Resolution - 9642RESOLUTION NO. 9642
A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF
WEST COVINA, CALIFORNIA DENYING WITHOUT
PREJUDICE THE APPLICATION OF CHARTER
COMMUNICATIONS, INC., KELSO INVESTMENT
ASSOCIATES, V, LP AND ITS AFFILIATES, CHARTER
HOUSE GROUP INTERNATIONAL (COLLECTIVELY
"CHARTER") FOR A TRANSFER OF CONTROL TO PAUL G.
ALLEN OF THE FRANCHISE GRANTED BY THE CITY AND
SETTING FORTH THE GROUNDS AND REASONS
THEREFOR
WHEREAS, an affiliate and/or subsidiary of Charter (the "Franchisee") has been granted
a franchise (the "Franchise") to construct and operate a cable television. system within the City
of West Covina (the "City"), by action of this(City Council; and
WHEREAS, there has been filed with the City an FCC Form 394 requesting that the City
approve an assignment and transfer of control of the Franchise and Franchisee to Paul C. Allen
(the "Buyer") (the "Transfer"); and
WHEREAS, pursuant to the Franchise and various regulatory ordinances, neither the
Franchise nor control of the Franchise and/or Franchisee can be transferred to the Buyer without
affirmative written consent of the City; and
WHEREAS;.the City requested certain information from Franchisee, Charter and/or the
Buyer (collectively; the,"Applicants") relating to the legal, technical, and financial qualifications
of the Buyer, the impact, or potential impact, of the Transfer upon current and future rates, the
financial ability of the Buyer to generate sufficient cash flow to meet debt and obligations,
satisfy capital expenditure obligations, and provide a reasonable return of and on its investment
(see Exhibits A-C); and
WHEREAS, the Applicants unreasonably delayed or refused or failed to provide a
material portion of the requested additional information (see Exhibits D-E); and
WHEREAS, given the failure of the Applicants to provide all requested information, and
further given the existence of the various issues outlined in this resolution, the City, through its
staff and attorneys, has requested that the Applicants extend the 120-day review period specified
in Section 617 of the Cable Communications Policy Act of 1984, as amended (the "Cable
Act" )(Exhibit. F); and
WHEREAS, the Applicants have failed or refused to timely extend the 120-day review
period; and
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WHEREAS, the Franchise expires on fc.'. �, / % 1! ;and •
WHEREAS, the Franchisee has submitted an application to the City for renewal of the
Franchise; and
WHEREAS, the Franchisee and the City have been engaged in renewal proceedings
pursuant to Section 626(h) of the Cable Act (the "Renewal Proceeding"); and
WHEREAS, the Renewal Proceeding has not been completed as of this date and a
franchise renewal agreement has not been executed by the Franchisee and the City; and
WHEREAS, the City has attempted to complete the Renewal Process in an expeditious
manner whereas Charter and the Franchisee have delayed the Renewal Process as described on
Exhibit D; and
WHEREAS, it would jeopardize the City's rights and interests in the Renewal
Proceeding to approve the Transfer prior to completion of the Renewal Proceeding; and
WHEREAS, the City has reviewed the FCC Form 394, all supplemental information
submitted in relation thereto, as well as information compiled in any compliance audit, and the
various Staff reports and related documents; and
WHEREAS, the City has determined that it would not be in the public interest to approve
the Transfer at this point in time and has determined that it would be in the public interest to .
disapprove the Transfer without prejudice subject to future and further consideration.
NOW, THEREFORE, the City Council of the City of West Covina does hereby resolve
as follows:
1. The recitals above are hereby declared to be true, accurate, and correct.
2. The transfer of control of the Franchise and Franchisee from Charter to the
Buyer, as described in the FCC Form 394, is hereby disapproved for the following reasons:
(a) The Applicants have failed to timely provide all necessary additional
information, as requested by the City in writing, relating to the Transfer's potential impact upon
existing and future rates and the legal, technical and financial qualifications of the Buyer to own
and operate the cable television system serving the City (the "System").
(b) The Applicants have refused or failed to reasonably cooperate with City
Staff, Special Counsel, and outside consultants retained by the City in undertaldng the due
diligence investigation of the Transfer.
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• (c) The Buyer has failed to demonstrate that it is a technically and financially
qualified applicant for the following reasons:,
(1) The burden of. proof is upon the Buyer to demonstrate its legal,
technical, and financial qualifications to assume control of the Franchise and the Franchisee.
(2) The Buyer possesses absolutely no track record in the operation of
cable television systems or the provision of cable television services. The Applicants have failed
to present any affirmative evidence demonstrating the Buyer's technical and experience
qualifications to own and operate cable systems. Although the Buyer may well possess
significant experience and expertise in the development of computer software and related
products, as well as the operation of professional. sports teams, no evidence was presented by
the Applicants demonstrating the Buyer's technical and experience qualifications to own and
operate cable television systems. on a limited or large scale basis.
(3) No evidence has been presented by the Applicants as to the Buyer's
contractual commitment, long-term, short -tern, or otherwise, to maintain existing Charter
management and/or operating policies and procedures. It should be noted that the Buyer is
pursuing acquisition of various properties owned by Marcus Cable Communications, Inc.
("Marcus"). It has already been announced in the trade press that many senior executives of
Marcus, including the founder/chairman and its president, will be displaced as part of the
operational merger between Marcus and Charter.
(4) The lack of a track record in this case is even more problematic
given the proposed operational merger of the Charter properties and the Marcus properties
pursuant to an organization to be controlled by the Buyer. Both Charter and Marcus have grown
extremely fast in terms of their subscriber base over the last five years and it is unclear whether
or not an operational blend of these two entities under the Buyer will result in an excessive
burden upon management capabilities as well as the introduction of.operational problems into
the Charter systems. Once again, one cannot look to the track record of the Buyer in order to
adjudge its ability to assimilate a large number of cable television subscribers into an
organizational structure within an extremely short period of time. The Buyer has failed to
demonstrate, based upon the information provided to the City, that it possesses sufficient
experience, organization, and business plans to assimilate a massive influx of subscribers within
a short period of time into a single organizational structure and maintain a level of cable service
equivalent or superior to that currently provided by the Franchisee.
(5) The lack of a track record on the part of the Buyer magnifies the
financial concerns set forth herein since the Buyer cannot historically demonstrate how it will
react to the need to generate significant increases in cable revenues from a relatively flat
subscriber base. Although other large and small cable operators possess financial leverage ratios
and other financial structures which could potentially impose significant upward pressure on rates
or threaten the financial viability of the cable operator if revenues cannot be increased one way
or another, the bulk of those operators possess significant operating histories and a long
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association with the debt and equity market. The performance of those operators can be
constantly reviewed to determine their reactions, both from financial and operating viewpoints,
to the financial pressures .associated with this kind of transaction. On the other hand, the
Buyer's absolute lack of operating experience poses a significant risk to the City and subscribers
in that the Buyer may not be able to meet its financial projections and thus be forced to expand
the revenue base by way of aggressive rate increases, operational expenses decreases, reduction
in service quality, and other operating and fmancial practices which may or may not be
consistent with generally accepted practices in the cable industry and the existing practices of
the Franchisee.
(6) The Buyer has failed to present any business plan or other .
documents indicating its short-term and long-term intent as to how it will operate the cable
television system and how it intends to achieve an acceptable and reasonable return of and on
its investment.
(7) The City has carefully reviewed the financial qualifications of the
Buyer. In order to determine the qualifications a buyer for a cable television system, or a series
of cable television systems, it is necessary to not only review the personal wealth, or lack
thereof, of the individual or entity assuming control of the franchise operations, but it is also
necessary to evaluate the economic reasonableness of the transaction to determine whether the
transaction will impose unreasonable financial burdens upon the purchaser which could result
in material rate increases beyond that associated with normal operation of a cable system,
reduction in service quality based upon cost cutting and expense minimalization, a combination
thereof, a premature sale of the system, or financial insolvency. The lack of financial
qualifications on the part of the Buyer can impose significant and serious financial consequences
upon the City and its subscribers. These kinds of concerns should not be underestimated even
in the case of an extremely wealthy individual purchaser who possesses absolutely no experience
in the operation of cable television systems and the provision of cable television services.
(8) The individual wealth of a proposed purchaser is only the starting
point for the financial qualification analysis. Obviously, if the proposed purchaser does not
possess sufficient cash or borrowing capacity to acquire necessary proceeds to close the
transaction, financial unsuitability is established. In addition, if the proposed purchaser does not
possess sufficient financial resources, by way of cash or reasonable and customary borrowing
capacity, to operate the system, meet current and long-term liabilities when due including, but
not limited to, capital expenditure requirements, financial unsuitability is the logical conclusion.
However, even in the case of a proposed purchaser which possesses sufficient cash to close the
transaction and operate the system consistent with franchise requirements, there are
circumstances under which.a buyer or proposed transferee may pay such a high acquisition price
that it is financially impossible for that buyer, absent massive influxes of additional personal
wealth, to operate that cable television system in a manner which pays current and long-term
liabilities, covers debt service, and provides a reasonable and adequate return of and on equity
investment as prescribed by the Regulations of the Federal Communications Commission (the
"Commission").
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• (9) The Commission has established presumptive financial standards
pursuant to its Preliminary and Final Costs of Service Regulations (collectively, the "COS
Regulations") to measure the financial performance of cable television systems. Pursuant to
those COS Regulations a cable television operator is presumptively entitled to earn a return of
11.25 % on a post -tax basis on its rate base. A cable operator is entitled to rebut this
presumption and earn a higher rate of return based upon certain showings including the use of
the cable operator's actual capital structure as -opposed to a hypothetical capital structure.
Pursuant to the COS Regulations, regulated rates are adjusted to reflect a revenue target based
upon the application of the permitted rate of return to the permitted rate base.
(10) The cable television industry, including but not limited to Charter,
have utilized costs of service filings to justify regulated rates in excess of Benchmark Standards
based upon the use of the acquisition price paid in a system sale as all or a portion of the
permitted rate base. Charter has, in fact, admitted in its response to City's First Request for
Information that it has engaged in such regulatory practices. (See Exhibit G, Response to
Request for Information No. 15, pp. 7-&) Although the COS Regulations have been recently
modified by the Commission, they continue to provide a useful yardstick to adjudge the financial
feasibility of cable television transactions, and thus the financial qualification of cable system's
transferees and buyers, as one indice of reasonableness.
(11) It is fair and reasonable to assume that a rational purchaser will
attempt to recover its investment. and a reasonable return thereon over a financially reasonable
projection period. Irrespective of the personal wealth of a purchaser, it is not reasonable to
assume that any purchaser is willing forsake investment recoupment and the attainment of a
reasonable return. Although some purchasers may be willing to defer a return on a cash -flow
basis for some reasonable period of time, that deferral will simply magnify the return that must
be earnedat a later period in order to allow the investor to achieve targeted returns over the
projection period. In the cable television industry, 10 years is often used as a customary and
reasonable projection period. The Applicants have provided 10 year income projections (Exhibit
If). Thus, although financial acceptability does not require a yearly return equal to the cable
industry's Weighted Average Costs of Capital so as to preclude equity flight to cable operators
or even other industries, a financial transaction which cannot produce a reasonable rate of return,
as adjudged by the standards set forth by the Commission as well as industry -accepted standards,
cannot be deemed financially responsible and a purchaser, irrespective. of personal wealth, that
subject itself and its subscribers to such a transaction cannot be deemed financially qualified.
(12) In evaluating initial franchisee awards, it is custom and practice in
the industry for franchising authorities to consider the economic reasonableness of the franchise
proposal in determining financial suitability in addition to the net worth of the applicant or the
parent of the applicant.. A proposed purchaser should not be adjudged under a lesser standard
than that applicable to the same entity if it was applying for a new franchise.
(13) In evaluating the financial suitability of a proposed purchaser, it is
?*mmpriate to evaluate the reasonableness of the financial, projections that underlay the
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calculation of the acquisition price. By definition, failure on the part of the Buyer to achieve
the projected revenue and ultimately net income levels could produce a serious risk to the
fmancial viability of the cable operation. To the extent that project income levels are not
achieved, the proposed purchaser will not achieve the targeted rate of return. Serious
deficiencies between projected and actual revenues and income can result in debt service
coverage breaches, debt service payment breaches, capital expenditure reductions, operating
deficiencies, and sizable rate increases in both regulated and unregulated rates.
(14) According to the Applicant's Documents (Exhibit IT), the Transfer
is based upon an adjusted enterprise value of $4,466,471,364. The Buyer will assume existing
debt and then pay cash to that amount. The acquisition price is approximately $4,000 per
subscriber (the "Acquisition Price") based upon an enterprise value of $4,466,471,364 and a
reported 1,100,000 subscribers. The trade press has reported the per subscriber value at
approximately $3,700. The difference could be explained by the use of a slightly larger
subscriber base. The Cable TV Financial Data Book published by Paul Kagan Associates, Inc.
("Kagan Databook"), a respected industry financial publication, indicates that even in a period,
of rising subscriber values, this sale, at approximately $4,000 per subscriber, is si ' rcantiy
higher than any other transaction including the still uncompleted Telecommunications, Inc.
AT&T Corp. Merger (the "TCI Merger") which was reportedly priced at $2,923 per subscriber.
The TCI Merger constitutes the next richest transaction within the last two years of reported
transactions. In addition, the Kagan Databook values the TCI Merger at 7.7 x 1999 cash flow
as opposed to this transaction which is priced, based upon information provided by the
Applicants, at 14 x 1999 cash flow. In addition, by way of comparison, Paul Allen, the Buyer
herein, purchased the 1.1 million subscribers of the Marcus systems at a' subscriber value of
$2,523 per subscriber or a cash flow multiple of 11.6 x 1998 cash flow. All of the reported
1997-1998 transactions fall significantly below, in many cases by approximately 2,000-2,500 per
subscriber, than this transfer. The Acquisition Price materially exceeds market values for 1997
and 1998 by a quantity of 50-100%.
(15) The extremely aggressive nature of the Acquisition Price is further
highlighted by comparing the Acquisition Price to the price that Charter paid, in some cases only
this Summer, for portions of the cable systems which are being sold to the Buyer pursuant to
the Transfer as reported by the 1998 Kagan Databook. In June of 1994, Charter purchased
certain Crown Media systems representing 267,000 subscribers for a per subscriber value of
$2,058 or 9.3 x 1995 cash flow. Crown Cable had purchased many of the same systems from
Cencom Enterprises, in September of 1991 for $1,984 per subscriber or 10.2 x 1992 cash flow.
In 1996, Charter purchased certain cable systems comprising approximately 100,000 subscribers
from Cencom Cable Income Partners for $2,110 per subscriber or 9.3 x 1998 cash flow. In
August of 1996, Charter purchased cable systems representing approximately 70,000 subscribers
from KC Cable Associates for $2,143 per subscriber or 8.6 x 1997 cash flow. In 1995, Charter
purchased cable systems from United Video Cablevision representing approximately 45,000
subscribers for $1,984 per subscriber or 9.0 x 1996 cash flow. In February of 1997, Charter
purchased 35,000 subscribers from Prime Cable for $1,946 per subscriber or 9.1 x 1997 cash
flow. In December of 1996, Cbarte.r ^ --- rnximately 31,000 subscribers from Masada
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Cable for $1,757 per subscriber or 9.0 x 1997 cash flow. Finally, in the Summer of 1998,
Charter purchased approximately 117,000 subscribers from Sonic Cable for a reported $1,564
per subscriber or 8.0 x 1997 cash flow. Thus, in many cases, Charter is doubling its total
investment in acquired cable systems, and in some cases more, within several months to several
years. Since, those acquisitions were highly leveraged, the return on equity, is, in all probability,
significantly higher.
(16) Not only does the Acquisition Price, as calculated on a per
subscriber and cash flow multiple basis, exceed contemporaneous market values, the income
projections which ultimately underlie the calculations of the Acquisition Price, as represented
by the Applicants, likewise materially exceed the generally accepted industry projections. For
example, and without limitation, although Charter projects relatively flat subscriber growth in
its systems between 1998 and 2007 (2-3 %), it projects Basic Service Revenue increases of 5-
10 % per year on an average annual basis. The Kagan Databook projects Basic Cable Revenue
to increase at 5.1 % compounded annual growth rate. The Applicants project Expanded Basic
Revenues, which most likely constitute Cable Programming Services which will be deregulated
as of Anril 1 1999 to grow at 17-20% per year notwithstanding a Kagan Databook ejection
of approximately 5 % for the full range of currently regulated revenues. The Kagan Databook
projects total Cable Telephone Revenues and High Speed Internet Access Revenues to grow at
a 38-45 % compounded average annual growth rate whereas the Applicants project those revenues
to grow, in some cases, as much as 77 % per year. The Applicants predict Advertising Revenues
to grow at 23-25 % per.year whereas the Kagan Databook projects Advertising Revenues to grow
10.5 % per year for the same timeframe. In some cases, the Applicants project A la Carte
Service Revenues to grow at an average of 240 % per year. The Kagan Databook projects mini -
pay revenues to increase at 7.4 % per year. In almost every case, the Applicants' revenue
projections materially, and in some important cases by factors of 3 or 4, exceed the generally
accepted industry projections set forth in the Kagan Databook.
(17) The Applicants, have been requested by the City to provide an
explanation and justification for the aggressive income projections but have failed to provide any
independent corroboration or justification for its income projections.
(18) Based upon a review of relevant industry data and the information
provided by the Applicants, it is reasonable to conclude that the attainment of the Applicants'
income projections over the next 10 years, especially given the competitive pressures which will
be caused by pending telco, DBS, and N5WS entry into the market, is questionable or worse.
There can clearly be no assurances that the Applicants' financial projections will be attained.
The Transfer poses a significant risk to both the City and cable television subscribers without
offsetting subscriber benefits.
(19) If the Applicants' financial projections cannot be attained, and the
Buyer is not able to obtain a reasonable return of and on its investment by way of operations of
the System, there is a significant risk that the Franchise will be sold or transferred once again
during its existing t-� _... potential disruption.. of services and potentially forcing.
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subscribers to bear the costs, including the transactional costs associated with this transaction and
future transactions, without any offsetting subscriber benefits.
(20) The Applicants have failed to provide evidence denying the
existence of the various risks described above or demonstrating the potential benefits to the City
and subscribers which might justify the incurrence of the risks described above. The Buyer is
clearly less qualified to own and, operate the cable system than the Franchisee. In addition, the
Acquisition Price and the income projections underlying the Acquisition Price materially exceed
industry standards and thus expose the City and its subscribers to risks beyond those currently
associated with the Franchisee and in excess presented by the average cable operator in the cable
industry.
(21)• To the extent that the Applicants' revenue. projections cannot be
obtained, the Applicants may be forced to increase Basic Service and Cable Programming
Service Tier rates to levels which exceed industry averages. The Applicants have already
projected a 17-20% annual increase in Expanded Basic Service Revenues which will, in all
probability, mean roughly equivalent rate increases in the provision of CPST services. If the
Applicants' aggressive revenue projections in other categories cannot be attained, there will be
added pressure to increase CPST rates beyond the projected levels in order to offset revenue
deficiencies in other regulated and unregulated categories of services.
(22) Given the risks associated with the Transfer, as identified above,
it will not be in the public interest for the City to unconditionally approve the Transfer at this
time. • This disapproval of the Transfer contained herein is without prejudice and may be
reconsidered by the City Council when and if the Applicants are able to present evidence
demonstrating the Buyer's technical and financial suitability.
(d) The Franchisee is in material breach of the Franchise based upon, without
limitation, a failure to pay franchise fees as required by the Franchise.
(e) The parties have failed to negotiate and approve a mutually acceptable
franchise renewal agreement as of this date and the City would be irreparably damaged and
disadvantaged if it approved the Transfer prior to the completion of the Renewal Proceeding.
3. A transfer of the Franchise, transfer of actual or managerial control of the
Franchise, and/or transfer of control of the Franchisee, shall be deemed a material breach of the
Franchise.
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This Resolution is hereby approved and adopted by the City Council of the City of West.
Covina on this 1st day of December, 1998, by the following vote and the Mayor is hereby
authorized and instructed to execute this Resolution on behalf of the City.
AYES:
NOES:
ABSTAIN:
ABSENT:
ATTEST:
City Clerk
Herfert, Howard, Wong, Helendez
None
None
Touhey
APPROVED AS TO FORM:
City ttorney
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