Telco Act Review: regulator seen sidelined; analyst weighs impact on Chorus

The early verdict on the crucial Telecommunications Act (2001) review: Chorus is the winner, the Commerce Commission the loser. (UPDATE: Chorus shares [NZX:CNU] jumped 4.83% as the NZX opened.)

ICT Minister Amy Adams kicked off the review this morning with a key discussion document, which is billed as neutral - but which key commentators see as an indication of the government's thinking.

The review will have bearing on what we all pay for broadband (or at least the copper broadband lines most of us use today while we wait for fibre) and in turn the fortunes of Chorus, the network operator spun off from Telecom.

Chorus shares listed at $2.94 in November 2011 then rose as high as $3.54 before crashing from $3.40 to $2.78 in a day on November 30 last year as the Commerce Commission released a draft pricing determination proposed cutting the regulated wholesale price of hundreds of thousands of home lines by as much as $12.50 a month - a move Chorus said would wipe $150 million to $160 million from its full year annual earnings before interest, tax, depreciation and amortisation (ebidta), based on existing connections (to put that in context, Chorus had ebitda of $399 in 2012).

The discussion document released this morning suggests the price will drop between $2.50 and $7.50 a month as the government moves from a complicated international benchmaking regime to tying copper prices to those of the cheapest UFB fibre plans.

Today's news is good for Chorus because it seems the pricing hit will be significantly less than expected. Opposition parties and consumer groups seem to have lost their argument that the $12.50 cut should be implemented and the sooner the better. Chorus argued cheaper copper lines would retard (already sluggish) UFB fibre uptake.

From his initial glance, Forsyth Barr analyst Blair Galpin tells NBR Online, "Any increase in certainty is positive for Chorus, and the message [from Amy Adams today] reflects the signals the government has been providing which again is positive."

But he cautions, "However we still have to work through the process to see where prices end up ... Based on my calculations on a like-for-like basis, this represents UBA pricing in the range of $14.4.0 to $19.40)." The wholesale pricing of UBA (unbundled bitstream access; that is the copper broadband used by hundreds of thousands of customers today) today is $21.06; at a closed-doors industry conference, CallPlus, Orcon, Telecom and Vodafone pushed for $8.93. This morning, Vodafaone CEO Russell Stanners issued a statement saying the review lacked aspiration, and had too narrow terms. 

Two problems
While he sees the increased regulatory certainty as a positive for Chorus investors, Mr Galpin says there is a long way to go.

He sees two immediate problems.

One, pricing outside rural areas has yet to be resolved.

Two, the other UFB contact holders (Ultrafast Fibre, Enable, and Northpower) won't like the fact lower copper pricing will make fibre a harder sell. And unlike Chorus, they have no copper business to fall back on or protect.

Last year, Prime Minister John Key said the government would legislate if necessary to over-rule the Commerce Commission's proposed $12.50 price drop.

Today, Ms Adams put three options on the table: two involve the government directly setting the pricing for local lines; the third would see the Commerce Commission set pricing based on UFB network deployement (already set by the government).

"In effect, the government has sidelined the Commerce Commission process and taken the reins of the market directly in hand," Telecommunications Users Association CEO Paul Brislen tells NBR.

ABOVE: Chorus 12-month price history (NZX.com). November 30, 2011 saw a one-day thumping as the Commerce Commission released its draft wholesale price determination - which now seems destined to be sidelined. Chorus shares [NZX:CNU] jumped 3.79% on open today.

Govt: both regulator and investor
He also calls the review effecitvely a renegotiation of UFB contracts after the event.

"The UFB contract included the new telco act, which included Chorus having to lower its wholesale price to a cost-based model, the Tuanz boss tells NBR Online. "That was part of the Act, part of Chorus's constitution and part of the UFB negotiations. It's been expected for nearly three years.

"To now remove that is a fundamental change to the Act, and so to the contract. I imagine if Vector had been offered something similar - a release from electricity reform for example - it would have bid more aggressively [for the UFB contract].

"The decision to sideline the Commerce Commission and for central government to take on the role of both investor* and regulator is unprecedented and could potentially breach our international  trade agreements," Mr Brislen told NBR. 

Later, he issued the pithy statement, "In the bad old days we used to see MPs debating the price of butter in the House. This is a return to that and worse - instead, we won't have the debate, the price will simply be set by the Beehive."

Interest parties have until September 13 to make submissions on the discussion document released by Ms Adams today.

Last week, Forsyth Barr upgraded Chorus to buy with a 12-month price target of $3.25. Chorus [NZX:CNU] closed yesterday at $2.90.

The impact of regulator uncertainty has been overstated, Mr Galpin wrote last week. Based on today's development's, he's correct.

ckeall@nbr.co.nz

* Most of the government's $1.35 billion contribution to the Ultrafast Broadband (UFB) rollout is in the form of its $929 million investment in Chorus through a 50-50 mix of buying non-voting shares, and providing the network operator with interest-free loans. Chorus does not have to repay the loans until after the 10-year UFB rollout is complete. The government will sell its Chorus shares once the UFB is complete. Chorus' market capitalisation today is $1.17 billion.

RAW DATA: ICT Minister Amy Adams speech at Telecommunications Act (2001) discussion document launch

Good morning. I am pleased to welcome you all to Parliament today for an event that reflects our shared interest in the telecommunications market in New Zealand.

It is no surprise to anyone here this morning that technological advances are expanding markets and increasing demand for data and bandwidth at a dramatic rate. New Zealanders increasingly have expectations of instant and high-quality connectivity wherever they go.

In what seems like the blink of an eye, technology has become an integral part of our day-to-day lives.

As a small, sparsely-populated country situated at the last bus stop on the planet, high-speed connectivity has the ability to neutralise the tyranny of distance as well as revolutionise how we connect with each other and provide education, health and other services.

This means we are faced with a clear challenge; to help New Zealanders take advantage of digital opportunities, we must ensure they have early access to high-quality, competitively-priced services based on world-leading technologies. 

As a Government, we must ensure we have the regulatory and policy settings right to support and incentivise investment in those technologies. 

That is as true for fixed network infrastructure as it is for issues relating to the roll out of next generation mobile technology that we will be addressing later this year.

A number of supply-side initiatives are underway to meet the expectations of consumers.  As you all know, the Government has invested in the Ultra-Fast Broadband and Rural Broadband Initiatives, and will soon allocate the 700 MHz spectrum for a move to 4G networks to make faster and better quality telecommunications services available to New Zealanders.

However, we also need to make sure the rules that govern such a fast-moving and innovative industry keep pace and reflect the circumstances of the time.

That is why our 2011 changes to the Telecommunications Act 2001 provided that a  review of the regulatory framework for telecommunications would be required during the transition period from a predominantly copper fixed line network to next-generation fibre.

The legislation provides that that review must be commenced no later than 30 September 2016.

In February I announced the review would begin this year to address significant concern about the on-going uncertainty over changes to the regulated copper wholesale price and the destabilising effect that could have on the transition to fibre.

Today, I am releasing a discussion document that formally begins this review.

The overarching objective for New Zealand telecommunications is for consumers to benefit from markets which deliver competitive prices and innovative products, and to have early access to high-quality, widely-available telecommunications services.

The scope of the review in its entirety will be broad, extending to the entire regulatory framework under the Act.

Over the years ahead, the review will take account of market structure, technology developments and competitive conditions in the telecommunications industry, including the impact of fibre, copper, wireless, and other telecommunications investment, all with a focus on the long-term interests of end-users.

The review will be guided by a series of key principles: 

·         Promoting competition

·         Encouraging efficient investment

·         Supporting innovation

·         Deregulating where sufficient competition exists

·         Maintaining technology neutrality as a general principle and;

·         Where policy initiatives support social objectives, such measures should have the least distortionary effect and be transparent

Today, we are part way through the transition from a legacy network based on copper, to a modern, world-class fibre network, which will deliver the higher speeds, capacity and reliability that New Zealanders increasingly need and expect. 

As you know, the fibre network is being built by private sector partners, with a $1.35 billion investment in the UFB build by Government being more than matched by the fibre companies. 

This private investment is an order-of-magnitude larger than any recent telecommunications investment.  At the same time, the companion RBI initiative is designed to lift connectivity to 86% of those living outside the UFB areas.

During the transition period until 2020, while the legacy network is still being used and the replacement network is being built, fibre providers face a unique series of challenges.

They are building a new network in the face of uneven and unpredictable demand, to make sure that the new capability is there when we need it. At the same time they are also promoting the transition of customers to fibre while the legacy copper network remains available.

We have a regulatory regime and associated pricing principles that have worked pretty well since they were introduced, when we have effectively just had one legacy network that required regulated prices to be set in the absence of clear domestic information on the costs of building a replacement network.

What we are going through now is a once-in-a-many generation shift from one complete technology network to a replacement network, and the question that has been asked is whether the pricing framework is properly calibrated to deal with that transitional investment.

New Zealand is not alone in facing these issues. Many other jurisdictions, such as the European Union, are wrestling with how to strike the right balance between prices for access to legacy networks and investment in replacement networks.

Having a stable and predictable regulatory framework that promotes competition and facilitates significant new investment in infrastructure is essential during this period.

In general terms, if we do not have the regulatory settings right to enable infrastructure providers to invest in new replacement technology, we run the real risk that our consumers will not have access to those technologies or not have access to them for some delayed period of time.

I do not think that can be viewed as being in the long-term best interests of end users.

What I am interested in is whether we have the settings right to ensure that the incentives are there to make replacement technology available to consumers as soon as possible.

That is why the first phase of the Telecommunications Regulatory Framework Review will focus on the fundamental relationship between pricing for the legacy copper network and pricing for the new fibre network during the transition period until 2020.

It is also the main focus of the discussion document being released today, which considers whether the current regulatory framework is fit-for-purpose for this period. 

The discussion document finds that the underlying principles of the current regulatory settings are sound.

In particular, it finds that the price of access to the copper network should continue to be based on the forward-looking costs of building a replacement network, but notes that the current processes used to estimate that cost are not optimal for this transition period.

The traditional process we have relied on to date of setting prices is based on long-run, forward-looking costs using benchmarking or cost models which can be very time-consuming because complex modelling and extensive consultation are involved.

Modelling is particularly difficult during a transition period when one network is gradually and progressively replacing another.

The Commission’s pricing decisions are also subject to appeal.  This could lead to an extended period of detailed cost modelling, with considerable uncertainty over the outcome and timing, at a time when investors, retail providers and consumers are seeking certainty.

This would divert industry focus and resources into regulatory hearings and away from investing, competing and innovating.

Rather than using these complex series of calculations based on a limited pool of international benchmarks, or on contentious and complex cost modelling, the discussion document points out that we already have a reliable estimate of the costs of building a modern equivalent to the copper network in New Zealand, as a result of the competitive tender process for the UFB roll-out.

No-one would build a new copper network today; they would deploy a modern fibre network.

Accordingly, the discussion document comes to the preliminary conclusion that the UFB tender process gives us the best indicator of the cost of a replacement fixed network, and so the competitively-tested entry-level prices for fibre should be taken as a proxy for copper access prices set in a competitive market during the build period.

The wholesale UFB prices therefore provide an efficient and market-based means of estimating the actual costs in New Zealand, and ensuring that prices are set at a level that reflects efficient and actual costs.

Having established this principle, there are still some important questions that would remain to be addressed:

·         Where in the wholesale fibre price range of $37.50-$42.50 should the total copper access price sit?

·         Who should set this price in this transitional period to 2020 to achieve certainty – the Commerce Commission or the Government?

·         And, how should this total cost be split between the two copper pricing components of UCLL and UBA?

The discussion document canvasses three main options to respond to these questions, and discusses the advantages and disadvantages of each approach, without recommending a preferred option.

It is important to note that all three proposed options would result in the total copper price dropping from its current level, as this is higher than the entry-level fibre price range. 

The current total wholesale copper price is $44.98, so the price reduction would be between $2.48 and $7.48 per month.

This approach means consumers get the benefit of lower prices for their existing services in the short term, and will also have access to the long-term benefits of replacing the copper network with a modern fibre network.

This approach also ensures that those involved in the sector can get on with rolling out new and innovative products rather than focusing their energies over the years ahead on litigation and uncertainty.

Let me make it quite clear that this process is not about whether the Commerce Commission was “right” or “wrong” in its determinations. 

The Commission quite rightly followed the prescribed process mandated under the Act and came up with the positions they did. 

This process is about considering whether that prescribed process is best set to meet the needs of New Zealand over the transition period.

The discussion document also canvases the issues that could be included in the subsequent phases of the review regarding the optimal regime post-2020, when the roll-out of the UFB network will be largely completed and new mobile technologies deployed.

The review will need to consider whether an alternative framework would be preferable for ensuring appropriate access to bottleneck facilities after 2020, for example, through reliance on generic price control under Part 4 of the Commerce Act. 

The discussion document also seeks feedback on what other issues such as convergence and content regulation need to be considered in subsequent phases of the review.

There will be a five week public consultation period on the discussion document until 13 September 2013.

The Government will then make decisions on what, if any, amendments are needed to the telecommunications regulatory framework, with a view to introducing legislation, if required, in early 2014.

As you know, the Government is also currently reviewing the Telecommunications Service Obligations for local residential telephone services, and submissions on that review will close on 20 August. 

The TSO review is designed to test whether obligations to guarantee available and affordable basic telecommunications services are still needed, or whether the market can address such requirements.

As both reviews raise issues relating to the transition of customers between networks, this timing means any common issues, and any cumulative effects from the two reviews, can be fully considered.

The options we are canvassing give us an opportunity to provide clarity and certainty during a period when large investments are being made in a once-in-a many-generation upgrade of our telecommunications infrastructure that will deliver significant benefits for New Zealanders well into the future.

Thank you for coming along today, and I look forward to receiving your feedback.