Moody's downgrades Chorus

Rating agency says Chorus's bank covenants could be breached in 2015 if efforts to alleviate the impact of regulatory decisions do not succeed.

Moody’s Investors Service has downgraded New Zealand network operator Chorus’s credit rating from Baa2 to Baa3, with negative outlook.

The downgrade comes after regulator the Commerce Commission determined it would cut the wholesale price Chorus can charge internet service providers for copper-based broadband access by 23%.

Such copper services are the bulk of Chorus' income and will remain so until New Zealanders migrate to the company's new Ultra Fast Broadband (UFB) network, which is still being rolled out.

"The downgrade to Baa3 reflects the material impact on Chorus's credit profile of [Commerce Commission] regulatory decisions as well as higher capital expenditure and operating expenses compared to our original expectation", said Maurice O'Connell, a Moody's vice president and senior analyst.

"In particular, the recent [Commerce Commission] regulatory decision regarding ... pricing will have an adverse impact on Chorus's financial profile, with annual EBITDA decreasing by around 20% from 2015 absent measures being contemplated by Chorus.

"As a consequence we expect adjusted financial leverage, measured as debt/EBITDA, will likely exceed the tolerance level set for Chorus's Baa2 rating."

Chorus chief financial officer Andrew Carroll said the downgrade was disappointing given that the Commission’s pricing decision does not come into effect until December 2014 and while Chorus is exploring a range of initiatives to mitigate its financial impact.

The downgrade will result in an "immediate but modest" increase in the cost of Chorus’s borrowing.

“As we explained in December, we are assessing all options available to us, including cutting all discretionary activity, re-pricing commercial services, generally managing for cash and assessing capital management options," Carroll said,

Chorus is also in discussions with Crown Fibre Holdings, the government company administering the UFB contract.

Chorus has also appealed the Commission’s decision to the High Court and requested that it undertake economic cost modelling of pricing, a different approach from its original benchmarking.

Moody's acknowledged Chorus's focus on mitigating the adverse impact.

Nevertheless, it said it expects leverage to increase as the fibre rollout continues with adjusted debt/EBITDA expected to approach 4.5 to 5 times within three to four years,  considerably higher than Moody's original expectation and not consistent with a Baa2 rating.

Moody's noted bank financial covenants would be breached in 2015 in the event Chorus is unable to alleviate the impact of the regulator's decision.

Chorus's share price has more than halved since September from around NZ$3.00 to NZ$1.44 earlier today.