Opinion ID: 372907
Heading Depth: 1
Heading Rank: 4

Heading: the reasonableness of the overall result

Text: 130 From Hope Natural Gas through Permian Basin Area, and up to the Supreme Court's latest statement, the scope of review of rate regulation by appellate courts, the reasonableness of a rate of return allowed to a regulated company has been judged from the perspective of its effect on the company and the public. Permian Basin specified other factors for review, of course, and these have been treated above. 76 The question we now address is the third issue emphasized in Permian Basin Area : whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection to the relevant public interests, both existing and foreseeable. 390 U.S. at 792, 88 S.Ct. at 1373.
131 While suggesting that the Satellite Act entitled COMSAT to rely more heavily, perhaps, then other regulated companies upon governmental support, COMSAT has conceded that nothing in the legislative history of the Satellite Act or any other statute entitled it to a certain level of profit, or even a profit at all. The objection eventually condenses to a comparison of the rates of return actually earned by COMSAT over the course of its history, and those earned by AT&T as a comparable regulated company. COMSAT claims that it is not comparable, that it is a more risky enterprise than AT&T. It correctly cites the Commission's finding that COMSAT was more risky until 1973, and asserts that nothing has changed since then to make it less risky. We are not concerned with the years before 1973 since we find nothing in COMSAT's particular situation to justify a departure from the usual rule that past losses are immaterial to present rate-setting proceedings. 132 As for the present, it is a truism that AT&T generally is not a risky investment, though the degree of risk varies with whether one is talking about its common stock, its preferred stock, or its bonds; and in each of these there may be substantial risk to one's investment objectives immediate or distant depending on the price and the state of the market generally. AT&T may be a less risky enterprise than COMSAT, but that does not make it a less risky Investment opportunity. The price of AT&T stock has not ranged as widely as COMSAT over the years both have existed, 77 and COMSAT's variance has been entirely on the upside since it was offered at $20. The Commission used AT&T to compare with COMSAT, and for that reason, COMSAT's rebuttal based on dividends and book value is not an inappropriate exercise. However, one must keep in mind that an investor who buys AT&T stock at a relatively high point and watches it fall will be little convinced that his investment was not risky because AT&T never missed a dividend. 133 COMSAT has placed great reliance upon a depiction of the returns of each company from 1964 to 1973. See Table in Brief of Petitioner at 35. The table shows the book value per share in 1964 and in 1973 for COMSAT and for AT&T, and the dividends per share compounded at 6% Per annum from the year declared through 1973. The sum of that figure and the increase in book value per share is listed as Total Return, which is then expressed as a percent of the 1964 book value in each case. The result is a figure of 81.14% Total return for COMSAT and 136.00% For AT&T. COMSAT argues that its rate of return is therefore less than what the statute requires as just and reasonable. 134 The comparison is fundamentally false. COMSAT has nothing but equity in its capital structure. 78 Every dollar represented in book value corresponds to some investor's equity holding. AT&T, by contrast, has maintained a considerable amount of debt in its capital structure throughout the 1964 to 1973 period. AT&T's earnings were made partly upon its equity capital, and partly upon the capital it borrowed generally at a lesser cost than the dividends it pays on its equity holdings. A fixed rate of interest had to be paid on the borrowed capital, but having met that obligation, the remaining portion of earnings on the borrowed capital was available to AT&T to pay out in dividends or retain as earnings. 135 What makes COMSAT's comparison unsound is that the Total Return is expressed as Percent of 1964 Book Value. In 1964, AT&T had $9.176 billion of debt outstanding and $18.860 billion of equity, for a debt-to-capital-ratio of 32.73%. 79 By 1973, AT&T had a capital structure consisting of $28.371 billion in debt and $31.224 billion in equity, resulting in a debt-to-capital ratio of 47.6%. 80 Hence, over the relevant years, AT&T increased its amount of outstanding debt by over $19.194 billion, which more than tripled its 1964 debt level; and its debt Ratio increased by almost half. During all this time, COMSAT floated no bonds at all. 136 Thus, not only do the figures for AT&T reflect a rate of return on borrowed capital, which COMSAT did not have; but also, most importantly, they reflect a return on an ever-increasing Amount of borrowed capital, resulting in an ever-increasing leverage of equity over debt. It would have been imprecise enough to compare a leveraged company with an all-equity company, but to compare COMSAT with AT&T whose ratio of debt was Increasing substantially over the period presents an even more distorted result. 137 If a comparison with AT&T is deemed informative, the figures should attempt to reflect the return earned by AT&T, and by COMSAT, on the Equity represented in the capital structure of each. Based on the figures set forth, the average level of equity for AT&T was $25.042 billion over the 1964-1973 period, and the average level of debt was $18.773 billion. The $37.78 per share total return does not include the earnings that went to debt service; adding back an approximation of 6.5% Debt service per year (compounded on the amount of debt), 81 the total of earnings and debt service for AT&T on these figures would come to $47.07 per share. 82 If the $47.07 per share total return for AT&T were then prorated according to its capital structure, $26.90 would be earned on that portion of the total capital contributed by equity, and $20.17 would be earned on the part contributed by debt. 138 For the limited purposes of analyzing the rate of return figures advanced by COMSAT (Brief for Petitioner at 35), the $26.90 figure may be taken as one measure of what AT&T did earn on the equity in its capital structure. 83 As a percent of its 1964 book value, that per share figure represents a 96.83% Rate of return, which is substantially below the 136.00% Rate of return claimed in the brief. The remaining difference between that rate of return and the 81.14% Earned by COMSAT, to the extent any direct comparison of this sort is useful, can be justified by the fact that COMSAT stock carries a high potential for capital appreciation.
139 The comparison with AT&T, therefore, does not demonstrate that COMSAT's rate of return has fallen short of what is just and reasonable. COMSAT's complaint was more general, however. It asserted that the original subscribers of COMSAT stock were being denied the right ever to make a fair rate of return on their investment. The Commission has prescribed rates only for the future; the revenues COMSAT received from 1964 to 1973 were left unadjusted and COMSAT's plea to capitalize the difference between those actual revenues and its conception of adequate revenues was turned down. Hence, no matter what AT&T was making, COMSAT equity investors who subscribed in 1964 are, in COMSAT's view, being compelled to accept 6.45% Per annum as the only rate of return they are to receive for their investment from 1964 to 1973. 140 Because COMSAT has been regulated from its inception, it is argued that it should be an exception to the accepted law that earnings shortfalls during the formative years are not to be capitalized. That argument is a familiar one; it is simply the same assertion that a regulated company is entitled to some minimum rate of return. The most compelling aspect of that argument in this setting is that Congress intended COMSAT to become a prosperous company, and that it expected investors to view it as a sufficiently profitable prospect so as to merit their capital. 141 All of this may well be true. The conclusion that COMSAT urges follows from it, however, is not. COMSAT looks at the 6.45% Rate of return and infers that no investor would have committed funds for that small reward. But the 6.45% Figure was calculated only from increase in book value and dividends paid. It did not consider the appreciation of an investor's capital from a rise in the price of COMSAT stock. It is hardly necessary to state the financial fact that stocks most often sell at multiples of the book value per share of the company. The difference represents investor confidence in the likelihood of appreciation of the stock itself. And it is for this reason, in many cases even more than the hope of dividends (and certainly more than the simple expectation of increase in book value), that the public invests. 142 COMSAT makes much of the public relations strategy used to induce investment in COMSAT in 1964: buy it at the start, put it away, and let your grandchildren benefit. Undoubtedly the prospect of getting in at the ground-level on a government-sanctioned monopoly was attractive, but the logic underlying that attraction was that the price of the stock would appreciate as global telecommunications increasingly came to depend upon the use of satellites, and as the day of COMSAT's self-sufficiency approached. This is not to say that the entire appreciation in stock price was unrelated to the underlying appreciation in book value or the rates COMSAT was permitted to charge its customers, but it is important to recognize the speculative aspect of an investment in COMSAT. 143 This aspect of a decision to invest in COMSAT was clearly stated by Commissioner Robinson in his separate opinion: 144 Thus, if the start-up period is expected to last five years and once out of that period Comsat is expected to earn $10 a year for eternity then investors will be willing to pay the value of stock earning an annuity of $10 a year with payments to begin in five years. Such a stock is worth less than a stock of a company earning $10 a year right now but it is not valueless. A rational investor would buy Comsat even if he never expected a cent of return deficiencies to be allowed. Nothing the Commission has ever done, and nothing in the history of rate regulation generally would lead reasonable investors to expect that Comsat would be permitted to make up any earnings shortfall particularly one defined as a return falling short of 12 percent by a special component in the rate base or in the rate of return. 145 (J.A. 93-94; 56 FCC2d at 1193-94) (emphasis added). 146 Initial subscribers of COMSAT stock were not all looking to the allowed rates that COMSAT charged to provide dividends and increased book value as a return on their investment. The expectation of speculative gain must also be recognized. The actual fluctuation in COMSAT stock provides all the proof needed that there was much opportunity for the early investor to make his speculative profit. In June of 1964, ten million shares of COMSAT were first offered to the investing public and common carriers at $20 per share. It has never fallen below $20 since. 84 Over the course of the last thirteen years, the stock price has varied widely, reaching a high of 84 1/2. 85 In the last two years, it has stayed within the range of 23 7/8 and 37 3/8. 86 147 The hope for appreciation of stock price is an aspect of investor behavior that COMSAT's argument to this court entirely ignores. And it is in light of that aspect that we may conclude both that the rate of return to be afforded COMSAT will not scare off investment, and that the historical return enjoyed by COMSAT stockholders was adequate to attract necessary capital, and fairly compensate investors for the risks they have assumed 87 in investing in an enterprise having the capital appreciation potential of COMSAT. 148 We have given careful consideration to all the many contentions raised by the petitioner, and any of those matters not specifically addressed in this opinion have been deemed insubstantial. The case is remanded to the Commission for further proceedings as directed by this opinion. 149 So ordered.