Is there light at the end of the tunnel for Chorus?

Is there light at the end of the tunnel for Chorus?

Chorus Limited (CNU) was created in 2001 when Telecom NZ split into two parts – Chorus, which owns the fixed network, and Spark, which owns the retail business and the mobile network. Telecom NZ was the first incumbent telco in the world to volunteer for such a structural separation, and in doing so positioned Chorus to participate in the build of the ultrafast broadband project (UFB) – NZ’s version of the NBN.

Things have been bumpy for Chorus since then. In 2013 New Zealand’s Commerce Commission announced a significant reduction in the regulated wholesale price Chorus had been able to charge for access to its network, and the Chorus share price took a beating. The reduced access price put Chorus under significant financial pressure, and it was forced to cut dividends, curtail discretionary capex, and look for ways to cut costs. Subsequently, the Commerce Commission has released a further draft pricing decision that indicates a higher access price will apply, and further announcements are expected in the months ahead, before a final price is settled on late in the year.

The challenge for the Commerce Commission is to balance the desire to provide affordable broadband for NZ consumers, with the need to provide network owners with an incentive to invest. If the regulated price is too low, the network owners can’t earn an acceptable return on investment and investment doesn’t happen. This seems to be the result of the earlier pricing decision, and longer term, this is to everyone’s detriment.

Until the pricing picture becomes clear, Chorus continues to pay no dividend, and investors face significant uncertainty as to its future economics. This is likely to put considerable pressure on the share price for the time being.

The Commerce Commission appears to have badly fumbled its earlier pricing decision, but if you believe that it will ultimately find the right balance, there should be better times ahead for Chorus. A great deal of expert time and effort is currently being devoted to the pricing question, and it seems to us that with the right application of time and expertise, finding the right balance should be well within its reach.

Also, if a degree of regulatory certainty and predictability can be demonstrated over time, this should translate into a lower discount rate being applied to Chorus’ cash flows, resulting in an increase in its market value. It seems to us that one of the best ways for the Commerce Commission to achieve its twin goals is to lower the hurdle rate that network owners require.

The Montgomery funds own shares in Chorus Limited.

Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To learn more about our funds please click here.

MORE BY TimINVEST WITH MONTGOMERY

Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.