Tue | Sep 29, 2020

Flow opposes OUR on separation of capital costs for fixed, wireless operators

Published:Friday | August 7, 2020 | 12:09 AMMcPherse Thompson - Assistant Editor – Business
Stephen Price, managing director of Flow Jamaica.
Stephen Price, managing director of Flow Jamaica.

Telecommunications operator Cable & Wireless Jamaica, C&WJ, which operates as Flow Jamaica, is taking issue with the Office of Utilities Regulation, OUR’s, approach to estimating the cost of capital for the telecoms sector, saying it is against the demarcation of rates assigned to the different service modes.

The telecoms, which offers both fixed line and mobile services, is basically arguing that the separation would put it in a less competitive position.

The OUR has estimated the weighted average cost of capital, or WACC, for fixed-line carriers at 10.75 per cent and mobile carriers at 12.63 per cent.

Its last determination on the matter was made in 2016 and is now due to be updated.

The cost of capital is the opportunity cost of investing a portfolio of debt and equity in one activity versus alternative uses. It’s the cost of financing a company’s activities and is typically utilised in regulatory proceedings to estimate the expected return on investment in a well-functioning capital market.

The WACC refers to the average rate of return a company expects to compensate all its different investors, weighing each financing source in the company’s capital structure, which typically consists of equity and debt.

Flow Jamaica says the estimates set by the regulator will have significant implications for the industry, as the WACC for fixed and mobile licensees are critical inputs to establishing cost-based interconnection rates.

Responding to the OUR’s consultation document on the WACC, the telecoms said there is no economic basis for the cost of capital for fixed and mobile networks to be different, noting that the scope of service offerings from operators in Jamaica include both a mix of wireline/wireless and fixed/mobile services.

It said that with Digicel having deployed a wireline fibre network, technology convergence for telecommunications is a reality in Jamaica today, and the companies sourcing capital in Jamaica for investment will be viewed as having similar service portfolios.

Second, the near future will witness even greater convergence as technologies become increasingly seamless, Flow said, adding that the ability of consumers to transition between fixed services, Wi-Fi and mobile services is no longer a perk but a competitive advantage, if not a requirement for operators.

“Thus, even if there were some risk difference between investing in a mobile and a fixed network, the entities deploying networks in Jamaica today are no longer distinguished along the lines of the two technologies,” the telecoms said.

It’s also arguing that technological differences are not a logical basis for delineating the cost of capital, and where it is separated, the bias should be on the side of the fixed-line network.

“Indeed, given the uncertainty concerning fixed broadband take-up, it could be argued that the cost of capital of fixed access networks is increasing and will be higher than that of mobile access networks,” Flow said.

However, its position is that only one WACC estimate should apply to the sector “in order to promote efficiency and provide a level playing field”.

Its main competitor, mobile service provider Digicel Jamaica, disagrees and is on board with the demarcation.

“While there has been some consolidation into multiplay fixed and mobile offerings since the last consultation in 2016, the investment profile of both services remains distinct,” Digicel said.

Both companies offer mobile, as well as Internet and cable services.

C&WJ said it also disagrees with the OUR’s approach to estimating the market risk premium. The market risk premium, also referred to as the equity risk premium, corresponds to the difference between the returns expected from equities and the return expected from risk-free assets such as long-term bonds.

“If the OUR chooses to apply the market risk premium estimate, then we urge the OUR to select the lower bound estimate of 4.66 per cent instead of the average of 4.66 per cent-6.26 per cent in order to counteract this overestimation bias,” it said.

In its response to the consultation document, Digicel said the fact that the OUR has carried out the exercise of estimating the cost of capital for both fixed and mobile and has arrived at a different answer, indicates that the investment parameters are not sufficiently aligned to move to a single sectoral WACC.