Telecom in subsidy dispute

By PETER GRIFFIN telecoms writer

The Commerce Commission's lowered calculations of Telecom's cost of capital have annoyed the stock exchange heavyweight.

The commission is in the process of deciding the monetary size of the Telecommunications Service Obligation, a replacement for the old Kiwi Share covering the supply of basic telephone and internet services nationally, the cost of which will soon be split among a handful of industry players.

Telecom originally put the monetary size of the Kiwi Share at $425 million a year. That was whittled down to $356 million a year after the commission asked Telecom to re-calculate its figures assuming a lower cost of capital.

But the figure is set to drop again, meaning Telecom could receive less subsidy for its Kiwi Share costs from its competitors.

In documents issued last week, the commission put Telecom's weighted average cost of capital (WACC) at 6 per cent, nearly half the 11.2 per cent figure Telecom put forward and below the 8.2 per cent previously suggested by the commission.

Telecom's head of corporate affairs, Philip King, said the commission's figure was "sickening" and flew in the face of independent estimates.

"If 6 per cent was all you needed to achieve, there'd be a lot more investment going on. Everyone knows the risk is much higher than that," said King.

But Osmond Borthwick, manager of the commission's network access group, said the commission was looking at isolated parts only of Telecom's business in making its calculations.

The Kiwi Share services were largely based around Telecom's switched telephone network. Therefore, some high-risk elements of the business were not relevant to count.

That view of Telecom gave it more of the appearance of an electricity or gas company.

"The New Zealand utilities businesses are appropriate comparitors. We've also said there's a level of insurance through the cost-sharing element of the TSO," said Borthwick.

"We've heard the Telecom arguments and come to a different view."

A contentious element of calculating Telecom's WACC was estimating the company's "riskiness", or beta.

The commission put it at 0.3, regarding Telecom as a low-risk business. Analyst estimates of Telecom's equity beta range from 1.02 to 1.19 and the asset betas range from 0.73 to 0.86.

Telecom argues that in calculating the cost of the Kiwi Share, revenue is considered from a range of "value added" services the telco provides, and the risk of providing those services should be considered.

"The TSO is not just calculated on the cost of basic local access; if it was, a low WACC would be justifiable. They can't just treat it as a basic utility service," said spokesman John Goulter.

Either way, the commission's figure is the one that will determine the cost of the Kiwi Share. Discussion on the calculation methods will no doubt fill the next few weeks before the commission comes to a draft decision on the cost in late June.

Contentious findings

* WACC - weighted average cost of capital is the minimum return the firm requires on its investments. Telecom puts its WACC at 11.2 per cent. The Commerce Commission says 6 per cent is more accurate.

* Beta - A measure of risk, the beta is a means of measuring the volatility of a stock in comparison with the market as a whole. A beta of 1 indicates that the security's price will move with the market. A beta greater than 1 indicates that the security's price will be more volatile than the market. A beta less than 1 means that it will be less volatile than the market, or less risky. The commission puts Telecom at 0.3, relatively low risk.