Taking issue with Chorus analysis

PAUL BRISLEN
Last updated 15:40 07/04/2014

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A Broker's View: Chorus

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OPINION: Stock brokers should know a lot about the company they're recommending to investors. They should know about price to earnings ratios, about the return on any investment made and so on.

But they should also know about the wider operating environment in which the company operates and sadly, all too often lately, that understanding appears to be lacking or entirely absent.

The chorus (my apologies) of complaints about the way Chorus is regulated is a case in point.

Stock brokers who have sold the shares on the basis that the company would be able to continue charging high rates for its service appear to have completely missed the introduction of the Telecommunications Act in 2010 and all that implied about the future state of regulation for the telecommunications lines monopoly.

Yes, investors were "surprised" by the Commerce Commission's determination. I'm not entirely sure why - it was clear to the entire industry that a move from "retail minus" pricing (we look at the retail price you charge, take off a margin and that's the wholesale price) to a "cost plus" model (we look at your costs, add on a margin and determine the wholesale rate that way) would result in a huge drop in revenue for Chorus.

So great a drop, in fact, that the Minister of Communications Steven Joyce gave Chorus a three-year regulatory holiday to allow the company time to prepare for the change.

Joyce is known as a hard-nosed negotiator and if he's willing to give a company time to get its act together, it's pretty clear that company needs to get its act together. That should have loomed large in any investor's mind. The broking community seems to have missed it altogether.

There's also a lot of misunderstanding about the commission process itself, most notably in Grant Davies' piece in which he describes the commission as retracting its decision (it has not) and basing its pricing on the price paid in Sweden.

The commission's process, as laid out in the law written by Joyce, is a two-part process. The Initial Pricing Principle (IPP) is conducted first and consists of a benchmarking exercise, comparing the New Zealand situation with those of similarly regulated markets around the world.

If any of the parties affected (not customers, you understand, just the telcos themselves) feel the IPP has produced an odd result, they can ask for the second part of the process to be initiated - the Final Pricing Principle (FPP).

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An FPP is a laborious process that requires the commission to build an economic model to work out the actual costs in New Zealand of any given service.

The commission hasn't had to do this to date, predominantly because its IPPs have delivered figures that most players grudgingly accept. The IPP process can take many months and includes a tedious amount of engagement with the industry, to the point where exhaustion seemingly sets in and the players accept the result.

This time round, the commission discovered only two countries that have similar regimes for regulating copper wholesale services - Denmark and Sweden.

The commission wrote to the minister and the industry to warn that this was likely to result in a bunfight, but its hands are effectively tied: the Act says it must benchmark and so it had no choice.

The call for an FPP was triggered almost immediately and now we're working through that part of the process, building a cost model and looking specifically at Chorus's costs.

There has been no retraction, no backing down, no change to the commission's approach, no deviation from the law in this regard. To suggest otherwise is simply incorrect - we are working through a process as laid down in the law.

The commission cannot deviate from the Act with all of this. It has to follow the prescribed path laid out by Steven Joyce back in 2010.

The only area for debate is around Section 18 of the act which says "consideration must be given to the incentives to innovate that exist for, and the risks faced by, investors in new telecommunications services" and it's on this one line that the broking community has seemingly pinned all its hopes.

This section has never been tested before and is currently before the High Court, but quite how one line in an entire Act is supposed to override the other carefully worded provisions is beyond me.

There is one point on which Davies and I are in agreement.

Chorus shares are very well priced at the moment. Chorus will have, in effect, a near monopoly on fibre services for the vast bulk of New Zealand for the rest of the century, they would seem to be a very good long-term stock.

That it has to invest its money in the network in the short term shouldn't dissuade investors from buying in. I think of it as Chorus being "on sale" at the moment, but then, I'm not stock broker.

Paul Brislen is the chief executive of the Telecommunications Users' Association (TUANZ).

- Stuff

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