Ten days ago Ofcom published a lengthy consultation on charge control for Wholesale Broadband Access, accompanied by a report from the Brattle Group on BT’s equity beta.
Wholesale broadband access is the ‘current generation’ (i.e. primarily DSL) wholesale broadband access products sold by BT to its retail competitors. Ofcom’s most recent review of this market geographically segmented the UK into four distinct regions:
- local exchanges where only BT is present (“Market 1”);
- local exchanges where in addition to BT, two of BT’s material competitors are present or forecast, or where three of BT’s material competitors are present or forecast but BT’s market share exceeds 50% (“Market 2”);
- other local exchanges where BT is present that are not in Market 1 or 2; and
- Hull (where only Kingston Communications is present).
Ofcom’s market review found BT to have market power in Markets 1 and 2 and Kingston Communications to have market power in Hull. In addition to various other remedies imposed by that review, Ofcom proposed a charge control on BT in Market 1 – hence this most recent consultation.
The consultation proposes to control the charge for BT’s 8 MBits/s IPStream Connect product only, on the basis that this comprises 86% of the product actually sold and that it will act as both a direct control and indirect constraint. Ofcom proposes a three year RPI-X control, with X set so that by the end of the charge control period, BT is expected to be able to earn a level of return on the basket of services that is equal to its weighted average cost of capital. This objective of course requires Ofcom to form a view on BT’s cost of capital – hence the Brattle report.
The Brattle report contains both:
- an analysis of BT’s equity beta based on a regression of daily returns for holding stock in BT and from holding a broad market index; and
- comparisons against two control groups, being other UK regulated utilities and publicly traded US telecoms stocks.
The Brattle analysis identifies BT’s one-year equity beta to be 0.96 and two-year equity beta to be 0.84. This is higher than other UK regulated utilities and the report speculates that BT is not considered quite as ‘safe a haven’ as UK utilities. By contrast, BT’s beta is in-line with the estimates for the US stocks considered.
Section 6 of the Ofcom consultation then take into account both the Brattle analysis and other factors (primarily lower interest rate and corporation taxes and a reduction in the perceived riskiness of BT) to come up with revised estimates for BT’s cost of capital. These estimates are lower than those made previously in May 2009 as can be seen:
- Openreach: May 2009 mid-point WACC 10.1% , proposed 2011 mid-point WACC 8.6%;
- BT Group: May 2009 mid-point WACC 10.6% , proposed 2011 mid-point WACC 8.9%;
- Rest of BT: May 2009 mid-point WACC 11% , proposed 2011 mid-point WACC 9.3%.