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

Follow @ChrisKeall

* 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.