96-5426. Cable Television Rate Regulation; Cost of Service Rules  

  • [Federal Register Volume 61, Number 47 (Friday, March 8, 1996)]
    [Proposed Rules]
    [Pages 9411-9413]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 96-5426]
    
    
    
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    FEDERAL COMMUNICATIONS COMMISSION
    47 CFR Part 76
    
    [MM Docket No. 93-215; FCC 95-502]
    
    
    Cable Television Rate Regulation; Cost of Service Rules
    
    AGENCY: Federal Communications Commission.
    
    ACTION: Proposed rule.
    
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    SUMMARY: The Commission adopted the Second Report and Order and First 
    Order on Reconsideration in MM Docket 93-215 to refine existing cost of 
    service rules and to create final rules governing standard cost of 
    service showings filed by cable operators seeking to justify rates for 
    regulated cable services. In a Further Notice of Proposed Rulemaking 
    
    [[Page 9412]]
    (``FNPRM''), the Commission proposes use of an operator's actual debt 
    cost and capital structure to determine the final cost of capital (or 
    rate of return). The FNPRM requests comment regarding the method to 
    determine the value of equity and debt, including the use of a market 
    valuation of equity to establish the proportion of equity in an 
    operator's capital structure.
    
    DATES: Comments are due May 7, 1996. Replies are due June 6, 1996.
    
    FOR FURTHER INFORMATION CONTACT: Tom Power, Cable Services Bureau, 
    (202) 416-0800.
    
    SUPPLEMENTARY INFORMATION: This is a synopsis of the Further Notice of 
    Proposed Rulemaking in MM Docket No. 93-215, FCC 95-502, adopted 
    December 15, 1995 and released January 26, 1996.
        The complete text of this Further Notice of Proposed Rulemaking is 
    available for inspection and copying during normal business hours in 
    the FCC Reference Center (room 239), 1919 M Street, NW., Washington, 
    DC, and also may be purchased from the Commission's copy contractor, 
    International Transcription Services, Inc. (``ITS Inc.'') at (202) 587-
    3800, 2100 M Street, NW., Suite 140, Washington, DC 20017.
    
    I. Further Notice of Proposed Rulemaking
    
    A. Non-Unitary Rates of Return
    
        1. Although a unitary rate of return applied to all cable operators 
    simplifies the administrative burdens of estimating an operator's rate 
    of return, it squeezes a wide variety of risk profiles into the same 
    regulatory box. We tentatively conclude that risk variables among cable 
    operators may be sufficiently widespread to justify consideration of an 
    alternative rate of return methodology tailored more closely to the 
    financial circumstances of individual cable operators. At the same 
    time, we recognize the risk that individualized rates of return could 
    involve highly detailed and potentially burdensome capital cost 
    determinations in rate cases. Thus, if we adopt a more tailored rate of 
    return methodology, we will nonetheless retain the current presumptive 
    rate, and its concomitant procedures for overcoming that presumption, 
    as an alternative to any new methodology.
        2. The capital markets have recognized a significant measure of 
    risk within the cable industry. Cable stocks trade at significant 
    premiums relative to the overall equity market and cable companies 
    often have high debt costs due to low investment grades. In addition, a 
    fair proportion of homes passed by cable do not subscribe to the 
    service, suggesting consumers and businesses do not regard cable as a 
    traditional utility service. We believe it may be necessary to 
    recognize such risk diversity in the cable industry and no longer 
    presume that a single rate of return should be applied to all cable 
    operators making cost of service showings. We seek comment on an 
    alternative to the presumptive 11.24% rate of return. This alternative 
    would provide an equity cost estimate that recognizes the historic 
    growth orientation of cable investors and would allow actual debt cost 
    and use company specific capital structures.
    
    B. Cost of Equity
    
        3. We propose to use the capital asset pricing model (``CAPM'') as 
    a method to estimate the cost of cable equity as an alternative to the 
    discounted cash flow (``DCF'') approach used in the initial Cost Order, 
    59 FR 17975 (April 15, 1994). As a general matter, the DCF method 
    relies heavily on the consistent payout of dividends as a key part of 
    its formula, a factor that does not apply generally to equities. The 
    absence of dividends may reflect fundamental differences in the 
    strategic nature of cable business operations and the operation of 
    companies whose stocks make up a broad stock index such as the S&P 400. 
    A formula designed to measure a future dividend or income stream may 
    not be an appropriate model for estimating the rate of return demanded 
    by investors who are willing to forgo an income stream in favor of 
    growth through reinvested cash flow. The CAPM attempts to quantify the 
    risk necessary to induce an investor to follow this kind of growth-
    oriented strategy. Under CAPM, equity cost is calculated by assigning 
    an equity premium to a company's stock that is commensurate with the 
    stock's systematic risk (risk that cannot be avoided through equity 
    diversification). Under this model, a stock's equity rate of return is 
    equal to the risk-free rate (obtainable on a risk-free government debt 
    instrument) plus a premium based on the systematic risk of a given 
    security (the beta).
        4. The Commission, in the Cost Order, decided against using the 
    CAPM to determine equity cost due to concerns that insider holdings and 
    monopoly profit expectations would distort the measurement of risk 
    associated with providing regulated cable services. Based on data 
    submitted in response to the Further Notice, we tentatively conclude 
    that it is unnecessary to reject alternative methods of measuring 
    equity cost. The Commission's initial decision to forgo the use of the 
    CAPM stemmed from a concern that insider decisions could overstate the 
    size of the risk premium assigned to cable stocks under the CAPM. A 
    systematic review of the relationship between insider holdings and 
    movements in stock price, however, was not conducted and data submitted 
    in response to the Further Notice, do not support the assertion that 
    cable insiders exaggerate the stock prices of their companies.
        5. In addition, with respect to monopoly expectations in cable 
    stock prices, we do not have sufficient data to determine the extent of 
    the relationship, if any, between the existence of monopoly power and 
    the stock price volatility premium assigned to cable company stocks.
        6. In establishing an equity cost for cable companies, we propose 
    to rely on data from the cable industry itself rather than forgo such 
    direct evidence of industry cost in favor of some other surrogate 
    industry or stock group. In the Cost Order, we developed an equity cost 
    estimate based on a selected quartile of the S&P 400. As set forth 
    above, however, we do not believe it necessary to eschew reliance on 
    betas of publicly-traded cable stocks as part of the cable equity cost 
    calculation. Using data submitted to the Commission in response to the 
    Further Notice, the Commission examined betas for 11 cable companies 
    that derive the vast majority of their revenues from regulated cable 
    services. Recognizing that cable industry investment in recent years 
    has focused on long term revenue potential from unregulated services, 
    we have limited our analysis of betas to the years 1987 through 1992. 
    Based on data submitted to the Commission, the average beta for cable 
    industry equity investment is 1.42. This indicates that, on average, 
    cable equities are 42% more volatile than the general stock market.
        7. Because we propose to examine an investment period of several 
    years, we propose to use the risk-free rate of the average yields on 
    five-year U.S. Treasury Notes after 1987. Based on Federal Reserve 
    data, the average yield on five-year U.S. Treasury Notes from 1987 
    through the third quarter of 1995 is 7.27%. Although this yield exceeds 
    the current yield on five-year notes, this figure is an average that 
    accounts for numerous rate fluctuations over an extended time period. 
    We believe an average risk-free rate may be appropriate for selecting a 
    cost of equity for cable because the equity cost estimate would be 
    relied upon in cost of service filings for at least the period 
    preceding an operator's next major rate filing. 
    
    [[Page 9413]]
    Moreover, we proposed to update this rate to account for subsequent 
    interest rate changes.
        8. Consistent with the CAPM approach, we estimate the average 
    return on investment in the general equity market. Using the S&P 500 
    from 1987 through the third quarter of 1995, the average compounded 
    return has been 13.53%. Applying the CAPM formula, the general equity 
    market premium above the risk-free rate of return is 6.26% (13.53%-
    7.27%). The 1.42 beta for cable equity investment multiplied by 6.26% 
    provides a cable equity premium of 8.89 percentage points above the 
    average risk-free rate. Adding the risk-free rate to the cable equity 
    premium results in an equity cost figure of 16.16%. We propose that the 
    average cost of equity for investment in cable operators providing 
    regulating cable services is 16.16%. We propose to adjust the figures 
    used to estimate the equity cost periodically. We ask comment on this 
    approach.
        9. We also request comment on a method that would, consistent with 
    the goal of maintaining administrative feasibility, adjust the equity 
    cost to reflect extraordinary financial risk. For example, should the 
    Commission consider debt-to-cash flow multiples as a mechanism to 
    quantify risk levels? We solicit data to establish equity cost figures 
    above and below the proposed 16.16% average equity cost estimate for 
    operators with debt burdens significantly above and below the average 
    in our sample.
    
    C. Cost of Debt
    
        10. The other principal component of the overall cost of capital is 
    the cost of debt. In the Cost Order, we relied on debt cost estimates 
    for the cable industry specifically and concluded that the range for 
    the average cost of fixed rate debt established by information 
    submitted in the cost of service proceeding was 7.8% to 8.65%. The 
    Commission noted the substantial proportion of floating rate debt among 
    cable entities and determined that a cautious estimate would place 
    average debt cost at 8.5%.
        11. We propose to rely on more direct estimates of capital cost by 
    gauging an operator's debt cost to its actual cost. This debt cost 
    would encompass fees or other premiums that the operator may pay to 
    obtain debt financing. We invite comment on this proposal.
    
    D. Capital Structure
    
        12. In the Cost Order, we decided against using embedded capital 
    structures and market equity values to establish the capital structure 
    used to calculate the overall rate of return. We indicated that a 
    capital structure range may be more appropriate for the debt-laden 
    cable industry and set that range at 40% to 70% debt and used that 
    range in setting the overall capital cost.
        13. We tentatively conclude, however, that actual, i.e., 
    individualized, capital structures should be applied to the estimation 
    of the overall cost of capital. The estimation of debt costs is 
    relatively straightforward because the cost of debt can be documented 
    and certified by independent accounting services. Because debt costs 
    can be measured directly, we tentatively conclude that reliance on the 
    actual percentage of debt in an operator's capital structure will 
    ensure the most accurate estimation of interest costs. Thus, if an 
    operator elected not to rely on the presumptive 11.25% rate of return 
    in favor of the alternative capital cost measure described in this 
    Order, we would look to the actual capital structures of the operator 
    to determine the appropriate overall capital cost.
        14. Estimating the amount of equity in an operator's structure is a 
    complex proposition. Many operators have a negative net worth. We 
    recognize, however, that, in the case of several publicly-traded cable 
    companies, the stock of operators with negative book values trades in 
    significant volumes in the open market. While public utility regulation 
    has relied traditionally on book value estimations of equity in 
    determining capital structures for regulated utilities, it may be 
    appropriate to take note of the equity transactions in the cable 
    industry that occur frequently, including the decisions of cable 
    investors to pay multiples of cash flow for cable systems that, based 
    on book value, should be worth less than nothing.
        15. In order to rely on actual capital structures, however, we must 
    ensure that measurement of the equity proportion filters out a 
    ``premium'' for anticipated gains in unregulated services. As we 
    consider this alternative, however, we recognize that several issues 
    must be addressed and resolved. Moreover, we remain committed to an 
    approach that is administratively feasible. To assist the Commission in 
    this endeavor, we request comment on the following issues:
        a. What mechanism or analysis should guide the Commission in 
    estimating the equity proportion of an operator's capital structure 
    that is dedicated to regulated services?
        b. How should the Commission estimate the proportion of equity in 
    an operator's capital structure when that operator is not publicly-
    traded?
        c. Should the Commission rely on the book value of debt or the 
    market value of debt in estimating the proportion of debt in an 
    operator's capital structure?
        d. Can the Commission develop a reasonable estimate of an 
    operator's capital structure by combining the market value of its 
    equity and the book value of its debt?
        e. If market capitalization is used to measure the proportion of 
    equity in an operator's capital structure, will increases in the 
    operator's stock price drive up subscriber rates by increasing the 
    proportion of equity in the operator's capital structure? If so, how 
    can the Commission ensure that reliance on market capitalization 
    measures for equity will not unduly impact subscriber rates?
    
    III. Regulatory Flexibility Analysis
    
        16. Pursuant to Section 603 of the Regulatory Flexibility Act, the 
    Commission has prepared the following initial regulatory flexibility 
    analysis (``IRFA'') of the expected impact of these proposed policies 
    and rules on small entities:
        The proposals, if adopted, will not have a significant effect on a 
    substantial number of small entities.
    
    List of Subjects in 47 CFR Part 76
    
        Cable television, Reporting and recordkeeping requirements.
    
    Federal Communications Commission.
    William F. Caton,
    Acting Secretary.
    [FR Doc. 96-5426 Filed 3-7-96; 8:45 am]
    BILLING CODE 6712-01-P
    
    

Document Information

Published:
03/08/1996
Department:
Federal Communications Commission
Entry Type:
Proposed Rule
Action:
Proposed rule.
Document Number:
96-5426
Dates:
Comments are due May 7, 1996. Replies are due June 6, 1996.
Pages:
9411-9413 (3 pages)
Docket Numbers:
MM Docket No. 93-215, FCC 95-502
PDF File:
96-5426.pdf
CFR: (1)
47 CFR 76