CNU - Chorus

[Aaron]

Somehow I am expecting interest rates to have risen above zero by FY2025 Aaron! If they rise to 2%, that would equate to a rate that Chorus has agreed to pay of 6% + 2% = 8%
On $86m worth of 'preference shares', that equates to a payment of:

0.08 x $86m = $6.88m or $6.88m / 444.041m = 1.5cps

That sounds affordable to me, although with borrowing rates as low as they are, it would make sense to replace the Crown Financed preferences share, with borrowed money at a much lower interest rate than 8%!

SNOOPY

Sorry I haven't responded sooner, had to think first which takes time. Thanks for the analysis, I did make the effort to read the 2020 financial statements but wonder at note 6 CIP Securities it states UFB1 is rolled out 31/12/2019 and they received $924mill of the $929 allowed although CIP securities are only $461mill in the accounts. This is probably a silly question but if they have drawn down $924mill for UFB1 shouldn't that be what is owing. Where is the other $463mill or has it already been repaid? hard to jump in when you haven't been following the company's progress.

Points of interest for me are

1/connections are their business since 30/06/2015 connections have dropped 21% from 1,794,000 to 1,415,000 although turnover has only dropped by 5%. I guess inflation and more profitable connections. Definitely not a growth company but I wonder what sort of stable dividend can be provided in the future then your buy share price could be based off your desired yield.

2/ margins have been maintained but interesting to see "Customer retention assets" pop up in the Statement of Financial Position in 2018. This appears to be a way of taking marketing costs out of EBITDA and adding them into Depreciation and amortization. Financial massaging for the benefit of who financiers/investors? Probably a realization that wireless networks are real competition and they need to get off their ar**s and promote fibre. Spark had it all over them trying to move people off chorus's fixed line networks to their wireless network. I suspect marketing will need to be a bigger part of their business than they imagined and should be treated as a regular cost of business.

3/ What is the expected dividend per share now that the rollout is over.

I have tried to read and understand the annual report a bit, mostly the financial section but I just get more confused and more questions get raised as I realise how little I understand.

[Snoopy]

Sorry I haven't responded sooner, had to think first which takes time. Thanks for the analysis, I did make the effort to read the 2020 financial statements but wonder at note 6 CIP Securities it states UFB1 is rolled out 31/12/2019 and they received $924mill of the $929 allowed although CIP securities are only $461mill in the accounts. This is probably a silly question but if they have drawn down $924mill for UFB1 shouldn't that be what is owing. Where is the other $463mill or has it already been repaid? hard to jump in when you haven't been following the company's progress.

You are right about the accounts not being the easiest to follow. I am currently looking through the 'Enable' Annual Reports ('Enable' is responsible for the broadband roll out in Christchurch) to give me an alternative perspective on how others use this government subsidised broadband roll out model.

For those who don't know, and I didn't, 'Crown Fibre Holdings' (CFH) has now been renamed 'Crown Infrastructure Partners' (CIP). So when you see historical references to CFH they are one and the same as today's CIP.

The result of this renaming is that the government funded CIP Securities are the same thing as what used to be called the government funded CIF securities. If you remember back then Aaron, the UFB1 roll out amounted in an equal number of CIF (now CIP) debt securities and CIF (now CIP) equity securities being generated as the broadband roll out moved past more and more front gates. The equity securities were in the form of preference shares, not ordinary shares. Now it is more realistic to think of both the 'CIP debt' and 'CIP equity' together as part of a 'total debt package'. I think you will find the 'missing' $463m you asked about is because you haven't counted the so called 'CIP Equity' in the overall debt package.

The other point your post brings up is about the $461m debt securities not matching the 'missing' $463m of what I believe to be still on the books preference shares. During the supplementary UFB2 and UFB2+ roll outs there was some optionality on what mix of what CIP debt and CIP equity Chorus chose to take. I don't understand why the funding deal changed between UFB1 and UFB2. But my guess is that this is why the 'CIP debt' and 'CIP equity' (which is accounted for on the books as debt, despite the name) no longer match in dollar terms.

SNOOPY

[Aaron]

If you look at note 6 it shows both debt and equity securities represented by the $461mill in the Balance Sheet. My understanding that for every dollar of debt they also got a dollar of equity up to $929mill so they should match. As $461mill is roughly half of $924 it sounds like I have missed something.

Equity has been increasing but I think this was the DRP. I also don't think the CIP equity funding will show as equity until 2025?

Maybe some got paid back early or they include crown funding which reads like it was a gift from the NZ taxpayer being written off through depreciation.

maybe I am reading it wrong. Crown funding and CIP funding are combined on the statement of cashflows.

UFB1 build was completed in December 2019 to a total value of $924 million funding received. This was slightly below the $929 million allowed for under the programme,

[Snoopy]

If you look at note 6 it shows both debt and equity securities represented by the $461mill in the Balance Sheet.

Yep, my mistake. It looks like you are correct Aaron.

My understanding that for every dollar of debt they also got a dollar of equity up to $929mill so they should match. As $461mill is roughly half of $924 it sounds like I have missed something.

Like I said before. The UFB1 funding has a 1:1 match between loan money and preference share money. The UFB2/UFB2+ roll out has a slightly more flexible arrangement between the two which I think is the reason that the loan to preference share ratio is no longer quite 1:1.

Equity has been increasing but I think this was the DRP.

The 'Statement of Changes in Equity' (AR2020 p37) shows equity down from $979m to $927m over the year. The DRP did make a positive contribution of + $28m, as of course did the earnings + $52m. But those were more than wiped out by the total dividends paid of $104m (twice earnings for the year).

I also don't think the CIP equity funding will show as equity until 2025?

The way I read the arrangements with the preference shares, there is an option to convert those to ordinary shares from 2025. But the other option is simply to repay them, or perhaps more likely take on alternative debt at lower prevailing interest rates. I would suggest the latter is more likely.

Maybe some got paid back early or they include crown funding which reads like it was a gift from the NZ taxpayer being written off through depreciation.

maybe I am reading it wrong. Crown funding and CIP funding are combined on the statement of cashflows.

UFB1 build was completed in December 2019 to a total value of $924 million funding received. This was slightly below the $929 million allowed for under the programme,

That cashflow statement reads as though the CIP funding was only part of the Crown Funding. I thought the only crown funding that Chorus received was CIP! Maybe it is!

Note 7 shows how the Crown Funding is offset against Depreciation. But even if you take last years offset of $27m (AR2020 p51) and multiply it by ten (which will overestimate the total depreciation adjusted figure) that does not match the $463m of 'missing funding'. So something else must be going on.

If you refer back to AR2020 Note 6 p50, there is a sentence that says:

"The fair value (of CIP securities) has been calculated using discount rates from market rates at balance date and using Level 2 of the fair value hierarchy as described in note 20."

I have never heard of capital debt obligations being 'discounted' before. But I wonder if this is the missing piece of the disappearing debt puzzle?

SNOOPY

[Snoopy]

Points of interest for me are

1/connections are their business since 30/06/2015 connections have dropped 21% from 1,794,000 to 1,415,000 although turnover has only dropped by 5%. I guess inflation and more profitable connections. Definitely not a growth company but I wonder what sort of stable dividend can be provided in the future then your buy share price could be based off your desired yield.

3/ What is the expected dividend per share now that the rollout is over.

The drop in connections is, I believe, largely due to people swapping out copper broadband to fibre broadband in areas where the fibre has not been rolled out by Chorus, (like in Christchurch where the fibre broadband was rolled out by Enable). Chorus still owns and runs the copper network in Christchurch. So anyone in Christchurch who upgrades their broadband to fibre is lost to Chorus as a customer.

Chorus has now joined the same dividend game as the power companies, distributing dividends to shareholders coming from cashflows rather than profits. You can read about my dividend expectations for the future in post 2658. Whether you agree with my reasoning and whether I turn out being right is another matter!

SNOOPY

[Snoopy]

Points of interest for me are

2/ margins have been maintained but interesting to see "Customer retention assets" pop up in the Statement of Financial Position in 2018. This appears to be a way of taking marketing costs out of EBITDA and adding them into Depreciation and amortization. Financial massaging for the benefit of who financiers/investors? Probably a realization that wireless networks are real competition and they need to get off their ar**s and promote fibre. Spark had it all over them trying to move people off chorus's fixed line networks to their wireless network. I suspect marketing will need to be a bigger part of their business than they imagined and should be treated as a regular cost of business.

Personally I think this 'customer retention asset' regime that transfers what used to be business expenses into 'assets' is a little dodgy. The electricity retailers do it too, so it isn't unique to Chorus. I think it was enabled by a change in accounting standards. It wasn't a trick thought up by the Chorus board. I would be interested if anyone on the forum has something positive to say about it!

SNOOPY

[zspoon]

Personally I think this 'customer retention asset' regime that transfers what used to be business expenses into 'assets' is a little dodgy. The electricity retailers do it too, so it isn't unique to Chorus. I think it was enabled by a change in accounting standards. It wasn't a trick thought up by the Chorus board. I would be interested if anyone on the forum has something positive to say about it!

SNOOPY

I think rather than ‘enabled’ you might want to use the word ‘required’ by the accounting standards (specifically the new revenue standard) - as there’s no accounting policy choice to not present in this way.

The concept is good - where an expense is an incremental cost incurred in obtaining a customer contract, it’s expensed systematically over the length of the customer relationship - rather than taking it all up front. This also theoretically means that the expense is more closely matched to the revenue earned from the customer acquired.

[LaserEyeKiwi]

Market update by chorus:

https://www.nzx.com/announcements/370164

Chorus reduces indicative Maximum Allowable Revenue range

6/4/2021, 8:30 am MKTUPDTESTOCK EXCHANGE ANNOUNCEMENT
6 April 2021

Chorus reduces indicative Maximum Allowable Revenue range

Chorus is today providing an update to the indicative maximum allowable revenue (MAR) range of $715 million to $755 million per annum included in its Initial Asset Value presentation update of 26 March, to a reduced range of $680 million to $710 million per annum for the first regulatory period.

Chorus is continuing to refine, and perform assurance over, its MAR model, which we expect to provide to the Commission in May. As this process continues MAR estimates may change and we will update the market if required.

As part of this process, two significant assumptions have been updated and one error has been corrected. The changes relate to indexation (negatively impacting MAR) and risk-free rate assumptions (positively impacting MAR). The indexation changes are net present value neutral because the Regulated Asset Base is also inflated by CPI annually.

The key changes are:

1. Inflation assumptions in 2022 and the first half of 2023 updated to reflect the latest Reserve Bank Monetary Policy Statement forecast, issued in February 2021. The previous range was based on the November 2020 forecast.
2. The risk-free rate assumption updated from 0.30% to the current spot rate of 0.51%.
3. Inflation assumptions in the second half of 2023 and 2024 corrected to reflect the long-term Reserve Bank forecast required by the Input Methodologies. The previous assumption was incorrectly based on the quarterly inflation forecast. Chorus apologises for this error.

The effect of the changes is that the revised revenue range for the first regulatory period is further below Chorus’ forecast fibre revenues, as depicted on the attached slide. However, we expect MAR outcomes for the first regulatory period to improve as Chorus works through the remaining aspects of the Commerce Commission’s process, including the Commission’s consideration of our revenue modelling alongside the Initial Asset Valuation Model and expenditure proposals.

Chorus notes that today’s updated revenue range is based on a conservative starting Regulated Asset Base (RAB) of $5.5 billion. As noted in our 26 March release, alternative cost allocation methodologies, which more accurately reflect the structural separation requirements of our public-private partnership produce a starting RAB of $6 billion. The Commission also has tools at its disposal that can be used to ensure regulatory settings deliver on the policy goal of a smooth transition for consumers and investors.

“We hold the strong view that the MAR should be set above forecast fibre revenue to maximise the socio-economic benefits of the investment we and the government have made in the Chorus fibre network. As we’ve said previously, poor outcomes for consumers could arise if the revenue cap constrains our natural expected rate of growth and perversely incentivises Chorus to constrain fibre uptake and investment,” said Chorus CFO David Collins.

The inflation/indexation rates reflected in Chorus’ updated MAR modelling are:

2022: 1.46% (previously 0.90%)
2023: 1.85% (previously 0.90%)
2024: 2.06% (previously 0.90%)

Final Price-Quality decisions on revenue will be updated for Consumer Price Index data for the quarter ended 31 March and inflation forecasts from the May 2021 Monetary Policy Statement. The final risk-free rate will be set based on the average over the three months ending 31 May 2021.

Authorised by:
David Collins
Chief Financial Officer

[Snoopy]

The financial loss asset represents an attempt to place a value on what Chorus has theoretically ‘unrecovered’ losses from building and operating the UFB network before demand/supply were more stable. The loss asset calculated becomes part of the RAB, which Chorus are able to make a return on (refer to the building blocks aka BBM methodology structure down the bottom).

Interesting announcement to the market from Chorus today:

https://www.nzx.com/announcements/370164

"Chorus is today providing an update to the indicative maximum allowable revenue (MAR) range of $715 million to $755 million per annum included in its Initial Asset Value presentation update of 26 March, to a reduced range of $680 million to $710 million per annum for the first regulatory period."

That doesn't sound good to me. The revenue is going to be further constrained but there is no mention of lower costs to offset that. For reference total fibre revenue over FY2020 was $393m (Fibre Broadband) + $73m (Fibre Premium) = $466m.

Currently Chorus charges a regulated price per user that is passed through to the retailer. But under the new regime total revenue is to be regulated. Presumably this means that when the fibre network reaches a certain level of utilisation, Chorus will be forced to reduce charges across the board? That of course will be good for consumers, at least initially. But Chorus are forecasting a downside to this policy.

" “We hold the strong view that the MAR should be set above forecast fibre revenue to maximise the socio-economic benefits of the investment we and the government have made in the Chorus fibre network. As we’ve said previously, poor outcomes for consumers could arise if the revenue cap constrains our natural expected rate of growth and perversely incentivises Chorus to constrain fibre uptake and investment,” said Chorus CFO David Collins."

I think Chorus have confirmed what I just said. Namely, right now, the projected increase in future cashflows is still below the regulated cap. But as that regulated cap reduces, the point of cutting prices to retailers, and hence consumers, approaches. Once the revenue per customer reduces, the incentive to enhance the network reduces. At least I think that is what Chorus is saying. Happy to be corrected.

Yet midway through the press release, Chorus are saying it is probably only a temporary 'potential blip' for potential earnings.

"However, we expect MAR outcomes for the first regulatory period to improve as Chorus works through the remaining aspects of the Commerce Commission’s process, including the Commission’s consideration of our revenue modelling alongside the Initial Asset Valuation Model and expenditure proposals."

Is this some kind of psychological playing of shareholders? Giving investors 'bad news' today, while hinting that within the month there may be some counterbalancing good news to restore the status quo? What say you LEK?

SNOOPY

P.S. CNU closed for the day at $6.76, down 19c or 2.7%

[Snoopy]

Contrary to popular belief, the roll out of fibre has only been partially and transiently funded by the government. Note 13 of AR2019 suggests that the total budget to roll out UFB1 (which covers the major towns and cities) followed by UFB2 and UFB2+ will cost $2.3b to $2.4b by the end of FY2022. Of that $548m to $568m is the cost of UFB2 and UFB 2+ going out to smaller towns (note 13 AR2020). By simple subtraction then, the cost of rolling out UFB1 alone must be between $1.732b and $1.852b. The total government funding for Chorus's share of UFB1 is $959m (Note 5 AR2012), or about half the cost of building the network.

If you look at note 6 it shows both debt and equity securities represented by the $461mill in the Balance Sheet. My understanding that for every dollar of debt they also got a dollar of equity up to $929mill so they should match. As $461mill is roughly half of $924 it sounds like I have missed something.

Maybe some got paid back early or they include crown funding which reads like it was a gift from the NZ taxpayer being written off through depreciation.

maybe I am reading it wrong. Crown funding and CIP funding are combined on the statement of cashflows.

UFB1 build was completed in December 2019 to a total value of $924 million funding received. This was slightly below the $929 million allowed for under the programme, ( From AR2020 p49)

This 'missing' $924m - $461m = $463m in Crown Funding for the Fibre Broadband roll out on the Chorus balance sheet that Aaron has highlighted has been bothering me. If you look at the note on 'Crown Funding' (Note 7 in AR2020), then you will see a table entry labelled "Additional Funding Recognised at Fair Value". I wondered what would happen if I took this total in each respective annual report then added them together.

In a similar way in the same AR note, I recorded the amortised total of crown funding each year (which is offset against depreciation on the books), and recorded the multi year cumulative total of that.

Crown Funding	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	FY2020
Additional Crown Funding	$45m	$196m	$208m	$107m	$131m	$80m	$82m	$89m	$86m
sums to Cumulative Crown Funding {A}	$45m	$241m	$419m	$556m	$687m	$767m	$849m	$938m	$1,024m
Crown Funded Depreciation	$1m	$4m	$8m	$12m	$15m	$21m	$22m	$25m	$27m
sums to Cumulative Crown Funded Depreciation {B}	$1m	$5m	$13m	$25m	$40m	$61m	$83m	$108m	$135m
{A}-{B}	$44m	$236m	$406m	$531m	$647m	$706m	$766m	$830m	$889m

So what to make of this? The Cumulative Total of Crown funding of $1,024m is somewhat close the the $924m figure referenced in AR2020 p49. My cumulative total will also contain some UFB2/UFB2+ funding (not yet fully rolled out) which helps explain why my 'Cumulative Crown Funded Total' is the higher figure. However, both of these figures are much higher than the $461m of Crown funding recorded on the balance sheet (AR2020 p36).

I wondered if the difference could be explained by taking off the amortised crown funding, that money set aside to offset depreciation. However, as you can see in the above table, taking away this 'amortised depreciation allowance' does not account for the difference.

The only other explanation I can come up with is that with the crown CIP debt recorded at 'fair value', there must be some other factor that has reduced 'book value' to a 'fair value' that is below 'book value'. But this would involve shrinking a debt on the balance sheet well below a face value that is ultimately required to be repaid. That explanation does not seem credible to me. Anyone else with ideas?

SNOOPY