12. Assignment of Proceeding
Susan P. Kennedy is the Assigned Commissioner and Principal Hearing Officer for this proceeding. ALJ Glen Walker is assigned to this proceeding.
This Alternative Draft Decision was prepared by Commissioner Geoffrey F. Brown. ALJ Walker assisted in the preparation.
1. Applicants seek approval of a transfer of control of MCI's California subsidiaries to Verizon that will occur indirectly as a result of a transaction between holding companies for Verizon and MCI.
2. As a result of the merger between Verizon and MCI, Applicants intend to strengthen the financial position of the combined company and improve its competitive position by combining complementary strengths and skills.
3. The California Attorney General filed his Advisory Opinion in this matter on September 16, 2005.
4. The Commission examines merger, acquisition, or control activities on a case-by-case basis to determine the applicability of § 854.
5. Applicants agree that § 854(a) applies to this transaction, but they challenge the applicability of §§ 854(b) and (c).
6. Although the proposed merger transaction is technically structured as a merger between the holding companies of Verizon and MCI, the practical result of the merger will have effects on the California utilities that are owned by Verizon and MCI.
7. In determining whether Verizon California is a party within the meaning of Section 854, the Commission focuses on substance rather than form.
8. It would elevate form over substance to find that §§ 854(b) and (c) do not apply to this transaction merely because Applicants designed the merger using a holding company structure.
9. It would elevate form over substance to conclude that the Legislature was more concerned with competition if the utility was a party to the transaction absent the holding company structure, but was less concerned about competition when a holding company was involved.
10. At the direction of the Assigned Commissioner, Applicants produced a calculation of net synergy benefits to California consumers on a discounted net present value basis, assuming the Commission applies § 854(b) to this transaction over Applicants' objections.
11. Applicants' calculated $6.6 million in net benefits to California consumers assuming the Commission were to find that § 854(b) applies. The $6.6 million represents 50% of the discounted net present value of Applicants' four-year forecast of merger synergies attributable to California, or approximately 1/10 of 1% of the total corporate synergies that Applicants forecast from the Verizon/MCI merger.
12. ORA and TURN performed separate calculations using Applicants' synergies model as a starting point. ORA produced a calculation of approximately $206 million in applicable net synergy benefits in California on a discounted net present value basis. TURN produced a calculation of approximately $365.7 million. ORA and TURN each propose allocating 50% of the calculated net benefits to consumers.
13. The two largest factors accounting for the difference between the ORA/TURN calculation of synergies versus that of Applicants are: (1) inclusion of MCI California operations in the allocation and (2) extending the measurement period to incorporate the full period over which total corporate benefits were considered as a basis for shareholders' evaluation of the merger.
14. Based upon the calculations of synergies performed by Applicants, modified to incorporate certain adjustments made by ORA/TURN, the total net synergy benefits reasonably attributable to California is $206 million on a discounted net present value basis under the provisions of Section 854(b).
15. A $103 million allocation of net benefits to California consumers represents a 50% share of total benefits of $206 million attributable to California, reflecting a long-range forecast of approximately eight years as calculated by TURN.
16. The adopted net benefit amount incorporates ORA's recommendation to reallocate offsetting costs to implement the merger so that a pro rata share are assigned beyond the period during which ratepayers share in the forecasted synergies.
17. The Attorney General's Advisory Opinion concluded that the merger will not adversely affect competition in California telecommunications markets with the exception of the market for special access.
18. By focusing its analysis on facilities-based competition, the Attorney General's Advisory Opinion did not fully address the effects of the merger on the overall telecommunications markets in which Verizon and MCI compete. In this respect, the testimony presented by expert witnesses on competitive impacts of the merger provided a more complete analysis with respect to the range of relevant markets.
19. In D.91-05-028, the Commission set forth analytical precedents for interpreting whether a party's proposal "adversely affects competition" within the meaning of § 854(b)(3). The Commission held that precedent developed under Section 7 of the Clayton Act provides a framework for analyzing the competitive effects under § 854(b)(3).
20. The goal of analyzing the competitive effects of the merger is to protect consumers by preventing transactions likely to result in increased prices or reduced output. Mergers can harm consumers when they cause structural changes to the marketplace that increase a firm's ability to exercise market power, defined as the ability to affect prices or reduce output of the industry.
21. Under traditional market analysis, the market power resulting from the merger of two competitors is usually measured in terms of concentration, or market shared. This is a statistical analysis using the Herfinhdahl-Herschman Index (HHI) which calculates the sum of the squares of each firm's market share.
22. The analysis of market share and HHI measures is a necessary starting point for analyzing market power due to a merger, after which additional indicators of prospective competition are properly considered.
23. Traditionally, the competitive effects of a proposed merger are analyzed by identifying the relevant product markets affected by the merger. The geographic scope of the market, the area in which the sellers compete and in which buyers can practicably turn for supply are identified as part of this analysis.
24. The relevant markets for purposes of analyzing the competitive effects of this merger include retail markets (i.e., mass market, medium and large enterprise customers) and wholesale markets.
25. Applicants did not perform an analysis of market concentration relating to this merger, either in the aggregate or for individual markets, since they believe that only forward-looking indicators of competition are meaningful in assessing the Verizon/MCI merger.
26. ORA and TURN witnesses presented calculations of the HHI with respect to individual market segments. These analyses show that the HHI was already highly concentrated before the merger, and becomes more highly concentrated as a result of the MCI acquisition.
27. Although the mass market is already highly concentrated, Verizon's acquisition of AT&T will not significantly change the degree of mass market concentration since MCI had already ceased actively marketing to this sector before entering into the merger.
28. Mass market customers could be adversely affected by the merger to the extent that merger-related costs could increase their utility bills, or utility resources could be diverted to reduce the level or quality of service offered to them.
29. Verizon and MCI chose to merge rather than to compete against each other through facilities-based expansion of their respective networks.
30. Given the failure of MCI to succeed as an independent competitor pursuing facilities-based expansion, the prospects for other carriers with less financial resources to compete successfully against the post-merger Verizon is called into question.
31. In the retail business markets and in wholesale markets in which Verizon and MCI compete, the measures of market concentration measured by the HHI indicate a material increase in Verizon's market power from the merger.
32. Evidence presented concerning forward-looking measures of competition in sectors other than the mass market does not paint a picture of a robustly competitive market today or in the immediate future.
33. Although some competition from intermodal sources such as cable, VoIP, and wireless technologies exists within certain sectors of the Verizon California service territory, such competition is not sufficiently developed in all relevant markets today to avoid the need for conditions to mitigate Verizon's increased market power from the merger.
34. Although their marketing focus differs to some degree, Verizon and MCI have been competing head-to-head for enterprise business customers throughout the Verizon footprint.
35. Certain proposed measures, as identified below, will mitigate the competitive harm that could otherwise result from the proposed merger.
36. Capping UNE rates in the manner proposed by CALTEL could conflict with broader FCC "just-and-reasonable" principles relating to the pricing of such UNEs.
37. CALTEL's proposal to permit carriers to opt in on any agreement negotiated by Verizon in another state or any provision(s) arbitrated in California is an appropriate mitigation measure.
38. Verizon possesses significant market power in the provision of special access services in California.
39. MCI has played a pivotal role in disciplining the rates, terms, and conditions under which Verizon offers special access generally, both as an alternative source of supply to other competitors and by its negotiating leverage in obtaining more favorable terms and rates.
40. Absent mitigating conditions, the removal of MCI as a competitor in the special access market will give Verizon additional opportunities to leverage its market power against competitors to the detriment of consumers.
41. Parties' proposed condition to permit a "fresh look" period following the close of the merger has not been shown to be justified except for the limited purpose of allowing carriers to accept the same package of terms and rates negotiated between affiliates of Verizon.
42. It is reasonable as a mitigation measure in response to MCI's elimination as a competitor in the short-haul market, to require that Verizon extend its existing transport agreements for a five-year period at the same rates, terms and conditions.
43. Level 3 has not shown that Commission intervention is warranted in calling for the exchange of VoIP traffic at reciprocal compensation rates.
44. Verizon's practice of refusing to offer stand-alone DSL service harms competition by making it more difficult for competitors to provide voice service to customers subscribing to broadband Internet access over Verizon's DSL facilities. The potential harm from this practice will increase through acquisition of MCI.
45. A reasonable merger mitigation measure is to require SBC to offer DSL on a stand-alone basis.
46. With the conditions adopted in this decision, the merger will improve the financial condition of Verizon and MCI.
47. The merger will maintain or improve the quality of management of the combined company.
48. Service quality will be maintained or improved as a result of the merger, with the service quality conditions adopted in the ordering paragraphs below.
49. The merger will be fair and reasonable to affected public utility shareholders, as reflected by the approval of the merger by Verizon and MCI shareholders.
50. With the adoption of conditions set forth in this order, the Commission will preserve its jurisdiction and ability to regulate and audit public utility operations in the state.
51. Subject to adoption of mitigating conditions relating to philanthropy, workplace diversity, and outreach to underserved segments of the community, as set forth in the ordering paragraphs below, the merger will be beneficial on an overall basis to state and local economies and to the communities served by the combined company.
52. Applicants entered into a settlement with Greenlining and LIF addressing the issues of net benefits to consumers, supplier diversity issues, and corporate philanthropic commitments to local communities.
53. While the terms of the settlement would result in greater commitments than Applicants otherwise propose to offer, the settlement, in total, is procedurally defective and contains unacceptable restrictions that would prevent the Commission from adopting it in its present form consistent with § 854.
54. A reasonable measure to assure that the proposed merger is in the public interest of local communities, including the underserved segments thereof, Verizon should be required to commit to philanthropic contributions in the amount of $20 million over a five-year period.
1. Section 854(e) requires that the Applicants have the burden of proof by a preponderance of evidence to demonstrate that the requirements of §§ 854(b) and (c) are met.
2. In order to determine whether § 854(b) applies to this application, the actual language of the statute should first be examined. In examining the statute's language, decisionmakers should give the words of the statute their ordinary, everyday meaning. If the meaning is without ambiguity, doubt, or uncertainty, then the language controls. Only if the meaning of the words is not clear should decisionmakers take the second step and refer to the legislative history.
3. The plain language of § 854(b) is clear, and applies where a utility of a specified financial size is a party to the proposed transaction.
4. Because the substance of the transaction should take precedence over its mere form, Verizon California and MCI California subsidiaries should both be considered as parties to this transaction in applying § 854(b).
5. Past mergers of telecommunications companies that were granted an exemption from review under §§ 854(b) and (c) are not analogous precedents for this transaction, which involves consolidating the assets of the state's second largest ILEC and one of the country's major CLECs.
6. Section 854(b) and (c) apply to this transaction.
7. Section 854(b) requires the Commission to allocate to ratepayers certain forecasted benefits that accrue as a result of the merger.
8. Section 854(b) requires that ratepayers be allocated a minimum 50% of California short-term and long-term economic benefits accruing as a result of the merger.
9. A reasonable estimate of long-term economic synergies accruing to California consumers under the merger consistent with § 854(b) is $103 million on a discounted net present value basis representing 50% of the total California synergies of $206 million.
10. The Commission should require as a condition of the merger that Applicants pass on to consumers the § 854(b) economic benefits associated with the merger as quantified in this decision.
11. The specific distribution and/or utilization of the § 854(b) net benefits among various consumer interests should be addressed in a subsequent order following opportunity for parties to file comments.
12. Section 854(b)(3) requires the Commission to find that Applicants' proposal does not adversely affect competition.
13. The Commission must determine the appropriate weight to give the Attorney General's Advisory Opinion, also taking into account the substantive evidence on competitive harm and proposed mitigation measures presented through expert witness testimony in the proceeding.
14. The proposed merger should not have an adverse effect on competition within the meaning of § 854 if specified conditions are adopted.
15. In carrying out its obligation to evaluate potential adverse effects under § 854, the Commission should examine all relevant effects on California consumers, even if a particular impact may involve services that are regulated by a federal agency.
16. In order to meet the § 854(b) standard that the proposed merger does not have an adverse effect on competition, conditions should be imposed to mitigate competitive harms that would otherwise result from the transaction.
17. With the imposition of the conditions set forth in the ordering paragraphs, the proposed transaction meets the requirements of § 854 and should be approved subject to those conditions.
IT IS ORDERED that:
1. The application of Verizon Communications Inc. (Verizon) and MCI, Inc. (MCI) (collectively, Applicants) is granted, subject to the conditions set forth herein.
2. Applicants shall notify the Commission in writing when the merger that is the subject of this application has been consummated. The written notice shall be delivered to the Commission within five business days of the effective date of the merger.
3. Verizon shall maintain a cap on basic residential and small business local exchange services, including 1 FR, 1 MR, 1 MB, and residential inside wire maintenance plans, to continue for a period of five years from the effective date of this decision. These services shall be made available to consumers on a stand-alone basis without any requirement to purchase other bundled services. The services shall be listed separately in Verizon phone directories and in any advertising on web sites or through bill inserts. Verizon shall retain a pricing option for California-jurisdictional long distance calling that does not have a minimum monthly fee.
4. Verizon shall implement appropriate measures to distribute Section 854(b) California synergy benefits in the amount of $103 million. The implementation method shall be determined through a subsequent Commission order following opportunity for parties to comment on the manner in which the Section 854(b) net benefits should be distributed. Comments on this issue shall be filed 20 calendar days from the effective date of this decision.
5. As a condition of Commission approval, Verizon shall implement the following measures to remain in effect for a five-year period from the effective date of this order.
a. Verizon shall be required to honor existing Internet peering arrangements and to offer extensions, if requested, for up to five years.
b. Verizon shall be required to allow any competitive local exchange carrier (CLEC) to adopt in California any agreement that Verizon has negotiated in any other state (except for state-specific prices and performance standards), or any provision or set of interrelated provisions that Verizon has included in an agreement as the result of arbitration in California.
c. Verizon shall offer digital subscriber line (DSL) service on a stand-alone basis without being tied to other Verizon services.
6. Applicants shall agree to the following conditions in order to satisfy the criteria under Section 854(c).
a. Applicants shall agree to an increased cumulative philanthropy commitment of $20 million over a five-year period. A more specific determination of how the philanthropy funds should be distributed, either among the affected groups, or through grants to community-based foundations shall be made following opportunity for parties to comment. Comments on the issue of the appropriate distribution and/or utilization of the philanthropy funds shall be filed 20 calendar days from the effective date of this decision.
b. As a condition of the merger, Applicants shall report to the Commission one year after the effective date of this decision on the impact of employee layoffs on union and non-union employees in the state of California.
7. Applicants shall file written notice with the Commission in this proceeding, served on all parties to this proceeding, of their agreement, evidenced by a resolution of their respective boards of directors, duly authenticated by a secretary or assistant secretary, to the conditions set forth in this decision. Failure of Applicants to file such notice pursuant to this order within 60 days of the effective date of this decision shall result in the lapse of the authority granted in this decision.
This order is effective today.
Dated ____________________, at San Francisco, California.
