple occasions about the impact of reductions in copper pricing to its business, as is appropriate for a listed company operating under continuous disclosure.  This information is freely-available to all market participants and everyone, including the Prime Minister, is free to form their own view on the information provided."

To wit, when the Commerce Commission's draft ruling came out, Chorus said the proposed cuts could reduce its ebitda (earnings before interest, depreciation and amortization) by $150 million to $160 million from December 2014 (Chorus' ebitda rose 1.2% to $654 million in the 12 months ended June 30, 2013. It's net profit rose to $177 million from $102 million in the prior year, which captured only seven months of Chorus' demerger from Telecom). Chorus also said the Commerce Commission's draft determination could require it "to fundamentally rethink its business model, capital structure and approach to dividends." (Chorus paid out $95 million in dividends to shareholders last year).

Certainly, Chorus investors shrugged off the PM's comments.

On Thursday, as the Coalition launched its "Axe the copper tax" campaign, Chorus shares [NZX:CNU] trade flat. Friday, they fell by 1.03% - mild stuff compared to the violent gyrations when the Commerce Commission first released its draft price determination in June last year, then the government's later comments it would over-rule the regulator (see chart above).

Chorus argues their was never any guarantee the Commerce Commission would lower pricing as much as its the lower limit suggested in its draft, and that its deep cut only applied to copper over broadband, leaving a lot of wiggle room for regulating copper network priciing overall.

A couple of key issues here, as I see them:

1). Like every IT project ever - and every infrastructure project in the history of man - the UFB is running over budget. Earlier this year, Chorus said it would cost $300 million more than it initially thought. The Coalition argues that there's no reason to think what it calls the copper tax will go toward subsidising the UFB, since Chorus is also focused on keeping dividend payouts to shareholders high. Instead of coming up with tortured rationales for why it's changing the rules, the government should come clean and admit the UFB is costing more than it thought, and that Chorus (which won the contract for 70% of the of the rollout) is going to need more taxpayer money (which is still very  likely to happen) and/or a regulatory break (which is happening now as the Commerce Commission's steeper wholesale price cuts are over-ruled).

2) John Key is not "helping out his mates who are Chorus shareholders". He is the shareholder. Or at least one of the most important. His government is in the process of becoming the largest investor in Chorus as it progressively buys more non-voting shares and interest-free debt securities (half of the $926 million the government is extending to Chorus to help fund its leg of the UFB is in equities, which the Crown will buy back at the end of the 10-year project, half in debt). The Coalition - which includes Orcon and CallPlus, two of Chorus biggest customers - is quite right to question whether the government can be both investor in and regulator of Chorus' pricing. The price determination role should have been left with the Commerce Commission.

3). Fibre uptake has been slow. Chorus argues cheaper copper broadband would make it slower still (and it could really hurt Enable, Ultrafast Fibre and Northpower, who won the 30% of areas not covered by Chorus, and whom have no copper business to fall back on). But I also think Paul Budde hits the nail on the head when he says fibre needs to be cheaper. And so does Orcon CEO Greg McAlister when he says the government needs to goose demand. Most households and businesses are simply unconvinced, or totally unaware, of the everyday benefits of shifting to fibre. It's only relatively recently that Crown Fibre Holdings has started to push messages such as fibre's benefits for cloud computing, and full-blooded office network from home. But its campaign needs a truckload more money behind it. The faster people move to fibre, the less regulatory fighting and "tax" shenanigans we'll see around copper, and the sooner Chorus and other LFCs can start making money from fibre (although I note on National Radio Chorus CEO Mark Ratcliffe said copper will be around for 20 years or possibly a lot longer).

4) People are correct to be dubious that wholesale cuts will automatically flow through to retail ISP pricing (which, unless the government changes the rules once again, immune to regulation). NBR is doing its best to pressure ISPs on this point (whether we see the Commerce Commission's orginal, steep cuts go through, or the government's much more modest proposals).

On Thursday, CallPlus CEO Mark Callander and Orcon boss Greg McAlister were a touch wooly on this point.

This morning Mr Callander (whose company includes the Slingshot and Flip residential brands) sharpened his language, telling NBR:

"The one thing that is guaranteed is if the $600 million is given to Chorus, consumers will see no benefit at all. 

"However, it seems the public want a straight answer on whether ISPs will pass on the savings, so the answer from CallPlus and Slingshot is yes

"If the government doesn't proceed with the proposed copper tax and Chorus doesn't find other ways to increase our wholesale prices, CallPlus and Slingshot will pass on the full benefits to our customers."

But he also sounds a warning:

"With regard to our new residential brand recently launched, Flip, the lower costs have already been factored into the pricing and the focus has been growing market share, not profits.  With Flip, a homeline and broadband bundle is priced at just $55 a month and it is unlikely that this pricing will be sustainable under the government’s proposal."

ckeall@nbr.co.nz


* A Coalition spokesman says "That's not quite right. The Commerce Commission came out with its determination and a warning that it would keep a watching brief.

"Vodafone launched its Talk pack and the minister wrote to the ComCom to ask if they thought this materially changed anything.

"The Commissioner said it did and the minister asked them to revisit the determination using the new Talk plan as part of the data set. The Comcom did and the MTAS decision was released.

"The minister didn't reject the determination, as legally ministers have no role in the decision making process.

"Minor detail but important. The current situation is unprecedented."

I'd argue the faff about a single Vodafone plan was just the excuse for Mr Joyce to over-rule the Commission.

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Comments and questions
35

What fundamental societal issue does this Ufb actually address. The only thing racy about it appears to be the name. Build and they will come. Don't build and.....who really has a problem.

Sky works will via satellite. There are lots of adequate existing solutions. In Wellington they are planning to build Ufb along side existing fibre.

White elephant...regulatory nightmare....political embarrassment?

There are lots of things I'd like to do that don't work very well over copper broadband/DSL.

Things like:

- use basic cloud computing apps
- use online backup and file sharing services (which I do, it's just so slow and limited on a DSL line with 1Mbit/s upload speed)
- use the internet at peak times without congestion slowing it to a crawl
- have a connection that's not just pretty quick, but consistently quick, so I can make a decent quality Skype call, or have a VPN connection from home office to office without it dropping out all the time

And for leisure, I don't want Sky; I want high definition, ondemand movie and TV options.

VDSL solves these problems, but only for some people given the way copper bandwidth degrades so badly with distance.

And just as was the case when we first transitioned from dialup, people will develop many more uses for faster internet over fibre.

The domestic UFB only solves half of the problem; the Southern Cross Cable is still a bottleneck for international connections. A monopoly is always going to price bandwidth higher than a company facing a competitor and manufacture scarcity.

Chris, if there was real demand for those services then people would be buying ufb. There is little demand and no one wants to pay for it. As usual in Aotearoa, "somebody else"(tm) has to give it to us.

Cabinetised VDSL would have addressed the technology issue, but, no, people jumped on the same old bandwagon of how we were going to "lead the world", etc.

And, surprise, surprise, we start to find out why we were leading. Nobody else was that dumb.

Key was right, we are a very socialist country - we expect to be given stuff for free without thought to the underlying cost. d'oh.

With only 3% of those able to connect to fibre signing up, it's self-evident there's no demand. The govt, and ISPs and other service providers have to do a much better job educating the public.

It would cost hundreds of million to put VDSL within reach of most urban dweller, and copper is on the way out anyway. I agree VDSL works well for those lucky enough to live close to an exchange or cabinet today.

"With only 3% of those able to connect to fibre signing up, it's self-evident there's no demand". - this is why govt should not be involved in business - they are spending other people's money on things they believe are worthwhile. This is just another private spending spree.

If there was an existing demand, the players in the market would be falling over themselves to provide it. And if the price is too high for most, it is an indicator either the demand is not actually there, or there is a lack of competition keeping prices high.

Chorus and it's mothership Telecom, have long existed on massive margins soaked up by inefficient systems and practices. Knowing the tighter margins they face with UFB, it was only a matter of time before the "we can't make this work" would come up; either that or a massive tightening of the belt and better service.

Personally I would love every business to have a 100MB fibre connection. But that is not a sufficient reason for govt to spend taxpayers money on UFB. It is an absurd waste of taxpayers money.

I would bet that there are more people who would love to fly first class instead of economy class on AIRNZ than there are people who would sign up for UFB. If the govt subsidized first class travel, I would guarantee you get a lot more than 3% switching to first class at no extra cost. But for the taxpayer to fund it would still be wrong.

Chorus needs to start tightening the belt, and the govt needs to stop throwing public money at private sector projects, no matter how generous the stance appears.

its not just lack of knowledge those of us who know all about fibre are turned off by the cost and lack of data allowance

I call BS on that reply CK. I have plenty of HD content - its called bitorrent and I streamezflicks/quickflix in HD no effort. Cloud storage works fine and Im using copper. Oh and my phone will still work in a power cut as will mysky

1Mbit/s up (the speed limit for most on copper/DSL) is no good for online anything but the lightest cloud storage or apps.

I can stream Netflix at lower resolution, but not full HD - and there would be no change at peak times when copper is contended, or when others in the household are doing something intensive online.

TV/video over broadband will go out if you lose your internet, but then again MySky via satellite suffers rain fade. Hybrid services are best (as we'll see when iSky is integrated to My Sky next year).

Yes, companies selling fibre should have thought through phone and Sky issues first. For a landline, they could have provided simple ways around it - e.g gateways with backup batteries.

So Chorus is another 'too big to fail' scenario - according to the mighty shoulder shrugger JK?
Mate, if a company can't survive without a government hand out it has no business being in business.
Move on Chorus, let someone come in and do the job.

I think the government was quite correct to think fibre would help NZ businesses, schools and hospitals run more efficiently, as well as helping work-from-homers, bringing households more entertainment choice, and helping all our interactions with the government move online.

(Similarly, I think Rod Drury's right that a second cable to the US would help business overall, but it will only happen through a public-private partnership.)

There are many benefits to our economy long term, but Telecom was always going to sweat copper for as long as it could.

I'm not sure the government went about the tender the right way. Intially, it called for proposals around "dark" or "layer one" fibre - or basically just fibre in the ground (or overhead), making it relatively easy for non-traditional player like lines company Vector to throw their hats into the ring. But once the rules were changed to a focus on "layer two" fibre (adding electronics to light up the fibre), it was hard to see any other outcome than Chorus winning most of the contract.

As noted in the article above, the UFB has ended up costing more than than Chorus anticipated at the time of its bid ($300 million more by estimates so far).

The government should stop talking about he Commerce Commission getting its regulatory formulas wrong, and be up front about the fact the UFB is costing more than thought so either:

1. The UFB will have to be scaled back (and in Australia we've seen Tony Abbott pledge to scale back the National Broadband Network from fibre-to-the-home to fibre-to-the-node (or fibre to the neighbourhood, with copper used for the last leg)

and/or

2. Chorus and other UFB contract holders get more taxpayer funds

and/or

3. (What's effectively happening now) Chorus gets lets off some of the steep price cuts to its copper lines that had been pending under the Telecommunications Act, which mandates a move from a retail-minus to a cost-plus formula for determining regulated wholesale pricing.

National passed the Telecommunications Act to split Chorus from Telecom, and set the ground rules for the Crown's $929 million investment in Chorus, which facilitates the UFB. It's now in the process of reviewing the legislation - or has opponents would have it, renegotiating the UFB after the fact, and rewriting the rules

maybe we should have had Vector build it instead in Auckland?

Change the southern cross cable pricing so that we all get fast broadband.
If we are going to bail out Chorus we need something in return.

Without the copper price reduction it's retailers like Orcon that will end up going bust.

If Elon musk can make his rockets reusable the cost of satellites will come right down and companies like o3b will expand their services.
In that scenario Chorus will find business difficult.

The speed of light is something that doesn't change with cheaper satellite service. 03b is good, but its latency is still 100x that of terrestrial fibre.

From their web site:

O3b's unique network of Medium Earth Orbit (MEO) satellites virtually eliminates the delay caused by standard Geosynchronous (GEO) satellites.

Round-trip data transmission time is reduced from well over 500 milliseconds to sub 150 milliseconds seconds.

This creates a web experience significantly closer to terrestrial systems such as DSL or Optical Fiber.

--–-------------
O3b are going to market small stationary flat panels to track their satellites. I think this solution could turn out to be very convenient for the end user.
If the web site is in the US then the access times for O3b like satellites could theoretically be less then fibre. I just pinged nytimes.com and got 210ms.

Speed of light in fibre(glass) is much slower than speed of light in vacum.
From vahoo answers...

The velocity of light is slower than its velocity in air or in vacuum.

The velocity of light in air is approx. 3*10^8 m/s

And its velocity in glass is 1.5*10^8 m/s.

It is exactly half the velocity in air.

The velocity of the light depends on the refrective index of the medium through which the light travels.

Perhaps all major NZ companies like Monopoly Chorus and their employees should just sit on their bums and do nothing..... supposedly rich NZ taxpayers to the rescue.

" With Flip, a homeline and broadband bundle is priced at just $55 a month and it is unlikely that this pricing will be sustainable under the government’s proposal."

How delicious - Mr Callander from Slingshot has just told us he's launched a business product that is unsustainable unless the government steps in and slashes copper broadband pricing through state intervention? Pot, kettle, black?

The telecommunications market has been one state intervention after another for the last ten years. Why expect anything different?

Not at all - the key issue is the business may not be sustainable at these low prices because the government has stepped in. The point you see seem to miss is an independent body such as a regulator should be setting prices, not the government. Over 70% of customers joining Flip are first time broadband users, so Flip is doing a great job in getting more kiwis online. That is pretty important in my opinion.

Any new technology will take time to be generally accepted- digital cameras took 5 or more years to supplant film, and after much resistance (remember cell phone radiation scares) every primary student carries one to school, while analogue TV bites the dust in two weeks. There is a problem with data caps which will limit video in the short term, but it won't be many years before copper users will be in a minority and will be crying out to the Government to subsidise their ever increasing share of the cost of maintaining this old technology.

So the rural economy, which produces the majority of govt. revenues, is paying extra $600 million so jafas can watch movies on their intertubes?

Did I get that right?

As NZ wants to move from subsistence farming to a knowledge based, tech economy this infrastructure is required.

Or we could just rest on our laurels and wait for the food miles tax to destroy our whole economy when we the import tariffs on our products make them too expensive

You missed the $300 million being spent on the Rural Broadband Initiative (RBI). Compare this to the $600 million to cover 75% of the population with UFB and it looks like the jafas are paying for their rural cousins to watch all the youtube clips they've been emailing them

I think we all forget we should be thinking about what we want in 10 years time. South Korea for example is putting some 1GB/s FTTH connections in because the demand for existing fibre is outstripping basic offerings. Google Fibre in Kansas is a whole home offer. CK hits the issue on the head - its about education (how many people who can get broadband still use dialup?). Also hasn't broadband got much better and much cheaper (value wise) in real terms over the last few years?

I know three things about all this for sure.

1. the word at the Wanaka Lone Star in July was that Chorus was losing a bundle on its contract; yet if you were within 700m of a large green box substation copper was able to provide a better solution anyway

2. the first part of 1. was no surprise having seen massive over manning on the contract in St Mary's and Herne Bays where the people supervising the hole digging had engineering degrees, as in one degree per hole and the disruption to the local community and their recently laid pretty footpaths was such that we were never going to be a customer of that lot anytime soon if we didnt have to be

and 3. no matter how fast this stuff is - my 16yo kid can find ways of eating as much of it as they can serve up

I got UFB as soon as I could, and I have never regretted it (even if Chorus dug up my lawn instead of drilling under it as promised!). I don't download movies or play on line games, but the speed and reliability for general on line searching and video viewing is worth it, plus I don't have to compete with all the kids in the street after school hours like I did with ADSL. Of course, I could have continued with ADSL, which was OK, just as I could have stayed with an old cell phone, or an old TV. Instead I chose progress, and by the way, the monthly cost is little more than I was paying for ADSL.

The potential for going broke didn't seem to be a concern in decisions around Learning Media.

The problem is that it did, the bigger problem is that govt chose to close it, rather than do anything positive - through a sheer lack of ideas or creative thinking.
. On the other hand, they choose to have internet users directly prop up a reportedly (from the PM) unsustainable company. Spot the difference anyone?
The Gnats should rename themselves "Business Subsidies R US"

As others have pointed out, Chorus is just the same old Telecom guys with a nice new logo. They can't run a business unless the government tilts the playing field for them.

Wonder when these wonder -boy objectors are going to set up their consortium to pitch for the great network build- "Ohh they arent you say? "
Just like a new undersea cable, all talk, zero action.
Lets transfer the profit margins to the retail sector where competition is rife because Chorus now stands as an independent profit entity and has helped cut down the grab on the cross-subsidised rort that Telecom had to succumb too.
Neither remain 'Government Departments' though still subject to this political play, and user pays was introduced and enhanced by previous National govts over 20 years ago, so get used to having to pay for the technology that politicians, not the market place, say we want.

"The domestic UFB only solves half of the problem; the Southern Cross Cable is still a bottleneck for international connections. "

Drury style urban myth Chris.Lets hear your argument with facts please.

I can't comment on Southern Cross Cable's pricing unless it's willing to share it.

I agree with earlier comments by CallPlus and Orcon's CEOs that if there were two competing cable operators out of NZ, pricing would be keener.

Both ISPs have said they would bump up their plans, including more generous data caps, if there was cable competition. It has a logic to it.

Southern Cross always points out it only has a monopoly on the Aus-NZ leg, and that it has consistently reduced prices over the years (as have all submarine cable operators).

But until a competitor enters the market, we won't know how much cheaper bandwidth could be with a second cable operator keeping Southern Cross on its toes.

Thanks Chris
2 points to note.Your wording was " bottleneck ' which implies a squeezing of capacity or shortage of some sort .This is the Drury line and one he has failed to show one tine piece of of proof for in the last 5 years .Thats probably because its bollocks .
Again ,if you have some facts to challenge that I would love to see them .
I havnt seen the comments you noted from Callplus or Orcon but I would question their veracity .If SX sells to Australian ISPs at the same price as NZ ones how come Australia has cheaper prices ? Simple its competition at the retail end and Australia has more .The Telstra -Clear boss was once asked why different prices at the retail level for Australia and NZ ( In the Dom-Post ) -his answer was " different markets "
If a company like Vocus can aggressively enter the market here and drive prices down then so can any other operator.None of this has anything to do with comparative prices between Australia and NZ for international cable bandwidth .What does have an impact in both countries is the 10 major price cuts that SX has effected since 2000.Even then SX estimate that the international data cost for them approximates 5cents per GB.

You correctly noted that all cable operators are dropping prices -quite dramatically actually.Perhaps this is why the Pacific Fibre backers decided not to risk their own millions building another cable to the US .Capacity increases due to new technology lead to an abundance of a product which forces prices down..Who wants to invest in a environment when returns are only going to decrease ? If a new cable is really the nirvana that Rod believes then why doesn't he take the punt himself rather than expect they taxpayer to subsidise him?

Going broke? isn't that part of the market philosophy to allow this.

Why has shares in what?

Suspectthe usual ... follow the money and vested interests...

Key should keep his nose clean.