Will Chorus gobble up Enable? Analyst gives his view

In part two of a Q and A with analyst Geoff Zame he discusses Chorus, the demand side of UFB and tech stocks

In part two of our Q and A interview with Geoff Zame from Craigs Investment Partners he talks to Sarah PUtt about Chorus, demand issues with fibre networks and tech stocks.

Mark Ratcliffe has been the one credited with getting the UFB deal though and he’s now CEO of Chorus. That’s a big step up from being CEO of a division. How does the market view that transition?

Ratcliffe was one of the more experienced executives, so he’d been in the business a long time in many different roles. The truth is that we have yet to hear from them in an official context, Chorus hasn’t really come out with a lot of information to date. We anticipate an investor day in April, which would be when he addresses the market officially.

But I would argue that most people would see him as a fairly safe pair of hands given his previous experience. The difference now is that he’s responsible for a full NZX listed company. He’s responsible for the capital structure of the business, the funding, and ensuring that he can deploy, keep the CAPEX at a level which enables them to generate some reasonable returns for shareholders.

It’s a much wider role but it’s a great opportunity, not just for Mark but for a whole suite of executives, to have that listed exposure.

Do you see Chorus gobbling up Enable Networks in Christchurch?

I can’t see anything happening in the short term personally but it’s anybody’s guess in the longer term. There’s obviously merit in the two of them working closer together but given the funding construct there’s no urgency on Enable’s part. I would say things would probably come to a head in five to six years down the track, when you really have some of the network deployed and you can see what the uptake is like.

The thing to remember in those situations - where Chorus is competing in places like Hamilton, Tauranga and Christchurch – it’s as much about what happens with Telecom as it is about what happens with Chorus. If Telecom’s customer base chooses to migrate to fibre then that will ultimately dictate the success, or otherwise, of that competing infrastructure.

So as much as we’d like to talk about Chorus and Enable, the industry is now vertically disaggregated so what happens at the retail level is really important to what happens at the infrastructure level.

It was conventional wisdom that Chorus got loaded with all the debt in the split - it got all the public money as well - is that (the debt) an issue?

I don’t think it’s an issue. As Telecom itself says, they optimised the Chorus balance sheet and I’d argue their (Chorus) debt levels are quite manageable. Yes they did receive the lion’s share of it but their debt levels are still manageable and they’ve still got plenty of debt head room, so I don’t think that’s much of an issue.

The quid pro quo is it did leave Telecom in a very comfortable position – there are longer term question marks about Telecom’s ability to compete in a competitive retail environment, but they have a very good starting position because they’ve got a great deal of operating profit and a pretty under-geared balance sheet. So they are well placed to compete in a more competitive market.

The Commerce Commission recently had a conference around demand – is that a problem, migrating customers from fibre to copper?

The jury is out and conferences and talkfests aren’t necessarily going to solve the problems. But there are some constructive elements to it such as the potential costs to connect and all that sort of thing. The Commission’s work has highlighted through some surveys and things that there are question marks over the propensity for people to pay for high value services. By the same token as we know, people don’t know what they want until you give it to them.

Then you talk to the ISPs about people’s propensity to pay and that actually differs from what the survey says and I’d probably argue that the survey of the ISPs are closer to the truth in terms of what they think their customers might be able to accommodate. Initially, depending on the offers that come to market, take up might be slow.

I still think that the 20 percent threshold for Chorus by 2020 to achieve the more favourable funding structure is quite achievable. And what we’re going to experience is a very long transition from copper to fibre. Nothing is happening overnight. There’s a lot of noise but the number of premises being deployed on an annual basis will eventually ramp up to 100,000 a year and from that there will some take up. It’s happening progressively and arguably fairly gradually over a decade. While there are question marks around demand now, the bigger issues are around execution of the project.

A lot of talk about Sky TV, and content and regulation in that area – how will the market view regulation of content?

I don’t see anything that’s broken in the content space. Yes Sky TV has secured some premium content, particularly in terms of sport but that’s just a function of a strong business model which is benefiting NZ and all of our sporting codes. That content is available over the internet anyway. I don’t see it as a show stopper but clearly it’s an area that will continue to be explored.

How would you characterise the state of tech or ICT-type stocks on the NZX today?

The NZX is not in great shape and there is plenty of literature on that, in terms of the number of companies that come to market across any sector, let alone the tech sector.

There are stocks like Rakon, Xero and Diligent. In theory there aren’t any barriers to entry, particularly in the tech/digital space relative to other mature industries. Trademe is another example of a company in the tech/digital media space.

And businesses are emerging all the time. Grabone within the APN stable is obviously another good example of a NZ company replicating something offshore and growing rapidly.

Whether it’s tech or any other sector, the capital market development taskforce paper outlined what’s needed to fatten the pipe of new listings. It’s partly a supply and demand issue. It’s partly about improving the savings culture industry and it’s partly about encouraging companies to list by making it easier.

It is quite a leap to seek capital in the markets because you do open yourself up to a level of transparency that you don’t have when using private investment.

It does place a whole new set of requirements on businesses and some find that really difficult, the disclosure and obligations to report externally regularly and interact with the market. There are issues to managing all of that. But there is also an enormous amount of benefit in terms of your ability to raise equity cheaper to grow the business. What it can do for the profile of the business and so forth.

Why should entrepreneurial tech start-ups consider an IPO?

Even a commitment to list may help secure early stage funding to grow a business. Listing brings visibility, transparency, profile to a business (e.g. Xero, Diligent) and this brings more opportunities for growth and Merger and Acquisition. Also, listed companies tend to trade on higher multiples to unlisted companies and it can help with executive/staff retention.

* See part one of this Q and A interview with Geoff Zame here.

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