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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Chorus Incremental regulatory wins</h2>
The Commerce Commission (CC) has released the first set of final decisions on the “input methodologies” into Chorus’s (CNU) new ultrafast fibre broadband (UFB) regulatory regime.
The reports total c.960 pages. At this early stage, our summation is that, from a CNU perspective, the final decision is (at least) incrementally positive relative to the CC’s updated draft published in July.
The principal changes that benefit CNU are:
<ul>
<li>Marginally higher cost of capital from:</li>
</ul>
o&nbsp;&nbsp;Asset beta:&nbsp;Increased to 0.50, from 0.49 (and the original 0.46).
o&nbsp;&nbsp;Debt premium:&nbsp;BBB, revised from BBB+.
o&nbsp;&nbsp;Gearing level:&nbsp;The above benefits are offset by lower assumed gearing of 29%, from 31%.
<ul>
<li>Crown financing: The benefit of the Crown financing is to be deducted in the determination of the “maximum allowable revenue” (MAR) CNU is able to earn on the UFB. The CC now proposes to calculate this benefit at a (lower) “finance rate”* cost vs. previously at WACC. We have not yet calculated the materiality of this beneficial change to CNU.</li>
</ul>
(*For CNU the CC’s finance rate is calculated using 50:50 debt:equity in line with its contract with the Crown, where (1) the cost of debt is based on an estimate of senior and subordinated debt costs with the mix in line with the Crown contract, and (2) the cost of equity is based on a 75% weighting to our benchmark cost of equity and 25% weighting to the benchmark cost of debt.)
CNU is a long-dated business with substantial operating and financial leverage, and therefore, any assessment of the company’s fundamental value can vary materially depending on the CC’s input methodologies and, ultimately, on the MAR its UFB network is able to earn. This will not be finalised until 3Q/4Q CY21. As such there remains an inherently high margin of error in any CNU valuation, but all-else-equal the changes above are positive.
Matt Henry &nbsp;CFA Head of Wealth Management Research
<figure class="editor-figure mceNonEditable"><img src="https://mail.google.com/mail/u/0?ui=2&amp;ik=f57c39853c&amp;attid=0.1&amp;permmsgid=msg-f:1680382066373021673&amp;th=1751ea961919cfe9&amp;view=fimg&amp;sz=s0-l75-ft&amp;attbid=ANGjdJ_b-lrpai7O6ePTgNPWwKxhsHcfEh2m91f65yPQJk-tM698YdJdRrbnJkOaZMZx2NJM3VogYZqoEWdJsJMFmQ06j_64eVDN-ptv_DCOHEj8gx--VY2mtE4nHSY&amp;disp=emb" class="editor-image img-responsive"></figure>
M: +64 21 329 291 |P: +64 9 368 0115 | TF: 0800 367 227&nbsp; Level 23, Lumley Centre, 88 Shortland Street, Auckland

Chorus Incremental regulatory wins
The Commerce Commission (CC) has released the first set of final decisions on the “input methodologies” into Chorus’s (CNU) new ultrafast fibre broadband (UFB) regulatory regime.
The reports total c.960 pages. At this early stage, our summation is that, from a CNU perspective, the final decision is (at least) incrementally positive relative to the CC’s updated draft published in July.
The principal changes that benefit CNU are:

Marginally higher cost of capital from:

o&nbsp;&nbsp;Asset beta:&nbsp;Increased to 0.50, from 0.49 (and the original 0.46).
o&nbsp;&nbsp;Debt premium:&nbsp;BBB, revised from BBB+.
o&nbsp;&nbsp;Gearing level:&nbsp;The above benefits are offset by lower assumed gearing of 29%, from 31%.

Crown financing: The benefit of the Crown financing is to be deducted in the determination of the “maximum allowable revenue” (MAR) CNU is able to earn on the UFB. The CC now proposes to calculate this benefit at a (lower) “finance rate”* cost vs. previously at WACC. We have not yet calculated the materiality of this beneficial change to CNU.

(*For CNU the CC’s finance rate is calculated using 50:50 debt:equity in line with its contract with the Crown, where (1) the cost of debt is based on an estimate of senior and subordinated debt costs with the mix in line with the Crown contract, and (2) the cost of equity is based on a 75% weighting to our benchmark cost of equity and 25% weighting to the benchmark cost of debt.)
CNU is a long-dated business with substantial operating and financial leverage, and therefore, any assessment of the company’s fundamental value can vary materially depending on the CC’s input methodologies and, ultimately, on the MAR its UFB network is able to earn. This will not be finalised until 3Q/4Q CY21. As such there remains an inherently high margin of error in any CNU valuation, but all-else-equal the changes above are positive.
Matt Henry &nbsp;CFA Head of Wealth Management Research

M: +64 21 329 291 |P: +64 9 368 0115 | TF: 0800 367 227&nbsp; Level 23, Lumley Centre, 88 Shortland Street, Auckland

Chorus Ltd

Chorus: Incremental Regulatory Wins