Chorus’ Lab Tour Highlights Strategies to Contain Rollout Costs

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Chorus provided a tour of its Auckland fibre lab last month. The tour included a demonstration of fibre equipment at the exchange, a mock-up of ducts and fibre connection from the exchange to the premise, and technologies at the premise. However, the regulatory uncertainty will remain a barrier for the share price to converge towards our fair value estimate in the short term. Chorus’ narrow economic moat is based on efficient scale and cost advantage. Its nationwide assets are essentially monopolies, and difficult to replicate. Post fibre rollout, the company’s fibre assets will cover 75% of New Zealand’s population.

With capital expenditure guidance revised higher at the fiscal 2013 result in February, the focus is on strategies to lower connection costs at the initial phase of the rollout. Chorus will install terminals between the cabinets and the premise. In the initial rollout, fibre will be rolled out from the cabinets to the terminals to defer upfront investments. The remaining fibre is laid on demand when a customer signs up to a fibre service. Existing fibre from the fibre-tothe- node network, or 40% of the existing network, will also be reused.

Another advantage is that power is not needed, providing flexibility on the location of the terminals. The tour reaffirmed our view that costs per premise will decline over the long term as scalability of the project increases once common infrastructure is completed. A fibre network also benefits from lower maintenance costs as the number of lines between the exchange and a cabinet is reduced. Chorus earlier noted fibre fault rates for the overall network, particularly at the distribution cabinets are half of that for a copper network.

Chorus will also offer a high speed DSL service – very high bit rate DSL (VDSL) – due to market demand. This is in line with our thesis that rising data demand is the main driver for consumers and businesses to upgrade to fibre from copper. VDSL offers speed of up to 50 megabits per second, depending on distance. Similar to ADSL technology, speed declines as distance to the exchange increases. As the fibre rollout remains in its earlier stages, we believe the premier ADSL product will ease the transition to fibre. It also accelerates the development of applications requiring higher bandwidth. Chorus expects to stop offering VDSL products by mid-2105 as the fibre rollout gains momentum.

Regulatory uncertainty on wholesale broadband prices will remain a barrier for the share price to converge towards our fair value estimate. Commentary from Chorus at a Commerce Commission (ComCom) conference held earlier this month in response to the draft decision largely echoed its disappointment at the outcome. Chorus revealed that share ownership by international investors declined to 45% from 55% post the draft decision. This is in line with our earlier view that the draft decision undermines private public partnerships in New Zealand.

Late last year, ComCom reduced the final wholesale copper price by 3.8% to NZD 23.52, significantly less than the 20% suggested in the draft decision. A final decision on wholesale broadband prices is expected on 15 August 2013, with pricing applicable from 1 December 2014. The New Zealand government – an investor inChorus and the UFB project – has also brought forward a review on the regulatory regime for the telecom sector.

 

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