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Chorus: earnings could fall up to $160m if ruling goes ahead

Chorus' annual earnings would be slashed by as much as 40% if the competition regulator goes ahead with draft plans to steeply cut what the telecommunications network operator can charge for access to electronic switchgear on its ageing copper lines.

The telecommunications network operator has slammed the Commerce Commission's draft regime on pricing for unbundled bitstream access (UBA) services, saying it could reduce annual earnings before interest, tax, depreciation and amortisation by $150 million to $160 million from December 2014, based on existing connections.

Wellington-based Chorus had $399 million ebitda in 2012.

Its shares closed down 14.41% [NZX:CNU] or 49 cents to $2.90 - three cents below its December IPO price 12 months ago.

Investor outraged
"The UBA decision confirms the Commerce Commission is wholly at odds with the government's IT policy," angry Chorus investor Aaron Bhatnagar told NBR ONLINE.

"Taxpayers should be outraged the unpredictable regulatory environment will distort the national fibre rollout approved by NZ voters," he said.

"Investors can only conclude it is unsafe to invest in New Zealand companies that have ComCom oversight, even when those companies are tasked with delivering on the most important policies of the government."

Dividends, entire business model under threat
"Today's decisions are a significant step backward," chief executive Mark Ratcliffe says in a statement. "Shifting the relativity of copper and fibre pricing will discourage that transition."

Mr Ratcliffe noted that while the decision announced today was a draft only, if it goes ahead it "could require Chorus to fundamentally rethink its business model, capital structure and approach to dividends."

Click to zoom. Chorus peformance since its Dec 2011 IPO (Source: NZX.com). Today's 11% fall echose a similar dive in May after the Telecommunications Commissioner's draft ruling was released.

Political push
The Chorus boss seized on comments by Amy Adams earlier today that it was difficult for the Commissoner to set pricing, because New Zealand's enviroment (with network division Chorus split from the now retail-focused Telecom) was relatively unique.

"We note the Minister’s comments and we will be talking to the Crown about the apparent policy disconnect, and Chorus’ role in the UFB programme," Mr Ratcliffe said.

"At the very least, we believe that the government should immediately look to bring forward the regulatory review already required by legislation in 2016, in order to bring about a sustainable framework next year that will support the UFB vision."

Expect a lot of back room maneuvering and lobbying before the level of the proposed UBA cuts are finalised in June next year. 

And Chorus investors should hold onto hope. The 3.85% UCLL cut finalised today was much milder than a draft determination by Dr Gale's predecessor, Ross Patterson, which called for a 20% cut.

Today's cuts, and the proposed cuts
The commission set the new unbundled copper local loop (UCLL) rates at a geographically averaged price of $23.52 per month per line from December 1, 2014, a 3.85% reduction to the prices set in 2007. 

Urban UCLL prices have been set at $19.08 and rural at $35.20, effective immediately. UBA prices will be provisionally set at $32.45 per month, effective from December 1, 2014, from the existing $44.98.

The regulator's softer regime for pricing the unbundled copper local loop (UCLL) would trim annual ebitda by about $20 million, Chorus says.

Wholesale prices for access to the copper lines were averaged as a result of legislation enabling Telecom to carve out its Chorus unit last year, something that annoyed rival telecommunications companies, who sayit will lift their costs.

At the time of the enabling legislation, Ministry of Economic Development officials downplayed concerns about the impact on copper-line prices, saying it wasn't "deemed significant" and that any increase in UCLL pricing may "have the positive impact of encouraging more investment and innovation on fibre".

Chorus shares sank 12% to $2.98 when they resumed trading after being halted for the announcement.

Among concerns is the potential for much lower copper network pricing to deter investment and uptake of ultra-fast broadband, using the government-subsidised fibre network being laid throughout the country.

Mr Ratcliffe says the company will take the matter up with the government "about the apparent policy disconnect, and Chorus' role in the UFB programme" with a view to at least bringing forward a regulatory review to foster the fibre environment.

Chorus was spun out from Telecom as a separately-listed company last year to free up the telecommunications company from its regulatory burden and allow the network operator to successfully win a billion-dollar subsidy to build a nationwide fibre network and rural broadband system.

Some 80% of the network company's revenue is still derived from the ageing copper network and is subject to the Commerce Commission's pricing review.

At a media briefing in Wellington, Telecommunications Commissioner Stephen Gale today stressed the UBA pricing regime was a draft decision and would go out to industry for consultation with a view to making a final ruling in June.

If telecommunications companies are unhappy with the final benchmark, they can request the regulator use a cost-modelling approach to determine pricing instead, he said.

"This (UBA) price when finally decided in two years may have a significant impact on Chorus' revenue." 

The UCLL service lets telecommunication companies use the copper network between an exchange and an end-user's premises to offer their own voice and broadband services.

UBA gives access to Chorus's electronics, software and transport over the network, meaning telcos do not have to build their own.

With reporting by BusinessDesk.

Comments and questions

If Chorus is going to be regulated to the point of major damage, then the government should do the right thing and nationalise it for a fair price since it can't be allowed to generate profits for investors. Then they can happily run it at a loss or whatever pricing path they see fit. No more unpleasant surprises...

Chorus is testing the government here:

- Cost-based UBA pricing was inserted into the Telecommunications Act last year before the fibre deal was done. Chorus can't turn around and try and renegotiate 12 months down the track.

- If Chorus believes the benchmarking is wrong, then it should apply for a final price under the Act. There is no need to go to the government unless they think they really to gouge copper customers with above-cost prices to subsidise fibre.

In truth, this is a test for the government. If they bend the rules now, they can expect Chorus to come calling again and again over the next 20 years. Why be efficient and control your costs if you can go to the minister every time there is an overrun?

If you invest in a company with a monopoly, then you should expect that company to be regulated.

If you form a public-private partnership for major infrastructure projects funded by the taxpayer, then you should expect the partner firm to not be butchered by a division of its partner and hurting the interests of the PPP.

Just goes to show too much uncertainty to invest in stocks subject to regulation – eg, telecoms and power companies.

As opposed to investments in competitive markets where there is no uncertainty at all. Yeah, right...

This is a very clever move by the government.
The lower you make the copper prices, the more Chorus will hate copper and work harder to get them on to fibre.

Brilliant!

Chorus can't do anything to get them on to fibre as it has no relationship with retail customers - that is left to the Telecoms and Vodafones of the world, whose incentives are based on what gives them the best financial return. If copper is cheaper for them to access, then that's what they will sell. That's the whole point behind the UBA. Most of the country does not have unbundled exchanges so UBA exists in most places and is used by most BB customers (outside of the main metropopitan areas).
The fall in UBA price means that Chorus gets lower revenues for the copper connection and even less likelihood of the retailer moving customers on to fibre as their margins for copper have in effect increased as a consequence of the decreased costs. Heaps of investment in a fibre network that will not be used.
It's a lose-lose for Chorus (who unlike the UFBs, has put up its own money along with the interest-free (but capital to be repaid) loans from the govt. Hence the share price crash. It's also a disaster for the government as fibre uptake will crash. But less of an issue for the non-Chorus UFBs. They only put up real money when individuals actually request to connect to fibre. Hence no access asked for, no money outlaid - they are using the govt's money to lay the fibre in the street.

Well done, Commerce Commission. Congratulations for having big balls to do this. Enough of Kiwis getting ripped off by sleepy, inefficient business practice. Chorus is making $400m profit by simply operating a networking business - a very simpleton type of business. This is obscene profit for running such a simplistic business. Now the profit might drop to around $250m and they are crying. We have a very expensive ADSL-based broadband network and the Commerce Commission recommendation will help bring this down.

Stuff UFB. UFB have to stand on its own merit, not the government mandating such infrastructure - aka Muldoon's Think Big all over again. If UFB is really good then it should be able to compete squarely with copper ADSL. Disaster is looming when technologically inept governmental officials are trying to force-feed the market. Obviously, they did not learn anything from the ongoing DotCom fiasco, and now they are breaking into new height of ineptness.

Regulatory uncertainty has dogged, threatened and chilled investment in NZ's telecom market for over a decade, at a time when the rest of the world is experiencing gigantic growth in this crucial area of a modern economy.

If anybody has any doubts that bureaucrats and politicians are getting in the way of progress in NZ they need look no further than examine the telecom market since Labour's first fool-hardy utterances back in 2002 and the resulting frozen, dysfunctional morass that it has descended into since.

Telecom will be the big winner here, plus a few smaller ISPs (Vodafone, Orcon).

This situation is playing out like a bad Monty Python sketch. Telco regulation has become crazily complex and there is far too much group think happening.

With the sheer amount of complexity in place it is no wonder Chorus could not see the impacts of a cost-based model vs retail plus.

Why is it that NZ businesses seem to find the most complex and inefficient way of doing things? It is no small wonder that multinationals tend to kick Kiwi businesses into touch.

"Cost-based UBA pricing was inserted into the Telecommunications Act last year before the fibre deal was done."
Before the fibre deal was done.

"This is a very clever move by the government.
The lower you make the copper prices, the more Chorus will hate copper and work harder to get them on to fibre."

I've read this 3 times now and still I can't fathom your logic. What?

"Chorus is making $400m profit by simply operating a networking business - a very simpleton type of business. This is obscene profit for running such a simplistic business."

Clearly, you know nothing. If it is simplistic, where is your network? How come people who decry Chorus, etc, aren't making their own networks?

"Telecom will be the big winner here, plus a few smaller ISPs (Vodafone, Orcon)."

Really? Please explain. Amaze me with your business acumen.

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