The short and light on detail Ernst Young Australia (EY) report on Chorus shows that while Chorus’s top line “$1 billion shortfall” statement was correct, it was also disingenuous.
First of all, we already knew that the $1 billion gap is until 2020, which is 7 years away, which is an average of just $143 million per year. This may still seem like a lot, but this is for a business with current revenue of over $1 billion and EBITDA of a staggering $663 million.
Secondly, the $1 billion to 2020 assumed that Chorus would make no changes to their current approach business, an inexcusable approach.
Thirdly the EY report, rather embarrassingly for Chorus, identified some simple ways to reduce the gap to $200-250m ($28-36m per year):
- Chorus had a dividend yield of 10.3% to June 2013, unsustainably higher than the 4.3% NZ and 6.7% Australian peer averages. Their FY13 return on equity was a staggering 29.7% versus peer averages of 12.5% in NZ and 11.2% in Australia. So EY is comfortable recommending that Chorus remove or reduce dividends.
- EY also point out that Chorus has been operating well away from the danger zone for their debt covenants, and so they can raise more money through debt
- They also show that there are ample opportunities to save costs and increase revenues.
I’ve seen teams successfully deal with turnaround situations that are a lot worse than this. While the report does not itemise the cost and revenue opportunities, my own experience is that these numbers are easily achievable, especially when we look at the current situation. I say easily achievable, but that’s only if the right approach is taken, which is to create departmental teams with CEO line of sight and authority to prioritise and systematically identify and fix the biggest and easiest revenue and cost opportunities. With the right approach Chorus should be able to eliminate entirely the remaining $200-250m gap, mainly by focussing on increasing fibre revenue per premise.
The huge opportunity
Chorus was formed with one primary goal – to install fibre on the roads past 70% of the premises in the country. The are behind their peers in this, but the industry is lousy at the real primary goal – of converting those premises to being lit fibre customers. Chorus may argue that it’s the RSP’s (ISPs) mandate to convert retail customers, but I hold them firmly to account for not making it easy for those businesses. This, I believe, is the real turnaround opportunity for Chorus.
Internet access is a strange business, where demand rises exponentially at a staggering annual rate. That demand though is largely influenced by the available supply, following an “if you build it they will come” model. The slow conversion of premises (rather than the roads in front of them) to fibre means that Chorus misses out on the essentially free incremental revenue above the fixed price base plans.
Fibre is intrinsically easier to upgrade than any other technology, and will always maintain a physical advantage over alternatives. While the GPON technology used for UFB is a poor choice, once fibre is in the ground then it is eminently upgradeable with newer equipment on each end. The more quickly the industry connects premises to fibre, the more quickly we they will be appreciated and upgraded, and the more money Chorus will make.
Some examples of the current industry pain that need to be fixed are:
- Chorus has 24 candidate areas for UFB, and has fibre in roads past 153,000 premises so far. The three other UFB players have just 9 areas, but have passed 94,262 premises, 64% more than Chorus has per area.
- Multi-family dwellings and offices are placed on hold during months-long waits for pieces of equipment (MDUs) that really should be in stock, or may not even be required in the first place.
- ISPs dealing with Chorus have to invoke black arts to get their systems to work properly, making installations slower and more expensive.
- The industry collectively presents poor quality plans and a confusing picture to buyers, which the new broadband product disclosure will help.
- The Chorus Gigatown promotion-spam debacle is a lottery-like distraction for individuals and towns that all just want Chorus to do their job of delivering gigabit internet to all premises.
- The international cable bottleneck is still unsolved – and Chorus would be an ideal partner in one or both of the two proposed ventures. They could also work to build or buy backhaul infrastructure, and offer a wholesale internet in a box transit service to RSPs large and small.
What should Chorus do?
The UBA decision and the EY report clarify the future for Chorus, and nicely align the public and shareholder incentives to replace copper with lit fibre. It’s time that Chorus embraces their true role of being the champion of this future.
- It’s time for Chorus to introduce a culture of continuous improvement, systematically prioritising and removing the barriers to increasing revenue and the wasteful costs.
- It’s time for Chorus to move on from playing politics and to place overwhelming board and management focus on delivering lit fibre at ever-increasing data rates. Bring us our UFB future.
- It’s time for this giant start-up to stop on paying out its short term earnings as dividends and instead invest for the future beyond 2020. That future will see ridiculously lower capital requirements, monopoly profits and dividend streams to please any investor.
I suspect that the current board and management felt that they had to give this politicking a go, but they now they have a clear chance to inspire and transform the company, and the country, rather than fight for the copper past.
If the Chorus board and management cannot manage their way out of this, then the logical long term controlling investor to step in is our government. They should then invest with an accompanying mandate to the new board to focus on accelerating the lit fibre rollout to deliver long term value, rather than on the Telecom of old strategy of underinvesting and high dividend streams to shareholders.
I see tremendous long term value in owning a controlling stake in this monopoly player. There are, however, government limits which prevent any shareholder from asserting control – and repeating the Telecom of old mistakes. That’s good, but perhaps the right long term investor is out there (Milford is a start), and if the government is unwilling to step in then this may be a way forward.
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