Investor Presentation

Chorus Limited
Level 10, 1 Willis Street
P O Box 632
Wellington
New Zealand

Email: company.secretary@chorus.co.nz

STOCK EXCHANGE ANNOUNCEMENT

27 September 2019

Attached is an investor presentation summarising implementation of the fibre
access services regulatory framework.


ENDS


For further information:

Brett Jackson
Investor Relations Manager
Phone: +64 4 896 4039
Mobile: +64 (27) 488 7808
Email: brett.jackson@chorus.co.nz

Nathan Beaumont
Stakeholder Communications Manager
Phone: +64 4 896 4352
Mobile: +64 (21) 243 8412
Email: Nathan.Beaumont@chorus.co.nz

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Implementation of the
fibre access services
regulatory framework
27 September 2019

Regulated Asset Base (RAB) framework to apply
from January 2022
key focus of legislation is a smooth transition for consumers andinvestors
the Commerce Commission has acknowledged importance of real financial capital maintenance:
the ability to make a fair return on and of capital over the lifetime of the assets
regulatory transition is unusual because the network will be almost completed before the
framework is applied and has been delayed from original January 2020 timeframe
Chorus will have under-recovered on more than $4 billion of investment (excluding shared
assets) made in the decade since the UFB rollout started
investors are clear that build and financing risks need to be recognised at the time they were
addressed, not in hindsight
the retrospective treatment of investment has implications for future public-private partnerships
27 September 2019
Legislation to implement the new RAB framework for fibre access services was
passed with bipartisan support in November 2018.
2

27 September 2019
The new regulatory framework
3

27 September 2019
Overview of current RAB implementation
In May 2019, the Commerce Commission released
an Emerging Views paper outlining its views on
certain aspects of the input methodologies to
apply under the new framework. Chorus and
investors have made extensive submissions on
issues raised by the Emerging Views paper.
The Input Methodologies are expected to be
finalised by mid 2020, followed by Price-Quality
decisions in mid 2021.
The Commerce Commission is implementing the new framework
4

27 September 2019
Emerging Views paper: summary of key issues
ParametersSummary of the Commission’s Emerging Views paper
Crown financingSuggestedthere is noactual financing cost of expected $1.33billion of Crown financing,
meaning no return would be earnt on the equivalent communal assets until the financing falls
due between 2025 and 2036.
WACC: 2011-2022Suggestedthe fibreWACC from 2011 to 2022 could be adjusted on an annual basis, rather
than applying a single WACC across the decade-long rollout period.
WACC: asset betaProposed anasset beta of 0.46, well below market expectations.
WACC: percentile
and TAMRP
Suggested no uplift (from 50
th
to 67
th
percentile) required to mitigate risk of under-
investment, but could consider a potential uplift for asset stranding risk. Suggested Tax-
Adjusted Market Risk Premium (TAMRP) will be updated in the cost of capital calculation.
Cost of debtIndicated risk-free rate, debt premium and debt issuance costs to beconsistent with other
Part 4 utilities.
IndexationSuggested RAB indexation will apply, consistent with other Part 4 utilities.
TaxationAllowanceconsistent with other Part 4 utilities, but suggested BBM tax losses in pre-
implementation period cannot be brought forward.
DepreciationAct requires straight line depreciation for initial RAB valuation, but Commission suggested
non-standard depreciation (i.e. tilted) could be considered post-implementation.
5

27 September 2019
UFB context: A public-private partnership
Chorus was required to split from Telecom to build the UFB network and took on extensive
contractual obligations, as well as substantial project and other related risks. The “fair bet”
that investors took was an expectation of a fair return reflecting these risks.
In return, New Zealanders now have access to a world-leading fibre network at reasonable
cost, well ahead of when it might otherwise have been built and with limited public
investment.
Crown contracts required:
•split of Chorus from Telecom
•Chorus to have investment grade rating (with
dividend stopper if falls below)
•contracted product pricing, set by Crown to
ensure initial uptake and limited for 10 years
•stringent rollout requirements, including material
damages
•management step-in rights for material breach
•limitations on ongoing copper network investment
6

27 September 2019
Crown financing: Chorus investors bore residual risk
The Commission’s Emerging Views paper suggests there is no actual financing cost associated with Crown funding. This
means Chorus would not earn any return on the fibre assets funded with Crown financing until the funding falls due from
2025 to 2036.
2011FY23
Chorus financedCrown financed
UFB investment
(illustrative)
Up to $1.33bn in Crown funding (57:43 equity/debt)
debt repayable in 4 tranches 2025-2036 with dividends payable to
the Crown proportionally on 4 equity tranches
Chorus required to issue warrants to Crown to share in investment
upside above 16% CAGR
the requirement that Chorus maintain investment grade rating, to
allow draw down of funding, placed greater risk on equity investors
Crown financing was notfree
Chorus view: If there was no actual cost, why is it explicitly contemplated
in the legislation? The Crown funding was equivalent to debt risk taken on
by the Crown, vs the project risk and other residual risks taken on by
Chorus investors. A minimum return of between 1.81% and 1.85% should
be earned on this portion of the RAB -otherwise it unstitches the UFB
agreement by incentivising Chorus to redeem the financing (and begin
earning a full WACC) ahead of the agreed dates.
$m
7

27 September 2019
Chorus fibre rollout: sources of funding
The Commission’s Emerging Views paper
suggests Chorus’ WACC could be retrospectively
averaged on an annual basis (2011-2022).
●GBP bond (NZ$677 million equivalent) with term
matching UFB1 rollout period and bank loan $1.7
billion on floating rate were required to enable
demerger
●$1.685 billion in Euro and NZD bonds issued to
investors as rollout progressed.
●Equity investors have had limited dividends due to
negative free cash flow during build period, while funding
~$180 million in equity via Dividend Reinvestment
Plan
●Crown financing is drawn down as rollout progressed.
Debt repayable from 2025-2036; Crown equity securities
attract dividends in tranches from 2025.
-
500
1,000
1,500
2,000
2,500
3,000
3,500
FY12HY13FY13HY14FY14HY15FY15HY16FY16HY17FY17HY18FY18HY19FY19
GBP BondsBank FacilitiesEUR BondsNZD Bonds (5yr)
NZD Bonds (10yr)DRPCrown DebtCrown Equity
GBP bond: 2011-2020; NZ$677m swapped at ~8%
Bank loan: $1.7bn on floating
rate unable to be replaced until
copper regulatory review
ended in Dec 2015
Chorus view: A 10-year WACC period reflects
the costs and risks taken on by Chorus
investors and matches the 2011-2022 pricing
period set by the Crown contract and
legislation. Retrospective adjustments send a
poor signal for future NZ infrastructure PPPs.
$m
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27 September 2019
WACC: Chorus investors have borne significant risks
NZ Herald: Yes, the Ultra-Fast Broadband project was a gamble(28 August 2019)
Build risk
Demand risk
Regulatory risk
Technology risk
●Ongoing risk of project over-runs throughout build period to 2022
●Risk realised when communal costs revised upwards in 2013
●Investment in network and systems was ahead of demand, requiring long-term pay-offs
and with no certainty of a return
●Unbundling requirement creates Layer 2 investment risk
●Wireless risk emerged in 2016/2017 as retailers promoted their own 4G wireless networks
●5G networks are now being developed
●Risk realised when copper pricing review 2012-2015 resulted in Moody’s ratings
downgrade, dividend suspended for two years and delay in refinancing bank debt
●UFB pricing constrained by Crown contract and legislation (e.g. anchor products,
unbundling and geographic averaging)
●Post 2020 uncertainty continues to weigh on equity investors with framework
implementation delayed 2 years (until January 2022) and perception of sovereign risk
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27 September 2019
WACC –asset beta
The Commission’s Emerging Views paper suggested an
asset beta of 0.46, reflecting a broad comparator
group of companies including integrated telcos(fixed
and mobile), tower and satellite operators.
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Asset beta ranges
CEPA midpoint 0.46
●Market analyst views, Crown Fibre modelling and international
precedent all indicate 0.46 is too low.
●Chorus is very different from tower and satellite operators given
unique wholesale-only constraints (e.g. revenue cap and anchor
products).
●The Commission’s experts, CEPA, indicated a higher average
asset beta (range of 0.49 to 0.63) when the integrated telco
comparator group was limited to companies with at least 50% of
revenues derived from a fixed line network.
●Fibre businesses face higher risk than copper/legacy businesses,
especially during construction and early growth phases, so asset
beta for standalone fibre should be higher than the midpoint of
the comparator set (Oxeramidpoint 0.52). Belgium’s regulator
recently decided 0.71 for copper and 0.90 for fibre.
Oxeramidpoint 0.52
Chorus view: The comparator companies used to
derive the asset beta significantly underestimate the
asset beta of a fibre network, particularly through the
rollout period.
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27 September 2019
WACC –uplift and TAMRP
The Commission’s Emerging Views paper suggested there
was no basis to provide Chorus with an uplift from the
50
th
percentile to encourage further investment.
Chorus view: All other regulated utilities in NZ receive
an uplift from the 50
th
percentile. An uplift is required to
adjust for uncertainty in estimating the WACC and
encourage ongoing investment for the benefit of
consumers.
●An uplift on WACC, at least equivalent to other regulated
utilities, is required to incentivise further investment in
network reliability, innovation and expansion.
●Mobile networks rely on fibre backhaul and therefore do
not provide an automatic back-up for consumers in the
event of fixed line outages.
●Compensation for asset stranding risk could include an
uplift on WACC to honour the fair bet principle (i.e. to
compensate for the chance a risky investment may fail).
●European regulators have provided a risk premium of
between 1% to 3.2% for fibre networks.
The Commission indicated it will review the current
TAMRP of 7%.
Chorus view: The current TAMRP under estimates the
cost of equity, as it has not yet been adjusted to reflect
material reductions in risk free rates.
0
2
4
6
8
10
12
FY15FY16FY17FY18FY19FY20
Commission IMs
Implied market returnRisk free rateTAMRP
%
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27 September 2019
Cost of debt: leverage and credit rating
●Our Board’s stated target credit rating since
demerger has been BBB.
●The comparator set used to determine notional
gearing will inevitably understate our gearing
because we are in network rollout phase.
●The Commission’s annual estimates for regulated
utilities with a BBB+ credit rating have been
consistently below Chorus’ actual cost of debt (see
chart). A more recent decision indicated a cost of
debt at 2.92%
The Commission’s Emerging Views paper suggested a
BBB+ credit rating and notional gearing of 33% should
be applied based on their comparator set.
Chorus view: Target BBB credit rating and notional
gearing of 30% for a standalone fibre business would
be consistent with the comparator set, and the higher
risk of fibre relative to copper. The Commission should
also consider whether this underestimates Chorus’
actual cost of borrowing for the UFB initiative.
12

The Commission proposes to assume there are no
unused tax losses when calculating the unrecovered
loss asset, because those tax losses could have
been used by other parts of Chorus’ business.
27 September 2019
Tax and Indexation
Tax
Indexation
●In addition to being inconsistent with the
approach for other regulated utilities in New
Zealand it is inconsistent with Australian
regulators who assume tax losses are carried
forward within the regulated business.
●The Emerging View requires assumptions about
the tax situation of other Chorus business
activities outside of the regulated fibre business.
Chorus view: The proposed approach is
inconsistent with prior practice for other regulated
utilities, where tax was modelled in isolation from
other business units.
The Commission proposes applying indexation to
the RAB, consistent with the approach applied to
other regulated utilities under the Part 4 regime.
Chorus view: We support indexation because it is
aligned with the principle of real financial capital
maintenance and inflation risk can be significant for
investors in long lived assets.
●Although indexation may affect the time profile of cost
recovery, a non-standard (i.e. tilted) depreciation
method could address this.
●The Commission has acknowledged that depreciation
could be accelerated to respond to asset stranding risk
and/or decelerated as fibre migration progresses.
●A flexible depreciation approach has previously applied
to airports.
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27 September 2019
source: Commerce Commission
Illustrative only