Brian Gaynor: Shaky telco regulation spooks investors

Telecom's share price was hammered when it was ordered to unbundle the local copper loop network. Photo / Greg Bowker

The Government and the Commerce Commission certainly know how to hammer the share prices of our listed telecommunications companies.

Last week's release of the commission's draft review of the unbundled copper local loop (UCLL) service had a draconian impact on Chorus' share price, which plunged 13.1 per cent, from $3.52 to $3.06, shortly after its release.

This was exactly six years after the Government announced its decision to require Telecom to unbundle the local loop.

The 2006 ruling had a horrendous effect on Telecom's share price, which nose-dived 17.1 per cent, from $5.55 to $4.60, immediately following that determination.

The commission's latest announcement coincided with the annual Macquarie Australian Conference in Sydney, where more than 110 ASX-listed companies make presentations to investors.

The statement caused widespread concern among the New Zealand contingent in Sydney, as it is extremely infuriating when regulators release draft reports that create huge uncertainties and have a negative impact on share values.

It was also frustrating because a number of Australian companies, including Telstra and Sydney Airport, told the Sydney conference that they now faced more stable and predictable regulatory regimes across the Tasman.

This is in stark contrast to the situation facing Chorus.

Six years ago Telecom was partly to blame for the Government's adverse decision because the company didn't meet commitments it had made to ministers. This rather cavalier attitude was reflected in a March 2006 video statement by then-chief executive Theresa Gattung that "the Government is way too smart to do anything dumb here [increase regulation]".

This time around is different, because Chorus is a good corporate citizen and a large number of the 1,917,300 KiwiSaver members have an investment interest in it. Thus, the sharp decline in Chorus' share price over the past week has had a negative impact on the retirement funds of many New Zealanders.

This begs the question whether the uncertain regulatory environment does more harm than good, particularly for individuals who benefit from any telecommunications price decrease but also have an investment in Chorus through their KiwiSaver fund.

Telecom was established in 1987 out of the telco division of the New Zealand Post Office. In 1990, the Crown sold it to a consortium headed by large United States telcos, Ameritech and Bell Atlantic, for $4.25 billion or $1.80 a share.

It was one of world's first government-owned telcos to be fully privatised. One of the conditions of the sale was that the US owners sell down their shareholding by September 1993, through an initial public offering to the New Zealand public. The IPO was at $2 a share.

The fourth Labour government, which ruled from 1994 to 2000, advocated liberal regulatory regimes and Telecom operated under no industry-specific regulation when it was privatised 22 years ago. The group was subject only to generic competition legislation, which was widely regarded as ineffective.

The American shareholders made hay in this environment and at the end of 1997, Ameritech bailed out at $8.85 a share and Bell Atlantic at a similar price through a complicated exchangeable bond offering.

US investors achieved a huge return on their investment through a combination of capital gains, capital repayments made by Telecom and big dividend receipts.

In 2001, the Labour government introduced the Telecommunications Bill which signalled the end of self-regulation and the reliance on generic competition law. However this legislation, which created a new position of Telecommunications Commissioner within the Commerce Commission, was still light-handed by international standards.

In 2004 the commission recommended against the unbundling of Telecom's copper local loop network. This was the regulatory process whereby all other telco providers could rent Telecom's copper connections between telephone exchanges and customer's premises.

The Government decided to accept the Commissioner's recommendation on the understanding that Telecom would allow competitors to use its DSL connections (the digital subscriber line that uses the higher-frequency spectrum that provides broadband data services from the telephone exchange to customers).

Telecom failed to deliver on this commitment and on May 4, 2006, its share price was hammered after the Government was forced to release its decision to require Telecom to unbundle the local loop. This followed the leak of a copy of the Government's draft proposal by a parliamentary messenger to a Telecom employee.

Twelve days later, chairman Roderick Deane announced his resignation and Gattung followed suit in February 2007. Telecom became subject to more regulation following the passing of the Telecommunications Amendment Bill in December 2006, with only two MPs voting against the legislation.

The company had become public enemy number one, and in a short period of time it went from being one of the world's most lightly regulated telcos to one of the more highly constrained. Since then there have been huge changes at Telecom, including the split with Chorus at the end of last year. The problem with this regulation is that it has become hugely complex and difficult to understand.

There is also a mismatch between this complexity and Chorus' investor base, which includes KiwiSaver funds and elderly investors seeking yield.

The commission's latest 86-page report on Chorus, which was released last week, is almost totally focused on customers and makes no mention of the company's shareholders or investors.

Our telco regulation regime has become far too one-sided against the Chorus/Telecom group.

The light-handed environment benefited shareholders, compared with customers, when Ameritech and Bell Atlantic were in control but it has favoured customers since the Chorus/Telecom group attracted a larger New Zealand shareholder base. It is little wonder that New Zealand investors have limited confidence in the domestic sharemarket.

In simple terms, the commission's latest report looks at the monthly price charged by Chorus, which now owns and operates the network, to other telco providers for the use of its high-frequency copper connections.

These connections from the telephone exchange to customers are used for the internet. These are effectively the DSL connections referred to earlier.

The commission is proposing to reduce the average monthly amount that Chorus can charge for these high-frequency connections from $24.46 at present to $19.75 by December 2014. These lines represent an estimated 6 per cent of Chorus' revenue.

However, the commission has also said that it would look at the price that Chorus charges other telcos, mainly Telecom, for the use of its low-frequency copper connections used for voice.

This represents a far larger percentage of Chorus' revenue and any major price reduction in this area would have a big impact on the company's revenue, profitability, credit rating and ability to pay dividends.

This obviously has major implications for the company's share price, and the returns for investors who bought into the company for its defensive qualities and high dividend yield.

A final decision on the high-frequency copper connections is due from the commission on August 10. No time-frame has been given for the price review of the more important low-frequency copper connections.

The commission's announcement has created considerable investor uncertainty with broker analysts taking a wide range of views on the final outcome.

Our inability to create a stable telco regulatory environment, 22 years after Telecom was fully privatised, is a poor reflection of our parliamentary process.

The regulatory debate has become far too one-sided, with little or no consideration given to the investors' interest.

This gives investors ominous signals as far as the IPOs of Mighty River Power, Genesis Energy and Meridian Energy are concerned.

If the telecommunications industry, which has consistently reduced prices in recent years, is subject to more and more regulation what will happen to the electricity sector, which raises it prices year after year?

A stable electricity regulatory regime needs to be firmly established before, not after, the IPO of the state-owned electricity giants.

Brian Gaynor is an executive director of Milford Asset Management.