Opinion ID: 372907
Heading Depth: 2
Heading Rank: 1

Heading: The Equity Rate of Return

Text: 78 Several different methods of computation were presented in the evidence before the Commission. Discounted cash flow, an Arthur Anderson study of four public utilities' authorized rates of return, a modern portfolio theory, and a capital asset pricing model were all presented to the Commission, discussed in the opinion, and dismissed as unreliable. (J.A. 63-70; 56 FCC2d 1163-1170). The method that was accepted was described by the Commission as follows: 79 The methodology we employ is to determine as riskless a return on invested capital as we can find, and add to it a risk premium reflecting the risks found present in Comsat's fulfillment of its statutory mission. We also find it useful, as a yardstick to compare Comsat's risks and cost of capital to AT&T. On these bases we are of the opinion that the return we are allowing Comsat on its INTELSAT rate base is adequate and fair and that such return, when considered together with the separate and discrete factors underlying Comsat's capital attraction capability for its non-INTELSAT undertakings, will permit investors to more intelligently evaluate Comsat's stock as an investment risk. 80 (J.A. 63; 56 FCC2d at 1163). 81 COMSAT has no quarrel with the rate of return evaluation theory employed by the Commission. The Commission's opinion comments, It is interesting to note that in its Summary filed May 18, 1975 Comsat has almost exclusively focused on, to the exclusion of other empirical evidence it has sponsored, this type of approach. Id., n. 102. After the Supreme Court's Hope Natural Gas holding, as re-affirmed in Permian Basin Area Rate Cases, supra, it would have been very difficult to mount a successful argument that the FCC was obliged to use some alternative approach. 24 82 For years prior to 1973, the Commission estimated a riskless rate of return from long-term U.S. Government bonds and added to it a risk premium in excess of the risk premium estimated for AT&T. As of 1973, however, the Commission found that COMSAT could no longer be entitled to a higher risk premium than AT& T, and it is here that the crux of COMSAT's appeal on this point lies. The Commission's logic proceeds as follows. (1) In 1972, AT&T's cost of common equity was 10.5%, and 10.5% Was a valid assessment into the foreseeable future. (2) In 1973, U.S. Treasury Bonds were paying 6.5%. (3) This implied that AT&T had a risk premium of 4% In 1973. (4) By 1973, the year Comsat obtained maturity and the year we have selected for determination of Comsat's allowable rate base, we find that Comsat's risks had declined considerably, and the record will no longer support a finding that Comsat was significantly riskier than AT&T. Based on our judgment and analysis of Comsat's 1973 risks from the record, independently and by way of comparison to 1964, we estimate a risk premium of 4%. (5) United States Treasury Bond yields rose to an average of 7.3% In 1975. (6) Thus, Comsat's current cost of equity is 11.3%. (J.A. 72-73; 56 FCC2d 1172-1173). 83 Petitioner's most strenuous objection can be focused upon the one statement in sentence number 4, above, that the record will no longer support a finding that Comsat was significantly riskier than AT&T. There is a separate section of the FCC's opinion just dealing with the comparative risks of COMSAT and AT& T, which also concludes, Comsat can no longer be regarded as more risky than AT&T with regard to technical and operational problems leading to service outages and revenue loss. (J.A. 62; 56 FCC2d 1162, footnote omitted). We will shortly deal with this most basic challenge. 84 First, however, it is necessary to consider the findings of the Commission on the elements of COMSAT's risk. COMSAT has impugned the validity of several of these component findings. As for those risk elements not explicitly addressed, (E. g., launch failures, COMSAT's cash) our conclusion, after reviewing the record evidence, is that none conclusively demonstrates that COMSAT is less risky than AT&T, but that each adequately resists the conclusion that COMSAT is More risky. Thus, the question turns upon the factors about to be addressed. 85 (1) Technical risk. 86 COMSAT emphasizes the novelty of its technology, and the Commission responds with a catalogue of scientific precedent in the communications satellite field. Prior to the formation of COMSAT, practically all the risk in developing the early technology was absorbed by the government. COMSAT was thus the beneficiary at no cost to it of substantial research and development that was done at the expense of billions of dollars by the United States. Although COMSAT renews its objections in the brief as to the degree of departure from prior technology that the synchronous satellite concept represented, we find that the Commission's treatment of the question amply satisfies the substantial evidence standard, particularly in this area of complicated scientific mechanics. (See J.A. 48-49; 56 FCC2d 1148-49). 87 (2) Business risk. 88 COMSAT alleged that there was cause for concern that overall demand for international telecommunications would not remain high, or that COMSAT's market share among other modes of commercial telecommunication would fall even if general demand did not. We find more than adequate the record evidence before the Commission regarding estimated overall demand. As for market share, the Commission relied on its own authority to allocate circuits and facilities between cable and satellite to guarantee COMSAT's place, a fair proportion of the available traffic. (J.A. 53; 56 FCC2d at 1153). COMSAT is correct in suggesting, however, that the Commission overstated its case in relying on the facility mix allocation decision, 25 which stated, (W)e will authorize implementation of needed circuit facilities in line with the proposals of the European Administrations looking toward maintenance of reasonable parity between cable and satellite circuits on transatlantic routes. 26 That decision does not speak to the critical question of revenues, and, as COMSAT's brief points out, a later facility mix allocation decision 27 reintroduced all the uncertainty that the prior statement might have alleviated: Our primary policy objective has been and remains the achievement and efficient utilization of the lowest cost combination of facilities which can satisfy valid traffic needs and service standards, irrespective of technology or supplier. 28 Of course, AT&T as an international carrier is subject to precisely the same kinds of overall demand and market share concerns; but AT&T is not solely in the international telecommunications market, as COMSAT's INTELSAT operations are. Hence, we do find that COMSAT raises a non-trivial objection to this aspect of the Commission's decision, and that COMSAT has more business risk, in this sense, than AT&T. 89 (3) International risk. 90 In August of 1964, the United States and twenty other nations entered into a consortium that assured COMSAT's INTELSAT facilities would receive a sustained amount of utilization. The Commission is correct in citing this development as an early risk-reducing factor. However, the 1971 updating of that agreement severely restricted the authority of COMSAT in the international consortium, and also restricted the potential for diversification by INTELSAT. Professor A. Chayes has noted, In the Definitive Agreements, concluded after more than two years of negotiations, the United States suffered major rebuffs on almost every element of its opening position. The Intelsat consortium was replaced with a formal International Communications Satellite Organization. Comsat was placed under a voting limit of 40% Instead of the 50% It proposed and was (thereby) stripped of its veto. . . .  29 91 The Commission's opinion on this point dwells excessively on COMSAT's status under the old, Interim Agreement, and takes note of the Definitive Agreements only to recognize, in passing, that Comsat's voting strength . . . has declined. . . .  (J.A. 57, 56 FCC2d 1157). However, this was not a trivial change. 92 As compared with AT&T, it must be admitted that COMSAT is subject to a greater degree of risk due to its need to reach agreement with foreign governments. The Commission found that the moderate institutional risks in 1964 arising from the necessity of foreign cooperation in the establishment and operation of the global satellite system declined with the signing of the Interim Agreement. (J.A. 57, 56 FCC2d at 1157). By the same analysis, it must be admitted that those institutional risks increased, with the substitution of the subsequent Definitive Agreements for the Interim Agreement. We agree with COMSAT that on this point the Commission underestimated the risk that COMSAT bore relative to AT&T. 93 (4) Regulatory risk. 94 COMSAT seeks a higher return because its regulated status subjects its major decisions to administrative review. But COMSAT is unable to distinguish effectively its status from that of any other regulated carrier on risk of this character. Indeed, as the Commission points out, a regulatory mandate that COMSAT prosper may be found in the Satellite Act, the Communications Act of 1934, as amended, and, generally by the record which details the government's involvement with Comsat's welfare. (J.A. 56, 56 FCC2d at 1156). The Congressional declaration of policy and purpose that serves as preamble to the Satellite Act amply demonstrates that it is a weak argument indeed to characterize COMSAT as the forgotten child of the regulated industry family. 30 95 This brings us to the basis for the Commission's conclusion that, on net, COMSAT's risk is no higher than that of AT&T. The factors discussed above indicate that, despite the Commission's conclusion of no difference, COMSAT does represent a greater risk in those factors. The principal countervailing factor is that COMSAT is 100% Equity-financed. There is no debt in its capital structure. AT&T, on the other hand, had a debt-to-equity ratio of 90.86% In 1973. 31 It is difficult to overstate the importance of this distinction. The shareholders of AT&T are not the first in line to receive earnings that are not retained; debt service has the first priority. And in case of insolvency, it is the shareholders who again line up last; the debt obligations will be paid first out of whatever assets can be garnered. This difference is not rendered academic by the very great probability that AT&T will remain solvent, or by AT&T's unbroken record of paying dividends, for the size of those dividends will be less, and the freedom of the company to enter into promising new areas will be restricted by the obligation of debt service. Perhaps the clearest statement of the risk-increasing effect of debt came from AT&T itself which, in its 1972 rate hearing, made a plea summarized as follows by the Commission: 96 It is claimed that changes in the capital structure since the Commission decision in Docket No. 16258 (in 1967) alone would call for a substantial increase in Bell's rate of return on equity. The debt ratio has risen from 31-33 percent to above 45 percent, but its equity earnings in the 9 percent range are still no higher than at the time of the Docket No. 16258 decision. 97 American Telephone & Telegraph, 38 FCC2d 213, 259 (1972). 98 Furthermore, this is not a case of comparing a company with some debt to one with a little more or less; it is a difference In kind between the two capital structures. A company with absolutely no debt is a rare thing, and for a public utility to be without debt is rarer still. 99 The comparison, therefore, is between an established utility with almost half of its capital structure in debt securities and operating in part in an international milieu, and a newer utility, subject fully to the risks of an international business environment, but with strong assurances of government interest, and in the unique position of owing no debt at all. While disagreeing with a few of the Commission's detailed conclusions, we hold that there was substantial overall evidence to sustain the Commission's decision that, as of 1973, COMSAT did not deserve a risk premium in excess of that afforded AT&T for the purpose of calculating a just and reasonable rate of return. 32