Telecom overstated its worth - watchdog

UPDATE 4pm: Labour's Clare Curran told NBR that while the Commerce Commission had disputed a regulatory rather than a market valuation, "It certainly does show that Telecom appears to be gaming the system for its advantage - which is a pattern of behaviour we’ve seen over a number of years."

The communications spokeswoman added, "Given the biggest factor in the ultrafast broadband programme is the cost issue, this doesn’t fill one with reassurance that Telecom’s accessment of cost and its negotiating positions put to the govenement and Crown Fibre Holdings".

Ms Curran said the episode underlined why all telecommunications companies needed "rigorous" regulatory scrutiny, rather than the 10-year regulatory holiday proposed under the Telecommunications Amendment Bill, which will govern public-private companies created under $1.35 billion ultrafast broadband (UFB) programme. Telecom is bidding for 25 UFB regions.

UPDATE 2pm: While there is no direct link between today's announcement and Telecom's bid for government Crown fibre business, Telecommunications Users' Association head Paul Brislen saw broader implications.

"The government is about to potentially give Telecom  $1 billion of public money and guaranteed limited Commerce Commission oversight for the rest of the decade - and that strikes me as something of a concern given the revelations of today," Mr Brislen told NBR. He added:

"I'd also expect to see some questions being asked of the TSO payments of the past decade if Telecom has been overestimating cost of keeping the rural sector connected. And I'd imagine Vodafone and TelstraClear will be asking for some of their money back."

The TSO (Telecommunications Service Obligation) levy was charged to telecommunications industry companies - chiefly Vodafone (around $16 million a year) and TelstraClear (up to $4 million) to subsidise Telecom for servicing so-called commercially non-viable customers. It is being phased out as the new rural broadband initiative is introduced.

UPDATE 10.30am: Asked if this Telecom-ComCom spat would have any impact for Telecom investors, Deutsche Bank analyst Geoff Zame told NBR that it was "largely side-line noise."

The government is focussed on Crown fibre and "is unlikely to enter into a spat over asset values which is more of a parallel academic discussion with the Commerce Commission", Mr Zame said.

"That said, it can't help but be negative for sentiment - for offshore investors in particular," Mr Zame added.

Credit Sussise analyst Greg Main noted this was not the first time the commission has called Telecom's regulatory financial statements unreliable - not that it had any consequence, as the statements "are not really used for anything."

"It has taken them [the commission] a whole year to say the same thing. All Telecom's regulated prices are set by benchmark so it shouldn't impact these," Mr Main said.

Forysth Barr's Guy Hallwright agreed. "[It's] definitely a regulatory spat on the sidelines," said the analyst. "And it all becomes irrelevant as we move into a UFB world."

Telecom shares (NZX: TEL) were down 1.16% to $2.13 in midday trading. The broader market was down 0.08%.

In a statement, the company said, "This report does not relate to Telecom’s statutory accounts, and has no impact on Telecom’s financial reporting, any regulated pricing or guidance .... Valuation methodologies have an element of judgment and subjectivity".

10am: The Commerce Commission today published its summary and analysis of Telecom’s regulatory financial statements for the year ending 30 June 2010, the watchdog said in a statement this morning. 

As a result of its analysis, the Commission concludes that the regulatory financial statements are unreliable for regulatory purposes.

Part 2B of the Telecommunications Act 2001 requires Telecom to publish financial statements and other information about its network, wholesale and retail business activities and services in a form determined by the Commission. These statements should provide useful information to the telecommunications industry about the operation and behaviour of Telecom.

Over-valued by a billion dollars
The Commission considers that Telecom’s valuation of key assets is overstated, and in particular, that Telecom’s access network is overvalued by over a billion dollars (the access network is the part of Telecom’s fixed network which connects end customers to the rest of the network. It includes the cables and most of the trenches laid in cities and residential areas).

This overestimation has a flow on effect throughout the regulatory financial statements and undermines the reliability of the information.

“In valuing its assets, Telecom is required to use processes which are objectively justifiable and reasonable,” said Dr Ross Patterson, Telecommunications Commissioner.

“However, Telecom has not satisfied the Commission that its 2009/10 trenching discount factors are objectively justifiable and, in particular, that they reflect economies of scale. As a consequence, a number of costs, including the cost of providing rural phone lines - for which Telecom has reported a loss - are likely to be substantially overstated.”

Telecom may have to prepublish its 2009/2010 regulatoy financial statements
The Commission proposes to consult on a range of changes to the requirements for 2010/11 and on whether Telecom should be required to re-publish its 2009/10 regulatory financial statements to address this overestimation issue.

Although there is no direct link between accounting separation and the coming rural broadband initiative and ultrafast broadband Crown fibre projects, it's a certainty that today's development will prompt Telecom's critics to highlight the Telecommunications Amendment Bill, which allows for the separation of Telecom; for the Crown to buy into Telecom; for Telecom in turn to buy into local lines or fibre companies without the usual level of M&A scrutiny; and for Crown fibre contract winners to enjoy a 10-year forbearance period or "regulatory holiday" from Commerce Commission oversight.

A summary and analysis report of Telecom’s regulatory financial statements for the 2009/10 year on the Commission’s website at: www.comcom.govt.nz/accounting-separation.

Telecom shares (NZX: TEL) closed down 1.5c yesterday to $2.155.