CNU - Chorus

[Snoopy]

Are you referring to the deduction of $18m per your calculation? If so, it is correct to not include that deduction as part of debt, as Chorus has done (in other words they are correct). Again that is an IFRS construct of spreading the cost of raising the debt over the term of loan and should be thought of as a prepayment. It doesn't reduce the debt obligation, rather it is an item on the Balance where the money has already been spent but it is to be expensed.

I am assuming that $18m of 'facility fees' (AR2020 p46) is connected to the 'Syndicated Bank Facilities' of $550m. This facility was not fully drawn down, with only $30m borrowed at balance date. It is not clear to me that these $18m facility fees do run over several years, If we go back to FY2019 the then $350m syndicated bank facility had facility fees of $17m. Back another year and the $350m syndicated loan had facility fees of $12m. The fact that these fees are of the same order every year would suggest to me that they are annual fees for the one year, apportioned to that year alone. Furthermore, if these facility fees are directly linked to the syndicated bank facilities in such a way that they would not exist if the syndicated bank facilities did not exist, then I feel they should be incorporated in the syndicated bank facility bank debt total.

The odd thing is the facility fees are reducing the debt, not increasing it. Could this be because a large facility fee was charged at some time in the past and was capitalised as a debt? As the years roll on, this capitalised fee is gradually being amortised away, hence the negative fee charge in AR2020?

SNOOPY

[zspoon]

Snoopy, with the greatest respect, I can see you generally disagree with a lot of how GAAP (in this case specifically IFRS works), but I really think your thinking time would be better spent understanding how IFRS requires the ‘commercial reality’ is presented to allow you to understand the underlying transactions. This may be the construct created by the ‘pointy heads’, but it’s the construct that defines how any large scale corporate reporting occurs. Therefore while you’re more than entitled to have your own views on what ‘feels right’ from an accounting presentation perspective, actually unpicking how the required accounting presentation works is going to be the best route to understand the underlying business mechanics.

Failing that, lobby the IASB for change.

[Snoopy]

Snoopy wrote
"You can take it from those questions that I am backing my own interpretation of debt from the balance sheet, over that espoused by Chorus."

I respectfully caution against such an approach given debt covenants, especially of this magnitude, are set in stone after what are usually protracted and bloody negotiations between lawyers and analysts for both parties.

I would not include the equity component, despite being classified under term liabilities for 2 reasons:

• it is debt that will revert to equity, so it is equity but just not right now, and
• more importantly, covenant calculations are very strict and not usually open to interpretation.

I cannot stress that last point enough - all I can point to is my experience in this area with some large NZ organisations with similar amounts of debt. I highly recommend you do not use your own version of debt for these calculations. Not only should you trust their process, but the bankers will be scrutinising these covenants every quarter. There is no (or very little) room for "favourable interpretations". I suggest you run with their values because the difference will be legitimate and the calculations are set in stone.

Chorus seems to have reduced their EMTN loan debt by valuing it at an intermediate point chosen (FY2020 balance date) from within the whole loan term. I don't doubt that if these loans were to be repaid early at balance date and those various hedges were unwound at balance date, then the value of NZD needed to extinguish those EMTN notes would be $NZ1,299m. Not the $NZ1,410m shown in the balance sheet. However, there is no intent or plan to terminate those loans at balance date. So while I am not doubting the accuracy of Chorus's net debt position in any ratio calculation, I am calling it out as conceptually irrelevant from my investment perspective. That extra $NZ1,410m - $NZ1,299m = $NZ111m of debt has not gone away. It has only gone away from a FY2020 balance date perspective and it will eventually have to be repaid.

On the subject of the classification 'preference share equity', I use the 'duck test'. The preference 'shares' have no voting rights. The 'dividend' associated with them has been predetermined as a percentage of the issued capital value of the preference shares. Yes there is a mechanism where these preference shares might be converted to ordinary shares later on. But IMO it is much more likely that they will be paid back. The ordinary share equity of Chorus will be unchanged, should that happen. The duck test tells me that if something looks like debt and behaves like debt, it very likely is a debt, despite what any accounting rules might tell you in the meantime.

SNOOPY

[Snoopy]

Snoopy, with the greatest respect, I can see you generally disagree with a lot of how GAAP (in this case specifically IFRS works), but I really think your thinking time would be better spent understanding how IFRS requires the ‘commercial reality’ is presented to allow you to understand the underlying transactions. This may be the construct created by the ‘pointy heads’, but it’s the construct that defines how any large scale corporate reporting occurs. Therefore while you’re more than entitled to have your own views on what ‘feels right’ from an accounting presentation perspective, actually unpicking how the required accounting presentation works is going to be the best route to understand the underlying business mechanics.

Failing that, lobby the IASB for change.

I think you have the wrong idea about where I am coming from with this zspoon. I am not doubting the validity of the information presented in the FY2020 annual report, or saying that accounting rules have not been followed correctly, or that I am trying to improve them for company reporting purposes. I am saying that from an investment perspective from 'today', I don't care what a company's financial balance sheet position is on any particular historical date.

I do care about company debt. Yet the fact that $NZ111m of EMTN debt has 'gone away' on 30th June 2020 (for example) is of no particular interest to me. Because I know at 'debt settle up time', that $NZ111m of 'temporarily absent debt' will be back. If the EMTN borrowings are planned to be cashed up early, then fair enough - the accounting treatment of 30-06-2020 should be respected. But Chorus has not given any indication that these borrowings will not run to full term.

SNOOPY

[Ferg]

I'm curious Snoopy - are you coming up with your own analyses or critiquing theirs? Fair enough if you are doing your own thing and if you are looking at total debt relative to other values, then go for it. However, it is misleading to present your covenant calculation beside theirs and claim "favourable interpretations" in the earlier post. Had an external person come to me and told me we were doing our covenant calculations incorrectly based on values in the annual report, I would have pointed them to the debt contract(s). Do not underestimate the work & scrutiny that goes into covenants or assume the covenant calculations are open to favourable interpretations. In post 2707 you refer to "senior debt" but your definition of "senior debt" differs to the contracted version of "senior debt" for the purposes of CNU covenant calculations. I sense you won't agree with me but I honestly cannot add anything more, so I apologise in advance for providing no further responses on this issue.
Regards, Ferg

[Snoopy]

I'm curious Snoopy - are you coming up with your own analyses or critiquing theirs? Fair enough if you are doing your own thing and if you are looking at total debt relative to other values, then go for it. However, it is misleading to present your covenant calculation beside theirs and claim "favourable interpretations" in the earlier post. Had an external person come to me and told me we were doing our covenant calculations incorrectly based on values in the annual report, I would have pointed them to the debt contract(s). Do not underestimate the work & scrutiny that goes into covenants or assume the covenant calculations are open to favourable interpretations.

Perhaps I should not have used the term 'favourable interpretations'. That phrase might imply that whoever calculated those banking covenants had the option to do it another way. I acknowledge what you say Ferg about Chorus's numbers being carefully put together and in accordance with the law and accounting standards. Nevertheless these banking covenants are drawn up for one underlying purpose: ensuring the banks get their money back.

If Chorus got into trouble and the banks get their money back while subordinated debt holders or even lower down the scale - the shareholders - did not, then the banking covenants have done their job. This is no real comfort to subordinated debt holders or shareholders though. It is in this sense that I used the phrase 'favourable interpretations'. The banks have set their own banking covenants with little regard to subordinated debt holders or shareholders. If they had drawn up banking covenants to take into account even just subordinated debt holders, then different covenant hurdles would apply.

I am not saying there is anything wrong with banks protecting their own patch. If I were a banker I would make darn sure I did just that! I am saying that shareholders who feel comforted by a company staying within their banking covenants may be in a false comfort zone. If a more embracing view ('a less favourable interpretation of the big picture') of debt due was taken, then shareholders and subordinated debt holders would have a better measure of their own likelihood of getting their capital back, should Chorus come under real stress.

My alternative presentation of the 'Debt' / EBITDA ratio and my labelling of both 'my selected debt' alongside 'Chorus's selected debt' with both labelled as 'Senior Debt' was sloppy. Labelling two different numbers as 'senior debt' does imply that one of those numbers is 'wrong'. So I have gone back to my post 2707 and relabeled both debt figures as 'selected debt', with the implication that I and Chorus can make different debt selections and come up with two different answers, one of which is suitable for banks (the Chorus figure) and the other (Snoopy's choice) more suitable for a low life scum shareholder, such as myself.

SNOOPY

[Ferg]

Fair enough and thanks for responding. I understand where you are coming from.

[Snoopy]

Snoopy wrote:
"The undiscounted value of that CIP debt is: $85m+$86m+$128m+$163m = $462m, equal to .the total value of the UFB1 debt. (Slide 42, November 2020 presentation), However, this may be a co-incidence, as why would the UFB2/UFB2+ funding be left out of the Chorus debt picture?"

Ah the penny drops. Previously I mentioned senior and subordinated CIP debt was muddying the waters but I think you have unpicked it. I believe UFB1 is the senior debt, UFB2 is the subordinated debt. The difference between the raw values you have above and those per the PV calculation we did earlier (being $85.3m + $104.7m + $166.7m + $210.2m = $566.9m) will be for UFB2. These will be the subordinated portions of the CIP debt (as opposed to senior).

Covenants usually only apply to senior debts and/or debts held by the senior banks. The subordinated debts are either lower ranking or held by banks that are not party to the contracted covenant, hence the reason they are excluded from the covenant calculations.

No I haven't unpicked anything. Look at Slide 43 of the November 17th 2020 presentation. The series of numbers that you carefully discounted over a multi year period back in your post 2696 -that added up to $566.9m- are clearly labelled as the "Debt Securities Maturity Profile of UFB1 & 2"

If we go back to AR2020 page 50, the second paragraph talks about CIP debt existing in 'senior' and 'subordinated' debt, with the proportion of each a fluctuating fraction of the total. But subject to the constraint that the 'senior debt' and the 'subordinated debt' always added up to the total capital that was contracted to eventually be repaid.

"The initial value of the senior portion is the present value (using a discount rate of 8.5%) of the sum repayable on the CIP debt securities and the initial subordinated portion will be the difference between the issue price of the CIP debt security and the value of the senior portion."

This means that for all CIP debt, be it UFB1, UFB2 or UFB 2+, it 'starts off' on the books as a relatively small senior portion that grows as the interest free loan heads for maturity until finally, just at the point the debt is due to be repaid it becomes all senior debt. The fact that the senior debt at EOFY2020 happens to equal the undiscounted UFB1 debt is I believe a co-incidence. It is not surprising the figures are close because all of the UFB1 spending has been done, and the discount notional interest rate has only a few discounting years to adjust for.

SNOOPY



"

[Snoopy]

As a regulated monopoly, CNU should be allowed to return a sufficient return on equity. Whether that return justifies the current share price is another question but there is no doubt that CNU will be profit and will pay a dividend.

Vector would be the closest comparison as the majority of its business is a regulated monopoly.

I like long life utility type assets as an investment prospect, and the Chorus network(s) tick that box. But I am still put off by the unusual funding structure of Chorus. I get that there has to be government assistance because Chorus are building the broadband fibre network ahead of the demand curve. In capital terms there is no subsidy though, as far as I can work out. That is because the 'Crown Infrastruture Partners' funding, the 'CIP debt' and 'CIP equity' (actually preference shares) ultimately have to be repaid.

$924m in accessed crown funding (AR2020 p49) is not chickenfeed, even in these days of low interest rates. If Chorus could get a commercial loan at 3% today, to replace that CIP funding, they would be up for an annual extra incremental interest bill of:

$924m x 0.03 = $28m

Net earnings last year were $52m. So underlying net profit at Chorus could eventually be nearly halved (by $28m x 0.72 = $20.2m) based on that incremental interest figure, once the government loan support starts to become 'commercial' from FY2025. This is a very different position to the electricity 'gentailers'.

Like Chorus those gentailer companies own long life utility type assets. Unlike Chorus, those renewable power assets increase in value as the wholesale power price rises. To see a similar effect at Chorus, the price of wholesale broadband will have to keep rising at a similar rate to rising power prices, while the cost to operate the now existing fibre network continually falls going into the future. That seems unlikely. This means, from a future funding perspective, Chorus is in a far worse position than the likes of Contact Energy, Mercury Energy and Meridian Energy at least.

The other point I really don't understand is the savings in depreciation of $27m (AR2020 p43) that can be obtained because Crown Funding has been used. How can the book state of the Chorus assets be affected by how those assets are funded? Surely depreciation is a function of wear and tear and maybe technical obsolescence? If, however, we do take that extra depreciation deduction at face value and we do look to the future when the Crown funding is repaid, presumably that extra depreciation deduction will no longer be available? The after tax effect would be a reduction in NPAT of 0.72x$27m= $19.4m. Add that to the underlying new incremental interest bill of $28m -before tax- and any underlying Chorus profits ( NPAT effect of 0.72x$28m= $20.2m) for an indicative FY2020 based future year Net Profit After Tax drops to a measly:

$52m - $19.4m -$20.2m = $12.4m (a near 80% reduction on the headline NPAT).

Am I missing anything here?

SNOOPY

[Ferg]

Am I missing anything here?

Unfortunately you are double counting by not following the debits and credits. In fairness to you, CNU have not helped with their presentation whereby some figures have been aggregated and others have been offset. If you can answer / solve these questions, then you will have your answers:

1) how much of the $924m Crown funding relates to CIP debt? For the purposes of calculating future cost, what is the recognition profile and interest rate(s) on this debt? {we figured this part out earlier}
2) how much of the $924m Crown funding will end up as CIP equity? Will those preference shares need to be repaid? If so, then yes add some interest to that component in future years. If not, what is the annual cost of the preference shares?
3) how much of the $924m Crown funding remains after deducting CIP equity and debt per #1 and #2?
4) how much of the value in #3 will need to be repaid, if at all? (this part is CRUCIAL) Only the amount that should be repaid to the Government should be subject to additional future replacement funding costs per your post.
5) is the "book state" of the assets actually affected by crown funding? (depreciation yes, book value no) But more importantly, where on the Balance Sheet did the credit to depreciation come from? And what is the forecast profile of it's amortisation?

If you can answer these then you will have your impact on future profitability.

FERG