Chorus hit by 'WACC-a-mole' downgrade

Chorus has been hit by a downgrade from outperform to neutral by Forsyth Barr.

The move stems from concerns that the Commerce Commission is being over-optimistic about UFB fibre's prospects and the cost of capital as it mulls how to set regulated pricing - and in turn potentially too tough on Chorus as it considers where to set a revenue cap and other criteria under new regulations.

Analysts Matthew Henry and Matt Dunn have also shaved the network operator's 12-month target price from $6.25 to $5.65 (shares closed yesterday at $5.87; the stock is up 45 per cent for the year).

A major overhaul of the Telecommunications Act, which will kick off on January 1, 2022 (following the ComCom's successful request for a two-year delay), will see Chorus subject to an annual revenue cap - as, for example, listed lines company Vector is in the power sector. The wholesale price of Chorus' "anchor" (or mass market) UFB fibre plan will also be regulated. It will also have to meet minimum quality standards.

The ComCom has just released an "emerging views paper" - a key step in the once-in-a-generation process of resetting the rules of the telecommunications game.

Telecommunications Commissioner Stephen Gale said the revised legislation is designed to stop Chorus (and smaller regional operators NorthPower Fibre and Enable Networks) "from earning excessive profits at the expense of network quality and consumers".

"The rules we are developing that underpin the revenue caps for Chorus will have an impact on the price consumers end up paying for broadband. We are keen to hear from consumer advocates on our current thinking around how we treat key issues such as the cost of capital and what is included in Chorus' regulated asset base," Gale said.

Competing technologies not taken into account

Henry and Dunn are not happy with the methodology the regulator is using to underpin its calculations, at this point.

"Unlike other international regulators, the Commerce Commission has not included any mechanism for recognising the added risks for a new fibre network. For example, uptake uncertainty, competing technologies and long-dated investment," the pair wrote in a note this morning.

Henry elaborated to the Herald that the competing technology risk is very real.

Spark has made hay from its fixed-wireless service, which uses its 4G mobile network as an alternative to a landline network for delivering broadband into homes. It uses the cellular network, but achieves fibre-like speed.

The retail telco has gone from a standing start to around 130,000 fixed wireless customers in just a couple of years.

Fixed wireless cuts Chorus out of the loop - both physically, and in terms of its wholesale margin, allowing Spark to pocket around $50m a year that would otherwise have gone to the network operator.

Spark boss Simon Moutter says fixed wireless is near its natural ceiling under 4G, but a pending 5G mobile network upgrade will allow his company to make a fresh push - and offer fixed-wireless plans with no data caps, and none of the lag (a slight delay in two-way communication) that undermines 4G's competitiveness with fibre.

Vodafone has been tepid with fixed-wireless so far, but Henry notes that its CEO Jason Paris recently earmarked the technology as one of those what could be unshackled under new owners Infratil and Brookfield. Paris told a conference call that if freed to invest in the technology, he could move 15 per cent of Vodafone's base of 430,000 broadband customers to fixed wireless within two years.

Chorus is awake to the threat. It flew an ex-BT executive to NZ for a round of interviews on the theme that spectrum scarcity and other technical drawbacks mean fixed-wireless could never be a full substitute for fibre. That is true, but under 5G, it could still crimp its style and maintain and grow the significant minority market share that has even today.

(It's worth noting at this point that while Spark has named Huawei has a preferred partner, Moutter has also told analysts that his company go live with its first 5G service by July 1 next year with alternative providers, if necessary.)

A WACCing

Henry and Dunn also say the ComCom's proposed weighted average cost of capital (WACC - a key metric for investors as they weigh potential return from regulated utilities) is a lot lower than they were expecting when they had their "outperform" rating.

The pair see potential for a high margin of error as the regulator tries to calculate the maximum allowable revenue for Chorus under the new rules.

This uncertainty is another key reason behind their downgrade.

A spokesman for the ComCom declined to comment on the specific points raised by Henry and Dunn, but did offer, "This is an emerging views paper so the purpose of it is to invite feedback and evidence that tests our thinking before the draft decision in November."

Telecommunications Users Association head Craig Young said his organisation is holding fire until the ComCom's workshop for consumer groups.

Submissions on the emerging issues paper are due by July 16.

Chorus shares were down 1.36 per cent to $5.79 in early trading.