CNU - Chorus

[Snoopy]

Note 6, shows how balance includes notional interest.
Note 20, contractual cash flows showing >5 year ultimate cash flows equals the current carrying value of the liability - which includes accumulated notional interest.

I see the CIP securities (that is the sum of CIP debt and CIP preference shares) of $461m listed as 'contractual cashflows' on p65 of Note 20, AR2020. But weirdly this $461m is not classified as a debt that must start being repaid starting in 5 years time (FY2020 perspective), which is what I understand the situation to be. This same $461m is listed on p63 of Note 20 as an interest repricing risk 5 years into the future (which does seem right).

Yet doesn't Chorus have the option of simply paying off these debts by refinancing the whole CIP securities balance at prevailing much lower interest rates? And if these debts are either refinanced or repaid, does this not mean that any 'notional interest' associated with these CIP securities disappears completely?

SNOOPY

[Nor]

Good grief. Don't some say that you should never invest in anything you don't understand? Luckily that's not my investment position.

[Snoopy]

Good grief. Don't some say that you should never invest in anything you don't understand? Luckily that's not my investment position.

Theresa enabled my Chorus shareholding to fall into my lap all those years ago. So I am in the unusual position of having a modest CNU shareholding, yet I have never bought a single Chorus share. I haven't been interested in buying more shares until now, as I perceived the take up rate of fibre broadband to be too uncertain. However, Covid-19 has brought 'working from home' and a more normalised use of the internet in all warps everyday life into sharp focus.

When an investment is complicated (broadband is simple, but the complexity arises in the delivery process, the workings under the Chorus hood) it pays to focus on the prize at the end. In the case of Chorus, the prize is the long term income stream from a utility that all homes and businesses will need, irrespective of the business cycle. Certainty implies returns going forward are likely relatively low (increasing new investors getting on board drives up the price and lowers the yield), but likewise so is the risk lower. I know there are some investors out there that might think that my targeted investment gross return of 5% for Chorus is not worth getting out of bed for. But I am thinking of Chorus as a kind of 'fixed interest substitute'. And when you go to the bank and they offer you a term deposit starting with a '1', then 5% sounds pretty good. Personally I do see bank interest rates rising in the near future. But to be offered a term deposit starting with a 5? I won't be holding my breath for the next ten years.

Now we know where we are going with the prize, we have the incentive to solve 'the problem'. 'The problem' in the case of Chorus is the funding model which has resulted from the government tipping in a lot of money up front (good, the CIP funding) but ultimately wanting it back from 2025 onwards. This is the bit I am trying to get my head around. The government is subsidising fibre roll out by issuing CIP debt with no interest repayments required. Yet the government still wants their capital back.

The 'Crown Funding Balance' (AR2020 Note 7) is partially amortised each year. That amortisation is transferred as an offset to depreciation, which boosts Chorus's profits each year. Yet it appears that if you follow the CIP repayment schedule, the crown do -eventually- want all of their money back after all. So is this amortisation of CIP funding only a temporary relief? I don't understand what is going on here.

Some would say that the CIP funding amortisation is a government subsidy. Yet from what I can see the crown still wants all of their CIP loan money back, and in the case of the CIP preference share component, they want interest too. So is it really a subsidy when the CIP funding is not forgiven?

Some would say use of CIP funding 'interest free' for ten or more years is a subsidy. But that would be a retrospective analysis. Roll back the clock to the birth of Chorus as a separate entity in FY2012. The revenue stream that Chorus was expecting from their 'paying broadband customers' to offset this CIP backing, which we have to remember only funded half the roll out - alongside equal amounts Chorus's own shareholder capital-, was far from certain. In effect Chorus signed up to quite a risky business plan as a condition of getting free use of crown capital for up to 15 years. This wasn't a free lunch from Chorus's 2012 perspective, and so I would argue CIP funding wasn't a subsidy.

SNOOPY

[Nor]

I got my free ones and bought the same again and then a few. It will be interesting to know if you conclude it is a buy at these levels which are still quite high historically. I find it difficult to know what to buy on nzx. The small pool of shares seems to comprise mainly dogs and too highly priced gems.

[Snoopy]

I haven't read historical documents but I suspect RBI will be completely different to UFB1 contractually and financially.

Just to clear up how the RBI funding worked for Chorus

From: AR2012 page F21

"Chorus receives Crown funding from the Ministry of Economic Development (MED) for capital expenditure incurred under the Rural Broadband Initiative.

Chorus is entitled to claim payment for the grantable costs attributable to the relevant milestones for deploying the rural link or rural cabinets. MED will pay Chorus one dollar of funding for each dollar of grantable costs incurred by Chorus up to a maximum of about $236m. In addition MED reimburse Chorus for all capital expenditure attributable to school lead ins."

The RBI initiative was finished during FY2016. Here is what was said on its completion.

From AR2016 page 2

"Rural areas also benefitted during the year with the final phase of the RBI extending fibre to our upgraded broadband cabinets and new Vodaphone tower sites. The five year roll out was completed at the lower end of our initial capital expenditure guidance range of $280m to $295m.and we delivered more coverage than originally contracted by the government.

We deployed about 3,500km of fibre to rural schools and hospitals and enhanced our broadband coverage to approximately 110.000 rural homes and businesses."

SNOOPY

[Ferg]

Note 7 of AR2020 says fair value on initial recognition of crown funding for the UFB roll out alone is $707m, close to the $710m that I derived, As you have pointed out, the last two years also include some UFB2 and UFB2+ funding. Yet if the total of $707m/$710m is correct, it falls well short of the $924m that has been handed out to Chorus for UFB1 funding alone (AR2020 p49). What gives?

This would be 'case closed' on the disambiguation of the various categories of crown funding taken up by Chorus, except for one point. If the CIP funding is the crown contribution towards rolling out fibre broadband, then why does the 'other' crown funding also specifically include $707m of funding specifically allocated to rolling out UFB 'Ultra Fast Broadband

Bear with me but I will answer your post with quotes from the AR, a worked example and your own workings from post 2648.

What gives is that Crown funding received is $707m per Note 7 plus CNU also received CIP debt+equity funding of $360m per Note 6 giving total funding received of $1,013m for UFB1 + UFB2. Assuming the full $924m has been booked/received for UFB1, this implies UFB2 funding received is $89m. As has already noted (and I think we are now in agreement), the "Crown Funding" balance includes additional funding for RBI & Others. In fact your amended table deriving A-B of $636m in post 2688 has proved the first column in Note 7 where the total without rounding differences is $633m.

{Re my (Ferg's) statement that interest should be excluded} Are you sure about that? The 'CIP debt' is interest free until 2025 (AR2020 p50). [...snip...] Accordingly, I can't see why you say that the $461m on the Chorus Balance Sheet for FY2020, under the collective label of CIP securities, contains 'accrued interest'

Absolutely yes it should be excluded if we are seeking to understand the funding received to date. But that answer changes to No if we want to know how much CNU owes. "Notional interest" is a book entry which is inflating the CIP debt+equity balances to $461m . Per note 6 total notional interest accrued to date is $101m. The annual interest accrual is confirmed if you look at the "reconciliation of movements of liabilities" statement on page 39 as being a book entry that is inflating the amount owing on CIP debt+equity.

I see Note 6 p50 talks about 'notional interest'. I wish when I had a debt due where I could just pay 'notional interest'! This term suggests to me that 'notional interest' is some kind of accounting construct. I do not understand 'notional interest' and doubt that it represents any real payment. I say this because I don't see any 'real interest' as falling due.

Accounting construct? Yes. It's not a real payment? Correct...for now. It is however showing as "payable" by virtue of being included in the balance of $461m being a liability, and it will eventually have to be repaid as part of the debt repayments of half of the $924m.

Think of it like this:

• CNU receives debt funding of say $100m in 2021
• CNU must repay $100m in 2023 (i.e. no interest)
• IFRS accounting says that CNU did not receive $100m of principal, IFRS says CNU received $90m principal and $10m of notional interest (assuming a simplistic $5m p.a. interest)
• At 2020 year end the debt owing is recorded as $90m
• At 2021 year end the debt owing is recorded as $90m + $5m notional interest
• At the end of 2022 $100m is repaid which is the $95m for last year end plus another $5m notional interest for 2022
• So what happened to the other $10m that was banked in 2020? That is sitting in "Crown Funding" per the note I quoted on post 2687 ("The difference between funding received and the fair value of the securities is recognised as Crown funding" from AR2020 page 49).
• The notional interest is not tax deductible per page 27: "The accounting interest and depreciation credit recognised in the Income statement in relation to CIP securities are non-taxable". This confirms it is an accounting construct and not real.

Per a note I quoted earlier in post 2687, page 49 of the 2020 AR (I previously quoted this as being from page 51; 51 is the pdf page number, whereas 49 is the report page number) of the 2020 AR: "Over time, the CIP debt and equity securities increase to face value and the Crown funding is released against depreciation and reduces to nil."

This "face value" part is crucial. I expect this means that when these financial arrangements mature in 2025*, only then will we see the $924m. It is not currently showing as $924m because the balance is sitting in Crown Funding. As each year passes additional notional interest will be added to the balance, until in 2025 the total balance of CIP debt+equity will be $924m.*

*Amending thinking: with differing debt maturity profiles we may never see the $924m given some tranches mature on different dates (your post 2648 made me amend my thinking) - more on this in my table at the bottom of this post.

In another post you point me to post 2648 which shows the repayment schedule and the PV of the debt repayments (very helpful thank you). Notice you had a total PV of $316m based on a discount factor of 5.5%. So you had the overall answer at your finger tips all along! I was only joining the dots.

​

p50 talks about 'fair value on initial recognition' of the 'CIP debt' and 'CIP equity' (preference share debt) facilities. This is the bit I am having trouble understanding. I thought a debt of $X was a debt of $X and couldn't be reduced in value on the balance sheet because it does not have to be paid back until some time in the future. But reading this page 50 (AR2020) suggests to me that I am wrong about this?

Yes the debt is reduced given it is "interest free" and not repayable for some years per my example of $100m above. Note your $316m PV on post 2648 is close to the "fair value" of $287m of CIP debt securities per the note on page 50 under the table of values. Note also page 50 talks about debt securities being split into senior and subordinated, and there are a range of discount rates smattered all over that page. Back-solving the $287m fair value into your debt repayment table per post 2648 implies an average discount rate of 5.88% (BTW I think the periodic divisors you used are short one period). 5.88% seems reasonable given the ranges presented on page 50 for the senior & subordinated debts. Note the splitting of the CIP debt into senior and subordinated further muddies the waters, but we have cut through that by using an average rate.

Below is a PV table using a discount factor of 5.88% and the debt repayment tranches you provided, to come up with the fair value of the CIP debt securities for each tranche and year (note this excludes the CIP equity component):

Avg. Disc. Rate =	5.88%
	Tranche:	2025	2030	2033	2036	TOTAL
	Amount:	$85.3	$104.7	$166.7	$210.2	566.9
Periods	FY	Fair Values:				TOTAL
	2020	$64.1	$59.1	$79.3	$84.3	$286.8
1	2021	$67.9	$62.6	$84.0	$89.2	$303.7
2	2022	$71.9	$66.3	$88.9	$94.5	$321.6
3	2023	$76.1	$70.2	$94.1	$100.0	$340.4
4	2024	$80.6	$74.3	$99.7	$105.9	$360.5
5	2025	$85.3	$78.7	$105.5	$112.1	$381.6
6	2026		$83.3	$111.7	$118.7	$313.7
7	2027		$88.2	$118.3	$125.7	$332.2
8	2028		$93.4	$125.3	$133.1	$351.8
9	2029		$98.9	$132.6	$140.9	$372.4
10	2030		$104.7	$140.4	$149.2	$394.3
11	2031			$148.7	$158.0	$306.7
12	2032			$157.4	$167.3	$324.7
13	2033			$166.7	$177.1	$343.8
14	2034				$187.5	$187.5
15	2035				$198.5	$198.5
16	2036				$210.2	$210.2

Can I say "case closed"?


Regards, Ferg

[Snoopy]

Yes the debt is reduced given it is "interest free" and not repayable for some years.

Back-solving the $287m fair value into your debt repayment table per post 2648 implies an average discount rate of 5.88% (BTW I think the periodic divisors you used are short one period). 5.88% seems reasonable given the ranges presented on page 50 for the senior & subordinated debts. Note the splitting of the CIP debt into senior and subordinated further muddies the waters, but we have cut through that by using an average rate.

Can I say "case closed"?

Regards, Ferg

Outstanding Ferg. You have connected the dots in a way that I can understand. Granted you and I are are probably the only two reading into this thread this deep! There are many readers for which tables of numbers 'don't do it'. Nevertheless I feel as though I am finally able to answer Aaron's question -which I realise you have just done. But I intend to use your work to answer his question in a 'non -numerical way' for those that have read this far and are still lost.

On another topic, you picked up that in my post 2648, which was discounting to a 'present value', maturing Chorus debts a long way into the future (up to 2036), that I was one discount period short. So I have gone back to that post and corrected it. However, given you have referenced that post as it was, before correction, I have left the old uncorrected calculations in there as well. Otherwise if someone read your post that referenced 2648, and went back to look at 2648, the numbers you have referenced would be missing, a potential source of confusion!

Thanks again.

SNOOPY

[Snoopy]

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?

To answer this question we have to go back to FY2012 when the 'Crown Infrastructure Funding' package came on stream. I take you back to a seemingly innocuous meeting between Mr Pointy Head, Chief Officer for the enforcement of New Zealand Accounting Standards and Andrew Carroll who was the Chief Financial Officer at Chorus at the time. Here is what out 'fly on the wall' microphone picked up from that meeting.

-----------

PH "All is looking good here Andrew. All your accounts are right up to date and meet the current accounting standards. I bid you good day! Wait a minute, what is that bucket in the corner of your office?"

AC "Oh that bucket is where I store all the crown funding that we are using to fund this Ultra Fast Broadband roll out that we are partnering up with the government to do. Stephen Joyce, the finance minister brought it in one day. He said help yourself to any money you need from that to help with the broadband build. It is free to use. We won't charge you any interest or anything so crass. Just make sure that in fifteen years time when I come to pick up the bucket that all the capital we lent to you is still in there. Very sporting of Stephen don't you think?"

PH "This is highly irregular Andrew. As the upholder of Accounting decency in New Zealand, we can't have you building a broadband network from a bucket in the corner of your office. Your accounts should reflect the full picture of your funding package, and frankly, having a secret bucket in the corner of your office is something your shareholders should know about. I am am afraid I am going to demand some changes."

AC "Look Pointy Head, Stephen has lent me a bucket of money and in fifteen years I will give it back to him. In the meantime a broadband network gets built. It seems very simple to me - no need to over complicate things."

PH: "Your bucket Andrew, will henceforth have to be split into two compartments. In one half will be the capital you have not yet touched. In the other half will be the capital you are using combined with the interest payments that you owe to the government for reaching into that bucket."

AC: "What interest payments Pointy Head? The capital that Stephen is lending us is interest free!"

PH: "We accounting standards people don't allow free lunches Andrew, and by any standards you are getting a big one here. So I think of you as paying 'notional interest' on that interest free loan of yours. Of course this 'notional interest' doesn't affect the amount of money that has to be in Stephen Joyce's bucket at the end. So to make up for the notional interest that you aren't paying, I am going to reduce the 'market value' of the capital you have borrowed. That way you still have the same amount of money in that loan bucket as before."

AC: "This is making things rather complicated Pointy Head. By telling me that I am paying 'notional interest', I now have to assess the risk of interest rates repricing according to market forces, which could affect the notional amount of interest that I am not paying."

PH: "Quite right Andrew. You also have to assess the transient liquidity risk of paying back your bucket of Stephen's money early."

AC: "You are talking about the same bucket that Stephen has said he is contractually not coming to pick up early?"

PH: "Yes that is the one."

AC: "Pointy Head, let me get this straight. You want me to compartmentalize my bucket into two. One part I label 'CIP debt' , which is the Crown Infrastructure Partners debt capital that I have to give back to Stephen. But as I use that debt I have to transfer Stephen's money into the other compartment of my bucket at which point that money splits into a reduced capital amount and a a notional amount of interest that nevertheless add up to the same amount of money I started with in the first place. By doing this Stephen's capital that he has lent me partially vanishes from the balance sheet. But then at the end of the broadband roll out, the notional interest that I haven't been paying reattaches itself to the reduced capital, and all of Stephen Joyce's loan bucket capital rematerialises on the books. At that point it is returned to the CIP compartment of the bucket ready to be repaid. That is the most ridiculous money go round I have ever heard of, and all along the same amount of money remains in the bucket! What is wrong with going to Stephen Joyce's office, asking for a bucket of money that will ultimately be repaid and and leaving it in the corner of my office? Any child could do that, and it would avoid all of your ridiculous rigmarole!

PH "Yes, any child could do that Andrew, and how much would you expect to pay them to do it? Now think, what salary are you on?"

AC "Ah Pointy Head, I am beginning to see your view with more clarity! If we want professional results we have to pay professionally for whatever sacrifice to the company that entails. I will implement your suggestion forthwith! And because the published accounts will be largely incomprehensible to the rest of our management team , the kudos I will receive will be immense. There are a few bright cookies on that 'Sharetrader' internet forum that might eventually figure out what a sham it all is. But I reckon it will take a few years for them to figure it out. I will be long gone from this CFO position by then, so it is all good. We will be in the clear."

PH "Andrew, I knew you would come around to my way of thinking. Must get back to the office. I am working on a new standard I am calling IFRS 16. We are really going to muck things around by dragging all leases onto every company's balance sheet!"

AC "Hah hah hah hah! Pull the other one Pointy Head! You will never get away with that! See you for a catch up next year!

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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.

You did good. Sitting in ignorance never earns many brownie points. Unless someone asks the right questions there is no path to finding the right answers.

SNOOPY

[nztx]

Didn't CNU promise some astoundingly good things for holders about 12 months so ago ?

Have they delivered or just on the excuses ?

[Ferg]

Well said Snoopy. IMO another nail in the coffin for IFRS accounting. My turn for a couple of (hopefully easy) questions.

I'm not currently an investor in CNU. Is this another dividend yield stock? Or is there room for some sort of growth over and above inflation?