Infrastructure Investment in Jersey Telecom Group Limited and Reduction in Dividends: Gigabit Jersey (PtP)

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A decision made on 09 December 2011:

Decision Reference: MD-TR-2011-0139
Decision Summary Title:	Infrastructure Investment in JT and reduction in dividends – Gigabit Jersey (PtP)		Date of Decision Summary:	7 December 2011
Decision Summary Author:	Treasurer of the States		Decision Summary: Public or Exempt?	Public
Type of Report: Oral or Written?	Written		Person Giving Oral Report:	N/A
Written Report Title:	Infrastructure Investment in JT and reduction in dividends – Gigabit Jersey (PtP)		Date of Written Report:	7 December 2011
Written Report Author:	Treasurer of the States		Written Report : Public or Exempt?	Public Appendix D Exempt 3.2.1 (a) (x)
Subject: States of Jersey Currency Fund Infrastructure Investment in Jersey Telecom Group Limited (JT) and agreement to offer a £3 million reduction for each of 2013-2015 financial years to JT to assist in the financing of Gigabit Jersey Point-to-Point (PtP).
Decision(s): The Minister decided to:- approve in line with the current Investment Strategy for the Currency Fund, a £10 million, Infrastructure Investment in JT to provide financing for the Gigabit Jersey project subject to the agreed conditions as detailed in the report. The infrastructure investment to take the form of a 2.5% Redeemable Preference Share instrument. agree to a dividend reduction of £3m for each of the 2013 to 2015 financial years (inclusive) subject to review at the AGM and the half yearly review for each of the financial years.
Reason(s) for decision: The Public Finances (Jersey) Law 2005, Article 6 (paragraph 1(a) and 3) relates to the investment of monies of the Currency Fund being carried out in accordance with the Regulations. Under the Public Finances (Transitional Provisions) (No.2) (Jersey) Regulations 2005, Regulation 4, the Minister is responsible for presenting the Investment Strategies and any review of them to the States, as soon as practical. Furthermore that monies may be invested in the extent and manner set out in the last Investment Strategy presented to the States. Therefore the proposal for the Currency Fund’s Infrastructure Investment in JT is made in line with the most recent Investment Strategy presented to the States on 31st October 2011 (R132/2011). The Public Finances (Jersey) Law 2005, Article 68 (2) relates to the Minister being responsible for the States for financial Interests in the Strategic Investment companies, including JT. The Minister for Treasury and Resources commissioned Oxera, the States of Jersey’s external economic consultants, to evaluate JT’s proposal to replace the existing copper network with a complete island wide point-to-point (PtP) Fibre-optic network. The report made comparison between the PtP and the Very high bitrate Digital Subscriber Line (VDSL) alternative options. Oxera recommended that in the interests of the shareholder, JT should adopt the PtP strategy rather than VDSL as it was a sound investment, thus protecting shareholder value. Officers of Treasury and Resources Department have also reviewed the business case in detail. Further, Gigabit Jersey is a project which is acknowledged would provide an initial stimulus to the economy and overarching longer term benefits to the Island of Jersey. JT made a presentation to the Council of Ministers on 27th October 2011 where they considered the project and the proposed financing for the project.
Resource Implications: This decision will see the transfer of £10 million from the Currency Fund during 2012 and a £3 million dividend reduction for each of JT’s 2013 to 2015 financial years (inclusive), impacting the Consolidated Fund Investment returns.
Action required: Head of Shareholder Relations to arrange for the Treasurer and a Director of States of Jersey Investments Limited to approve and sign the JT Special Resolutions (Appendices B and C). Head of Shareholder Relations to notify JT Group of the decision to give a dividend reduction for three financial years, subject to the conditions set out in the attached report.
Signature:		Position: Senator P F C Ozouf, Minister for Treasury and Resources
Date Signed:		Date of Decision:

Infrastructure Investment in Jersey Telecom Group Limited and Reduction in Dividends: Gigabit Jersey (PtP)

Treasury and Resources

Ministerial Decision Report

iNFRASTRUCTURE INVESTMENT IN JT GROUP AND reduction in dividends – Gigabit Jersey (PTP)

Purpose of Report

To enable the Minister to consider the proposed Currency Fund Infrastructure Investment in Jersey Telecom Group Limited (JT) and the proposed 2013-15 financial years dividend reductions from JT to assist in the financing of the Gigabit Jersey project (PtP).

Background

The Public Finances (Jersey) Law 2005, Article 6 (paragraph 1(a) and 3) relates to the investment of monies of the Currency Fund being carried out in accordance with the Regulations. Under the Public Finances (Transitional Provisions) (No.2) (Jersey) Regulations 2005, Regulation 4, the Minister is responsible for presenting the Investment Strategies and any review of them to the States, as soon as is practical. Further that monies may be invested in the extent and manner set out in the last Investment Strategy presented to the States. Therefore the proposal for the Currency Fund’s Infrastructure Investment in JT is made in line with the most recent Investment Strategy presented to the States on 31st October 2011 (R132/2011). Additional Information about Infrastructure Investments and the Currency Fund’s infrastructure Investment is shown in Appendix A.

Under the Public Finances (Jersey) Law 2005, Article 68 (2) relates to the Minister being responsible to the States for financial Interests in the Strategic Investment companies, including JT.

Under the Memorandum of Understanding (MOU) between the Minister for Treasury and Resources and Jersey Telecom, the objectives are:-

2.1 In its business operations Jersey Telecom aims to:

be as profitable and efficient as comparable telecommunications businesses that are not owned by the States of Jersey; and
enhance the long term value of the shareholder’s investment in the company and deliver sustainable returns to the shareholder comparable to telecommunications businesses that are not owned by the States of Jersey; and
be a good employer; and
be responsive to the wider interest of Jersey’s Island community within the framework of any license under which it operates. For the purposes of this objective, responsiveness will be measured by reference to the fact that a significant portion of the island’s residents are likely to be included in Jersey Telecom’s customer base and therefore the interests of customers will be closely aligned to the prosperity and well-being of the island.

The proposal arose as a result of discussions at the annual general meeting and further meetings to discuss the various Gigabit Jersey Project and the alternatives.

Proposal to support the JT Group Gigabit Jersey project.

Oxera Report

The Minister for Treasury and Resources commissioned Oxera, the States of Jersey’s external economic consultants, during July 2011 to evaluate JT’s proposal to replace the existing copper network with a complete island wide point-to-point (PtP) Fibre-optic network. The report made comparison between the PtP and the Very high bitrate Digital Subscriber Line (VDSL) alternative options. Analysis was carried out from a shareholder perspective to see if PtP was a sound investment.

Oxera looked at the business case and changed some of JT’s original business case financial assumptions to what they believed were more likely future outcomes which could be achieved. On that basis Oxera calculated that the option to move to a PtP Fibre project would have a positive NPV relative to the VDSL project and be a better option from a shareholder perspective.

The report did not address the following:-

The implications of the various financing options available in order to finance the difference in project costs between the PtP (£41.5million) and VDSL (£21.5million).
Possible wider socio-economic benefits PtP fibre option could possibly deliver.

A summary of the main findings of the report were:-

The point-to-point (PtP) fibre network appeared to offer a superior return on the necessary capital investment compared with the VDSL option. Therefore it was recommended, that it was in the interests of the shareholder and JT to adopt the PtP strategy rather than VDSL.
Although higher investment is required in the short-run under PtP fibre, this would likely be offset by lower operational expenditure and lower future capital investment as VDSL would be required to be renewed more regularly. Further PtP provided the opportunity to achieve marginally higher revenues from the ability to supply services with very high bandwidth.
In terms of the viable alternatives, the PtP fibre option was preferred to the VDSL option in overall financial terms. This was without factoring in the wider socio-economic benefits, which are difficult to quantify.

As already mentioned, the Oxera report did not address the wider socio-economic benefits but advice from the States’ Economic Adviser indicates that these could be wide ranging and come through a number of different channels. These benefits are not necessary to justify the investment in PtP fibre from a shareholder perspective and are difficult to quantify but are likely to be in the following areas:-

There would be an initial stimulus to the economy from delivering £41.5million over 11 years with; the majority of expenditure occurring during 2012 to 2016 against the backdrop of a difficult economic climate. Perhaps even more exciting are the potential economic spin-offs in a whole host of areas that could accrue by being one of the first truly Gigabit economies.
Public service delivery - superfast broadband should revolutionise the way certain public services are provided, from healthcare to education and energise future phases of the Comprehensive Spending Review.
The objectives of the new Economic Growth Strategy could all be underpinned by superfast broadband that will help to improve productivity and competitiveness for existing businesses within financial services and other key sectors such as tourism, construction, retail and agriculture.
Island-wide super-fast broadband speeds would create an innovative new environment for e-commerce entrepreneurs to establish new and thriving businesses.
New inward investment will be attracted to the Island by one of the fastest broadband services in the world, supporting new job opportunities and diversification.
New opportunities will be created for Islanders in terms of online entertainment, energy use, ways of working, the ways we interact with each other/people outside the Island and community engagement.
If the Island was to remain reliant on copper wires then not only could all these potential benefits be lost, but the Island’s future information and communication technology requirements would not be met which would only serve to undermine economic growth and competitiveness.

Jersey Competition Regulatory Authority (JCRA) view

JT have advised that they have been in contact with the JCRA with regard to the PtP project and can confirm that the Executive Director of the JCRA, has been specific in stating that a decision to proceed with the programme does not require approval from the JCRA and from his perspective it is simply a different type of access network (fibre instead of copper) used to deliver telecom services (albeit ones that are of a higher quality and speed). Further, the set of regulatory obligations that currently apply to JT, in terms of ensuring that the other licensed operators are treated equivalently and on a fair and equal basis to JT's own retail operation, remain irrespective of the access network and there is a firm commitment from JT in the business case to ensure full compliance with all such obligations.

On the 12th October the JCRA sent a letter to the Ministers for Economic Development and Treasury & Resources which confirmed the above view when it stated:

“Provided that the new FTTH [Fibre To The Home] network does not pose a risk to the quality of service, there is no basis in JT’s licence or the Law for the JCRA to object to a change in the technology used to deliver fixed-line telecoms services.”

The letter also set out their view of factors the States should consider both in relation to the States’ capacity as shareholder and also a promoter of long-term economic development in Jersey.

JT have further advised that there are no obligations arising under the terms of the Competition (Jersey) Law 2005 in regard to authorisation or pre-authorisation of the proposals as they relate to Gigabit Jersey on the matter of rollout, funding or anything else.

Officers of Treasury and Resources Department Review of the business case

Officers of Treasury and Resources Department have reviewed the business case in detail and taken into account the concerns raised by the JCRA and Cable and Wireless and equally considered JT’s responses. It is believed that the business case profits and operational costs are very conservative, with income being lower than anticipated after discussions with JT Senior Management. Therefore it is believed that the financial case presented to the board was conservative and we expect higher than forecast dividend returns.

It is recommended that the financial case should be kept under review twice a year, at the time of the AGM and the presentation of the half year financial results and that this become one of the conditions of providing financial support.

Financial Support for Gigabit Jersey

As Oxera recommended that in the interests of the shareholder, JT should adopt the PtP strategy rather than VDSL as a sound investment, various financing alternatives have been evaluated. The following approach is proposed:-

The Currency Fund is deemed to be the most appropriate vehicle for providing funds. For further information about Infrastructure Investment see Appendix A.
In accordance with the revised Investment Strategy for the Currency Fund recently published, to offer an Infrastructure Investment (in the form of a redeemable preference share) to JT for the value of £10m to be issued during 2012.
- It is recommended that this be in the instrument form of a redeemable preference share, to be offered at a rate of 2.5%. The rate exceeds the current long term cash returns of the fund (1.96%), maximising investment returns for the fund whilst offering diversification of Investment Asset Classes. Further, this investment will produce absolute returns for the Currency Fund and will provide a good mix of investments for the fund within the agreed risk profile. In line with the Investment Strategy, it is mindful that there should be a balance between risk and return for the Fund; absolute returns are an important factor as the Fund should not carry much risk as it backs the Jersey currency. Higher rates of return than the 2.5% can be achieved for the Currency Fund from its allocations to equities. However rates of return than 2.5% have been achieved in recent years from allocations to cash. The preference shares provide a guaranteed rate of return from a company that in any event is 100% owned by the States.
- It is important that the preference share is redeemable by both parties in order to maintain liquidity of the Currency Fund, however there is an appreciation that these monies would not oridinarily be required to be recalled in the short term (known as the “Investable balance”). Should the States need to redeem the preference share JT would need to source alternative funding from the market.
- Further, this will ensure that ultimately the States, as 100% owner of JT, will benefit from all potential income returns for JT Group rather than the company entering into new loans at potentially higher interest rates with external parties, therefore potential eroding shareholder dividend returns.
To offer a £3 million dividend reduction for each of the 2013 to 2015 financial years (inclusive). In accordance with the current dividend policy, JT Group should continue to calculate the ordinary dividend at 50% of each year’s PBT and then reduce the annual amount by £3 million in each of the years. It is planned that the £3 million dividend will be split equally between the interim and final dividends. This will affect consolidated fund cash flows in calendar years 2013 to 2016 but this can be planned for and managed through the States’ Medium Term Financial Plan.
Further, it is proposed that annually the future years financing requirements, in relation to the reduction of the dividends, be reviewed at the same time as the annual board meeting to discuss the annual business plan. This will consider whether a reduction in the dividend is still required dependant on forecast profits and cash flows compared with the initial financial forecasts provided by JT Group. JT Group has undertaken not to draw down funds that it does not need.
By providing shareholder support to JT Group this should protect and grow the value of the States’ Strategic Investment and support the Gigabit Jersey project which will have wider island economic benefits, as discussed above.
As shareholder the Treasury also has to have regard to the possible consequences of JT not investing in the proposed fibre optic network. JT has advised that the current network has a limited life and substantial additional investment would, in any event, be required by around 2015. The potential for the value of JT to fall if, as a technology led business, it fails to maintain its competitive edge, is a concern.

The cash flow requirements for the total PtP project and phasing for the States of Jersey financial support are as follows:-

Table 1

£’m	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021	TOTAL

Total Capital Expenditure	2.5	10.4	9.0	6.7	5.8	5.5	0.8	0.2	0.2	0.2	0.2	41.5

Financing from States of Jersey
- Infrastructure Investment		10										10.0
- Dividend reduction (1)			1.5	3.0	3.0	1.5						9.0

Financed from JT
	2.5	0.4	7.5	3.7	2.8	4.0	0.8	0.2	0.2	0.2	0.2	22.5

(1) For Financial years 2013, 2014 and 2015 each Interim dividend will be reduced by £1.5m and each Final dividend will be reduced by £1.5m . Therefore there will be a difference in cash flow timings impacting calendar years, compared to financial years.

Conditions for Financial Support for Gigabit Jersey

The following conditions are recommended to form part of the agreement with JT, when providing financial support for the project:-

JT to submit a revised Business Plan to Treasury by 31.3.2012 in order to order to monitor the Gigabit latest project costs. It should reflect all anticipated cost savings and revised pricing and should not be prepared on a conservative basis.
JT to agree to cooperate with the JCRA to ensure the fibre network is accessible to other operators on a fair, equivalent and auditable basis.
JT to provide quarterly valuations for the draw downs and confirm that the £19 million capital provided will only be used for the purpose of the Gigabit project.
JT to agree to work with Economic Development Department on Digital Jersey to maximise the economic benefit to Jersey.
JT to review the Business Plan with its shareholder (100% owned - States of Jersey) twice a year, at or near to the time of the AGM and the presentation of the half year financial results.
JT to agree to not change its basis for depreciating the capitalised asset unless it receives such a recommendation from its auditors and after having informed the Minister of such a recommendation.
JT to agree to establish a number of apprenticeships, bursaries and job placements for under 24 year olds in support of the States’ objective to get local people into work.
JT to notify the Minister of any significant changes to the Business Plan.

Details around the issue of £10 million 2.5% Redeemable Preference Shares

Based on discussions with JT and the Law Officers’ Department, they have advised that in order for JT to issue the new preference shares to the Currency Fund, the Shareholders are required to approve and sign the following documents:-

The Treasurer and a Director of States of Jersey Investments Limited to approve the amendment of the articles of association of JT Group Limited to allow the issuing of the new preference shares and various terms around the redemption of the new shares. (Appendix B)
The Treasurer and a Director of States of Jersey Investments Limited to approve a special resolution for JT Group Limited to issue £10 million 2.5% redeemable preference shares as set out in the Articles of association. (Appendix C)

The Treasurer and the States of Jersey Investments Limited (a States of Jersey owned holding company) are sole shareholders of JT Group Limited.

Advice has been sought from the Law Officers’ Department over the Currency Fund’s ability to issue Infrastructure Investments; the proposed preference share instrument and the above resolutions and the advice supports the actions proposed.

Further consideration is required in relation to the accounting for the new Currency Fund’s Infrastructure Investments.

Impact of reduction in dividends in 2013-5 on the States of Jersey Consolidated Fund

An analysis has been carried out to look at the impact of providing £9 million financing, by way of dividend reduction, on the Consolidated Fund. Revised financial forecasts for dividend returns for JT Group are not yet available as work is in progress to look at the full business case for the company as part of a wider review of their capital structure. Treasury continues to manage the overall budget which includes covering the proposed reduction in the JT dividends.

In summary the Currency notes and Coinage fund should benefit from increased income returns of £100k for 2012 and £40k each year thereafter compared to previous forecasts. Ultimately these increased returns will benefit the consolidated fund.

A summary of the cash impacts on the Consolidated fund are as follows:-

Table 2

£’m	2012	2013	2014	2015	TOTAL
JT Dividend return
Prior forecast–Draft budget 2012-14	9.02	9.25	10.55	10.82	39.64

Cashflow impact of a reduced dividend to assist in financing of Gigabit project(2)		(1.5)	(3.0)	(3.0)	(7.5)

Revised Dividend forecast	9.02	7.75	7.55	7.82	32.14

Currency & Coinage – increased income returns	0.1	0.04	0.04	0.04	0.22

Consolidated fund previous forecast closing balance	7	13	22
Consolidated fund revised forecast closing balance	7.1	11.64	17.68	14.72

(2) note a further £1.5m cash flow reduction in 2016 will occur for the agreed reduction in the 2015 final dividend

Presentations to the Council of Ministers and States Members

On the 27th October 2011 JT made a presentation to the Council of Minister in relation to Gigabit Jersey project following a detailed report provided to the Council of Ministers on the 12th October 2011. The Council of Ministers gave full consideration to the proposal and it was agreed that a wider briefing for States Members would be valuable.

On the 7th November 2011 JT made a presentation to members of the States of Jersey (Appendix D) and new members of the States that were elected and due to be sworn in on 14th November 2011. After the presentation was concluded there was a question and answer session. A further presentation was made to States Members on 6th December 2011.

At both meetings JT expressed their view that it was important that a decision was made quickly, in order for Jersey to gain a competitive advantage.

Recommendation

To approve financial support to JT for the adoption of the PtP strategy in the form of the Currency Fund offering an Infrastructure Investment of £10m in 2012 (redeemable preference share) and to offer a £3m dividend reduction for each of their 2013 to 2015 financial years (inclusive) subject to the conditions set out above.

In order for JT to issue redeemable preference shares it is further recommended for the Treasurer and a Director of States of Jersey Investments Limited be requested to approve and sign the JT Special Resolutions as sole shareholders of the company (Appendices B and C).

Reason for Decision

The Public Finances (Jersey) Law 2005, Article 6 (paragraph 1(a) and 3) relates to the investment of monies of the Currency Fund being carried out in accordance with the Regulations. Under the Public Finances (Transitional Provisions) (No.2) (Jersey) Regulations 2005, Regulation 4, the Minister is responsible for presenting the Investment Strategies and any review of them to the States, as soon as practical. Furthermore that monies may be invested in the extent and manner set out in the last Investment Strategy presented to the States. Therefore the proposal for the Currency Fund’s Infrastructure Investment in JT is made in line with the most recent Investment Strategy presented to the States on 31st October 2011 (R132/2011).

The Public Finances (Jersey) Law 2005, Article 68 (2) relates to the Minister being responsible for the States for financial Interests in the Strategic Investment companies, including JT.

JT has approached the Minister to agree to further investment (£10 million) and retention of dividend (£9 million) to enable JT to invest in Gigabit Jersey.

The Minister for Treasury and Resources commissioned Oxera, the States of Jersey’s external economic consultants, to evaluate JT’s proposal to replace the existing copper network with a complete island wide point-to-point (PtP) Fibre-optic network. The report made comparison between the PtP and the Very high bitrate Digital Subscriber Line (VDSL) alternative options. Oxera recommended that in the interests of the shareholder, JT should adopt the PtP strategy rather than VDSL as it was a sound investment, thus protecting shareholder value.

Further, Gigabit Jersey is a project which is acknowledged would provide an initial stimulus to the economy at a time of economic downturn and overarching longer term benefits to the Island of Jersey.

Resource Implications

This decision will see the transfer of £10 million from the Currency Fund during 2012 and a £3 million dividend reduction for each of JT’s 2013 to 2015 financial years (inclusive), this will reduce the expected level of returns to the Consolidated Fund in those years.