Valuation of Assets
For purposes of reimbursement from SBC Services, Pacific valued the space and assets in its application based on an item-by-item assessment in a manner approved by the Commission in previous decisions where Pacific has sought to lease space and transfer assets to affiliates.
ORA witness Francis W. Fok, a regulatory analyst, challenged that valuation on grounds that prior applications involved partial transfers of functions, whereas the current application envisions transfers of entire organizations within Pacific. Because of this, he testified that each of the organizations should be valued as a "going concern," including such intangible assets as the experience and skills of the employees. ORA proposes that Pacific refund to ratepayers the difference between a going concern value and the net book value of the assets transferred to SBC Services.
Pacific through its witnesses contended that there are numerous cases in which the Commission approved transfer or lease of space and assets used internally by Pacific for administrative support to an administrative affiliate that would then perform those same support functions for Pacific and other affiliates. In each of those cases, valuations were based on affiliate transaction requirements.20
Under the Commission's affiliate transaction rules, the space leases proposed in Pacific's application must be priced at the higher of fully allocated cost plus 10%, or fair market value.21 Affiliate transaction rules call for sales of assets to be priced based on the higher of net book value or fair market value.22
Pacific witness Kathleen Larkin, a regulatory director responsible for analyzing the transactions in this case, testified that the fair market value of the proposed leases was based on market value studies performed by independent firms specializing in commercial property leases. She stated that the fair market value of capital assets was determined by independent third parties through the higher of a cost approach, estimating reproduction cost less depreciation, or a market approach, comparing sales in the marketplace.
ORA argues that these valuations are inappropriate here. According to its witnesses, the massive transfer contemplated here resembles the 1990 transfer of Pacific's Information Services Group (ISG), a department within the company, to Pacific Bell Information Services (PBIS). In approving the transfer, the Commission ordered that the ISG be valued as a going concern, in part because the department had been developed using ratepayer funding.23
The PBIS case, however, is distinguishable. As Pacific points out, that case did not involve the transfer of administrative support functions to an administrative affiliate. Instead, the transferred function was a profit center that managed enhanced services provided to the public, such as voice mail and electronic messaging. SBC Services will provide its services only to Pacific and to other SBC companies.
In the PBIS case, the Commission specified that its decision was based on circumstances that were specific to that application. It further found that Pacific had failed to comply with a Commission directive to exclude ISG's costs from the start-up revenue requirement ordered by the Commission when it adopted the New Regulatory Framework (NRF) for Pacific in 1989. The Commission stated:
(W)e must address the fact that ISG is a valuable business which has had some, if not all, of its expenses paid by ratepayers from 1984 to the present, contrary to our stated intention in the NRF decision....
Our decision here resolves challenging issues which we do not want to face again in the future. The matter is one of first impression which Pacific forced upon the Commission by its failure to place costs associated with enhanced services below the line as we ordered it to do in the NRF decision. The NRF decision was not directly helpful in reaching today's decision, because it did not anticipate or address the situation we face today: Pacific's noncompliance with the NRF decision's directives concerning which costs it should include in its start-up revenue requirement. Consequently, the decision we reach here today is limited, and not intended to serve as a broad precedent. (45 CPUC2d at 130-31; emphasis in original.)
Pacific contends, and we agree, that the valuation and refund ordered in the PBIS case were, at least in part, a punitive measure based on Pacific's noncompliance with NRF directives. The refund was ordered to resolve issues that the Commission did "not want to face again in the future." After this decision, the Commission never again ordered a going concern valuation and refund in any of its decisions approving Pacific's requests to transfer assets or lease space to affiliates. There is no noncompliance issue with respect to the functions described in the application before us today, nor are the in-house administrative functions comparable to the profit center role of PBIS.
ORA contends that a refund is necessary because ratepayers are at risk for higher rates and lower quality service. Alternatively, ORA proposes a five-year rate freeze until the dust settles on the consolidation. ORA witness Farzad Ghazzagh, senior utilities engineer, testified:
"Pacific does not provide any assurance that the ratepayers will remain indifferent from the transfer of assets. In fact, Pacific has not even performed any studies to estimate any kind of benefits to Pacific from this transfer. Pacific has alleged that this transfer will result in management efficiencies. But the question remaining is: who benefits from these management efficiencies? The only answer available in the documents filed by the applicant is that SBC will benefit from these efficiencies. ORA agrees that the consolidation of the functions could possibly result in efficiency gains at the SBC level, however the transfer of Pacific's resources out of its direct control may result in a decrease in efficiency levels for Pacific and its ratepayers." (Exhibit 25, pp. FG-6 and FG-7.)
Pacific's witnesses testified that, in their judgment, the proposed consolidation likely will have no effect on rates and will improve quality of service by streamlining an internal structure that existed across subsidiary boundaries and included multiple financial systems, complex affiliate billing and other inefficiencies. They contended that, under NRF, Pacific's rates are delinked from changes in Pacific's costs with the exception of cost changes due to exogenous events beyond management's control. Therefore, they argued, ratepayers are not at risk of higher rates due to management's decision to consolidate support functions in SBC Services.
As discussed earlier, we find merit in ORA's contention that Pacific has failed to provide adequate assurance that this consolidation of support functions will not affect service to California ratepayers. We have dealt with that concern by imposing requirements for measuring service quality before and after the formal consolidation. Critics of the consolidation, however, have presented scant evidence of ratepayer risk that would justify a rate refund or an arbitrary rate freeze. In the absence of persuasive evidence, we decline to impose a going concern rate refund or a rate freeze at this time.
20 Application of Pacific Bell for Authority Pursuant to Public Utilities Code Section 851 to Transfer and/or Lease Assets Used for Research and Development to Technology Resources, Inc. (1998) D.98-07-006 (granting Pacific authority to lease or transfer assets used for research and development to an administrative affiliate, Technology Resources, Inc.); Application of Pacific Bell for Authority Pursuant to Public Utilities Code Section 851 to Lease Space to PTG and PTLG (1998) D.98-03-019 (granting Pacific authority to lease space to affiliates providing support services to Pacific and other affiliates); Application of Pacific Bell for Authority Pursuant to Public Utilities Code Section 851 to Lease and/or Transfer Assets to Administrative Affiliates (1998) D.98-02-005 (granting Pacific authority to lease space to affiliates providing support services to Pacific and other affiliates); Application of Pacific Bell for Exemption or Authority Pursuant to Public Utilities Code Section 851 for the Lease and Sale of Assets to Pacific Telesis and Affiliates (997) (granting Pacific authority to lease and sell assets to affiliates providing support services to Pacific and other affiliates).
21 Re Pacific Bell (1996) 69 CPUC2d 206, 210.
22 Id. at 210.
23 Re Pacific Bell (1992) 45 CPUC2d 109, 116.
