OUR cost of capital for telecoms understated, says Digicel - Carrier knocks regulator for ignoring reality
Citing the pandemic, Digicel Jamaica says the past trends that the Office of Utilities Regulation, OUR, has relied on are unlikely to be a reliable basis on which to forecast future levels of risk-free rates in relation to the cost of capital for telecommunications carriers.
The OUR proposed a risk-free rate of 2.26 per cent to calculate the weighted average cost of capital, or WACC, for both fixed and mobile telecommunications services, which it last revised in 2016.
The regulator calculated the risk-free rate based on the average market yield on United States 10-year Treasury bonds at constant maturity, using monthly data for the most recent five years.
In its response to the OUR’s consultation document on the WACC, Digicel Jamaica said there is significant uncertainty regarding risk-free investment in US Treasury bonds, with the yield on 10-year bonds declining from 1.8 per cent in January to 0.6 per cent in July.
Digicel said the OUR’s cited data source puts the five-year average risk-free rate at 2.1 per cent using data to July.
“Even if the office was to rely on past trends, the fact that the current rates are significantly below the rates used in the average means that the average risk-free rate will be overstated,” the telecommunications provider said.
“This is an even greater issue if one considers that the office is relying on a data sequence which ends, at best, in mid-2020 to estimate a rate which is not due to change until November 2021.”
The OUR has set the country risk premium, a measure of the specific risk associated with investing in Jamaica, at 3.42 per cent.
However, Digicel said the historical trends on which the OUR’s estimate of country risk premium are based cannot be relied upon to project forward.
It said the trends were based on stable economic conditions with improvements in Jamaica’s economy and its debt-to-GDP ratio.
The coronavirus has since derailed the country’s economic targets.
“The medium- to long-term impacts of contractions in global manufacturing and in global travel patterns, due to the COVID-19 pandemic, means that these past trends cannot be reliably used to infer future values,” Digicel said.
The telecoms said the estimate for country risk premium proposed by the OUR is likely to be a significant underestimate of the actual position over the period in which the proposed weighted average cost of capital will apply.
The OUR said the inflation parameters to be considered in the calculation of the WACC will be 4.76 per cent for Jamaica and 2.32 per cent for the United States.
Digicel pointed out that much of the progress in controlling inflation rates in Jamaica has been attributable to the strong fiscal policies together with economic growth.
However, it is clear that much of the economic progress of the past years will be unwound due to the impact of COVID-19, Digicel said.
The Jamaican Government has since estimated that COVID has taken Jamaica back about four decades, but also anticipates that some of the losses will be quickly recovered.
“The ability of the Government of Jamaica to continue its fiscal programme in light of reduced tax receipts and the need for borrowing to meet requirements for economic support in respect of COVID, and to support economic recovery, is not clear,” Digicel noted.
In Jamaica, and internationally, no one knows just how long economies will have to hunker down against the virus.
Digicel anticipates that social distancing and other virus-control measures will be protracted.
“These are likely to increase cost for businesses, feeding through into higher retail prices. While this dynamic will also be present in the United States, it is not clear if the underlying cost increases will be proportionately higher in Jamaica,” said the telecommunications carrier.
“Overall, it is premature to form a clear forward view of likely inflation trends in either the United States or Jamaica. The only thing that can be said with a degree of confidence is that the projections used by the office in the consultation are unlikely to be accurate,” Digicel added.
The OUR has posited separate WACC estimates – 10.75 per cent for fixed carriers in US dollar terms and 14.16 per cent in Jamaica dollar terms; as well as 12.63 per cent in USD and 16.09 per cent in JMD for mobile carriers.
Digicel says the estimates are understated.
“This will lead to under recovery of investment and adversely affect investment decisions in the Jamaican telecommunications market,” it said.
“These underestimates are exacerbated by the premature carrying out of the WACC review and reliance on historical trends which are not reliable inputs to future forecasts because of the uncertainty caused by the COVID-19 pandemic,” Digicel said.