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Chorus cost-saving options include worse service on existing network

Monday 16th December 2013

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Cost-saving options for embattled telecommunications infrastructure provider Chorus include allowing the quality of its service to drop by under-investing in maintenance and upgrades on its existing copper-wire networks, says the report into its future by Ernst & Young Australia.

Chorus says it is committed to striking the "right balance ensure New Zealand consumers continue to benefit from high quality infrastructure today and into the future."

But the E&Y Australia report, released on Saturday afternoon by Communications Minister Amy Adams, suggests close to half the $1 billion Chorus needs to find to finance the roll-out of most of the country's ultra-fast broadband network can come from revenue increases and cost savings.

The 28-page report contains almost no specific proposals for where those $400 million to $450 million of savings and improved revenues could occur, the fact that the existing copper wire network is subject to regulated price control suggests many of the initiatives would come at a cost to the quality of service on the current network.

The E&Y Australia report lists a range of risks to the potential savings and revenue uplift. They include:

* "service levels to retail service providers (RSP's) could be lower than they are today, and accordingly end consumers will receive lower service levels:

* 'network fault rates could increase as Chorus implements a reactive rather than proactive maintenance strategy, resulting in reduced network performance and increased consumer complaints;

* 'the lead time to remedy network faults may increase;

* "the number of businesses or consumers who cannot connect to the network may increase, as Chorus agrees to new connections only on a full cost recovery basis or where and when the UFB or rural broadband initiative is scheduled to be rolled out."

The E&Y Australia report also sees potential for "execution risk" reducing the available options for savings and revenue increases, either through delayed decision-making or some initiatives not being acceptable to stakeholders.

However, combined with a 50 percent reduction in forecast dividends, a higher allowable debt ceiling and by raising capital or debt of between $200 million and $250 million, the $1 billion shortfall could be bridged, the E&Y Australia report says.

Adams ordered the report after a Commerce Commission decision required an unexpectedly large cut in regulated prices for unbundled bit-stream access (UBA) from 2015, causing Chorus to warn its capacity to roll out UFB in 24 of the country's 33 roll-out areas could be jeopardised.

The Coalition for Fair Internet Pricing, which has driven the government to back down on threats to over-rule the Commerce Commission's decision, said the report not only showed that Chorus could fund the UFB roll-out without government assistance, but argued the $1 billion shortfall estimate is too high.

"Our initial view is that were Chorus to raise around $500 million in new equity, it could fill its alleged funding gap without recourse to the more barmy ideas to enhance revenue, such as reducing broadband speeds to that of the old dial-up services," said Paul Brislen, a campaign spokesman and chief executive of the Telecommunications Users Association of New Zealand.

E&Y advises that by raising it debt "headroom" from a ratio of 3.5 to 3.75 times net interest bearing debt to earnings before interest, tax, depreciation and amortisation, the company could raise an additional $130 million. A two year dividend "holiday" followed by a cut to 50 percent of current levels from the second half of 2016 through to 2020, when the UFB rollout is scheduled to be completed, would contribute a further $290 million to the shortfall.

That would leave a funding gap of $200 million to $250 million, which the report implies could be covered by further debt or capital-raising, even if it meant pushing debt to levels that would require Chorus to get permission to pay a dividend from Crown Fibre Holdings, the government vehicle overseeing the $939 million government contribution to the UFB rollout.

At the government's behest, Chorus has already entered negotiations with CFH on ways to meet its contractual obligations to the UFB project, which would still see the flagship policy implemented on the same timetable and over the same national "footprint" as it signed up to in 2010.

Adams said the government expects Chorus to meet "a significant part of the shortfall."

Chorus chief executive Mark Ratcliffe said in a statement the trade-offs proposed by E&Y would be "carefully weighed to protect consumers."

"While E&Y has provided a high level view on some potential capital management scenarios, our view is that the true cost and viability of those options is incomplete.

"As stated in Chorus's letter to shareholders this week, discussions with Crown Fibre Holdings need to be completed before we finalise our medium term strategy, which will include future capital management settings," Ratcliffe said.

The report shows that Chorus enjoys relatively high rates of return on an ebitda basis and pays higher dividends than many comparable businesses in New Zealand and Australia, and notes that numerous European telcos have recently cut dividend forecasts.

The only area where Chorus is identifiably at a disadvantage to peers is in its relatively high levels of debt.

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