Will Telecom unbundle?

The Ernst & Young Australia report into Chorus is not a review of Chorus's financial position, despite some media reports that would suggest that's what's happening. Rather it's a review of the impact the Commerce Commission's UBA and UCLL determinations will have on "key Chorus financial indicators".

The short answer is, naturally enough, yes it will.

I know of no business, regulated or otherwise, that wouldn't have some impact with a reduction in its incoming revenue.

On top of that, the review is explicitly barred from looking at Chorus's own "strategic choices" especially those that "may have led to higher capital expenditure than initially forecast."

That’s quite a limiting factor – especially if you think that Chorus’s problem is largely nothing to do with the Commission’s determination but rather is a matter of cost blow-outs in the rollout itself.

So what will the review look at, because without all of that it's going to be hard to come up with any result beyond "OMG, the ComCom is to blame".

One of the main factors in the report will have to be the counter-factual Ernst and Young comes up with.

The counter-factual is the “what if?” scenario. What would have happened if the Commerce Commission hadn't reduced the price? With the counter-factual to hand, we'll be able to determine the net difference in pricing regimes.

Incidentally, the government isn't waiting for this and has already directed Crown Fibre and Chorus to sit down together to renegotiate the UFB deal.

That may be the right thing to do at this point. I'm hard pressed to support yet another closed-door secret back room deal (they tend to have severe unintended consequences for the industry and the users, to put it mildly) but given the government isn't looking to reduce its requirements or increase the money being paid out, I presume the discussions will revolve around payment schedules, bank guarantees and the like.

I trust any such agreement comes with severe caveats around both the Final Pricing Principle review and the high court legal action Chorus is taking, not to mention certain performance criteria and a new dividend policy, but that’s just me.

Let's look at the counter-factual and the elephant in the room that nobody has mentioned.

On December 14 next year, Telecom will be allowed to unbundle Chorus's network.

(EDIT: An earlier version of this post said Telecom could unbundle at the end of the year)

As part of the separation agreement, Telecom has been excluded from being able to unbundle Chorus's network.

Telecom retains the lion's share of the fixed line broadband market and the belief was that Telecom would be able to sweep in, unbundle on a massive scale and undermine Chorus's ability to earn any money from the UBA component of its copper network.

The issue of whether Telecom wants to unbundle or not remains a key consideration for both Ernst and Young and Chorus.

If the UBA price is too high, Telecom will spend the money and unbundle, dramatically cutting Chorus's earnings. Never mind the impact of the Commission's determination, if Telecom took its 50% market share to an unbundled service, Chorus would lose everything.

Telecom doesn’t necessarily want to blow $50m or more on the copper network when it’s gearing up to fight a fibre war. It would rather spend its money on content and services that drive customers to the fibre network and reap its rewards in the longer run.

The question for Ernst & Young is: how high is too high? At what point would Telecom have moved to unbundle? It will have to work that out to produce a counter-factual that actually makes sense. If it just takes the existing regime and compares that with the new UBA price, it will have failed in its mission to provide a comparable counter-factual because despite the rhetoric from both Chorus and the government, there’s no going back to the old numbers.

The retail-minus model has always produced results that mean New Zealanders pay too much for broadband. Moving to a cost-based model was always going to be a shock to the system but nothing like the shock that could still come from half the market moving to an unbundled provider.

The report is due out shortly and we’ll be able to see what E&Y make of all this. Hopefully the negotiations between Crown Fibre and Chorus will result in an amicable agreement and we can put this sorry year behind us and get on with rolling out the future in a more rational, sober way.