Chorus’ share price has fallen from a high of $3.70 during March 2012 to a recent low of $1.28 due to a number of issues.
-Uncertainty around the pricing Chorus can charge for its copper broadband service due to a decision by the Commerce Commission
-The dividend Chorus can pay to shareholders
-The level of capital Chorus needs to complete the Ultra Fast Broadband (UFB) rollout
-A large international Fund has thrown in the towel and is selling down a substantial position.
In my opinion, as a new Chorus investor, the company is at the maximum point of uncertainty, with the negatives well baked in and the liquidity being provided by a large offshore seller at a discounted price; these are the main attributes I look for in a deep value investment.
There are two key elements to Chorus’ UFB build:
-The communal infrastructure or core network that runs down the street past every house in the UFB build area. This is being completed at the rate of circa 100,000 premises per year and will be completed around 2020. Chorus’ budget for this is in the range of $1.7 – $1.9 billion
-The second element is the installation of households to the core network as they decide to take up UFB. There are no prescribed timeframes for this take-up and in the absence of any planned migration from the copper to fibre networks is likely to occur over the next 20 years. This is forecast to cost around $1 billion although Chorus has not completed enough premises to confirm its initial forecasts.
Chorus takes all of the risk associated with the cost of the network but is receiving funding of just over $900 million from the Government for building the communal infrastructure – these payments are spread out evenly over the build period to 2020. This funding is interest free and has to be repaid between 2025 and 2035.
Chorus’ contract with Crown Fibre Holdings (the Government agency managing the UFB build) is very prescriptive around standards and timeframes associated with completing the build. Chorus signed this contract but the prescriptive nature of the contract and a lack of flexibility is limiting Chorus’ ability to manage its costs as it might have done had it been rolling out the UFB under its own steam.
So what could be done to help Chorus?
In New Zealand, when the UFB was being planned, consideration was not given to a number of issues that could have paved the way for a cheaper rollout. This includes:
-Giving the project special status under the Resource Management Act so that council processes were streamlined and infrastructure owners (i.e. power lines companies) were required to share infrastructure under agreed parameters to bring costs down. For example being able to go overhead instead of expensive trenching
-Addressing the cost of non-standard installations. Long drive ways, or more importantly shared access premises like Multi-Dwelling Units. These are important issues for Chorus and a national standard should be set around providing more efficient ability to install UFB in these premises
-No consideration was given to a managed migration from one network to another so that Chorus could get efficiency in its installation costs and have more certainty on the switch off of the copper network, thereby avoiding maintaining two networks
-Allowing Chorus to defer more expensive premises (without changing the number of premises passed each year) so that it can get costs down before working on more expensive properties
-Chorus has to roll-out and install fibre even in cases where a house may not yet be built. In a more flexible contract, Chorus could wait until later down the track before having to be rolling out communal infrastructure and therefore timing the expenditure closer to actual need.
We expect some of these issues to be addressed in negotiations between Crown Fibre Holdings and Chorus over the coming weeks – although solutions for some of the issues (like migration plans) would be complex and may not be first order priorities.
In addition, there are alternatives that Crown Fibre Holdings could recommend to the Government that would also help Chorus around funding and regulatory certainty. This could include:
-Bringing forward Chorus’ payment schedule from the Government so that more cash (the same total amount) was received up front when Chorus’ capital expenditure is highest
-Switching all of the funding from a mix of debt and equity to only equity so that Chorus has more headroom with its banks through the build out phase
-Bringing forward a review to look at the regulatory framework that will apply after 2020. At the moment Chorus and its investors do not know what framework will apply and what price it can charge for fibre or copper after 2020. This is a key uncertainty for investors and Chorus’ lenders.
Mark Warminger
Portfolio Manager
Disclosure of interest: Milford owns shares in Chorus on behalf of clients.