Valuation of infrastructure assets got an airing in Supreme Court litigation closing out a long running dispute over the cost to Telecom of providing uneconomic residential phone coverage. The court ruling will impact on pricing policies for utilities enjoying natural monopolies such as airports, power, gas and water. The Supreme Court frowns on revaluation of legacy assets, saying this results in windfall gains for the owner leading to unjustified retail price rises.
There has been no love lost between Vodafone and Telecom in arguments over the cost to Telecom of its former statutory obligation to provide a “free” telephone service to all residential customers. The two telcos have held over 90% of the market between them. Over the years, Vodafone has been obliged to pay Telecom millions of dollars as compensation for Vodafone’s share of the subsidised cost of a residential service to uneconomic customers. Not surprisingly, this has lead to tortuous litigation over the methodology used by the Commerce Commission to determine Telecom’s cost of providing infrastructure assets used by Vodafone and other telcos to service their customers.
Telecom is to be set free as a stand alone retailer following the establishment of Chorus as the infrastructure operator. Telecom was forced to settle all outstanding legal disputes with Vodafone so it could clean up its balance sheet prior to the Telecom/Chorus demerger.
Despite Telecom and Vodafone reaching a confidential commercial settlement ending their disputes, the Commerce Commission had to see the long running litigation through to its end in order to get some finality on rules governing the valuation of Telecom’s infrastructure assets.
Asset valuations feed into formulae used to determine the rate of return on infrastructure assets and have an impact on retail prices. In common use are ORC (optimised replacement cost) and ODRC (optimised depreciated replacement cost).
ORC is the present-day cost of acquiring an asset to provide efficiently a specified quantity and quality of service. Replacement cost is based on current market values, taking current technology into account.
The Supreme Court warned against distortions caused by artificially revaluing old assets which were in reality not likely to be replaced or improved. It is not appropriate to attribute a modern equivalent value to an old asset which is not actually being replaced, said the court. This has the effect of artificially inflating the value of the asset, providing a windfall in the terms of an increased capital base resulting in a “free lunch” equal to the amount of the upward revaluation.
In the Telecom case, the Supreme Court said the Commerce Commission erred in its valuation of Telecom’s infrastructure assets by inappropriately increasing the value of its legacy copper fixed line network and by not allowing in its valuation for replacement of uneconomic parts of the fixed line network with the cost of an alternative mobile phone service for geographically isolated customers.
Vodafone v. Telecom – Supreme Court (17.11.11)
11.11.003