Thinking beyond the WACC – the investment hurdle rate and the seesaw effect

The price cap for legacy telecoms networks impacts new investment in two important ways.

First, new networks must compete for customers with legacy networks, and so lowering the price of legacy services will reduce the price that can be charged for new ones - which in turn makes it harder to justify new investment in the first place.

Second, the treatment of legacy infrastructure will influence investor expectations on how new investment will be treated in the future - given that new investments will come to be seen as legacy over time - again potentially deterring fresh investment.

If investment in Very High Capacity Networks (VHCNs) is seen as desirable, it is therefore counter-productive to underestimate the weighted average cost of capital (WACC) for legacy networks and thereby set their pricing too low.

These issues are compounded by an approach whereby a comparatively small harmonised EU wide equity risk premium is combined with country-specific risk free rates, since this not only results in extremely low regulated returns in certain markets, but also means a divergence - rather than convergence - of investor returns across Europe.  

Brian Williamson and Stephen Howard have prepared a paper (on behalf of ETNO) considering these issues.