BEFORE THE UTAH STATE TAX
COMMISSION
____________________________________
XXXXX
XXXXX, :
Petitioner, : FINDINGS OF FACT,
: CONCLUSIONS
OF LAW,
v. : AND FINAL DECISION
:
PROPERTY TAX
DIVISION : Appeal No. 88-1334
OF THE UTAH
STATE :
TAX COMMISSION, :
:
Respondent. : Tax Type: Centrally Assessed
_____________________________________
STATEMENT OF CASE
This
matter came before the Utah State Tax Commission for a formal hearing on XXXXX
through XXXXX. Commission Chairman W.
Val Oveson presided during the hearing.
Commissioner Alice Shearer, Commissioner Roger O. Tew, Commissioner Joe
B. Pacheco and Administrative Law Judge G. Blaine Davis also heard the matter
for the Commission. Present and
representing Petitioner were XXXXX, XXXXX, and XXXXX from the law firm
XXXXX. Present and representing
Respondent were XXXXX and XXXXX, Assistant Attorneys General. Present and representing the affected
Counties were XXXXX, and XXXXX from the law firm XXXXX.
Based
upon the evidence and testimony presented at the hearing, the Tax Commission
hereby makes its:
FINDINGS OF FACT
1. This is a property tax valuation appeal.
2. The year in question is XXXXX, with a lien
date of XXXXX.
3. In its original assessment, the Property Tax
Division of the Utah State Tax Commission, (the Division) set the system value
of XXXXX at $$$$$ and set the value of the portion of XXXXX operating property
allocated to Utah at $$$$$, which was XXXXX% of the system value.
4. Petitioner, XXXXX is a telecommunications
company with its principal offices in XXXXX, XXXXX. XXXXX is a subsidiary of XXXXX, a telecommunications holding
company whose other principal subsidiaries are the XXXXX and XXXXX. XXXXX is a wholly owned subsidiary of XXXXX.
5. Until XXXXX, XXXXX was a wholly owned
subsidiary of XXXXX and one of XXXXX XXXXX companies. As a result of anti-trust litigation brought by the United States
Department of Justice, XXXXX and the Department of Justice entered into a consent
decree entitled the Modification of Final Judgement (MFJ), pursuant to which
XXXXX divested itself of ownership of portions of operating telephone companies
that related to exchange telecommunications services, exchange access
functions, XXXXX service, printed directory advertising, as well as XXXXX
cellular advanced mobile communications service business. Ownership of these operations was
transferred to XXXXX newly formed XXXXX, one of which was XXXXX.
6. XXXXX furnishes telecommunications services
in XXXXX, XXXXX, XXXXX, XXXXX, XXXXX, XXXXX, and XXXXX. It provides XXXXX data transmission,
transmission of radio and television programs, and private line voice and
tele-typewriter services in those areas.
Since XXXXX, telephone directories for the company’s service have been
published by XXXXX, an affiliate of XXXXX, pursuant to a contract with the
company.
7. For the year ending XXXXX, the principal
sources of revenue for XXXXX were local service (XXXXX%), access charges
(XXXXX%), and toll service (XXXXX%).
There were XXXXX network access lines in service on XXXXX.
8. The company has made and expects to continue
to make, large construction expenditures to meet the demand for
telecommunications services and further improve such services. Total investment in telephone plant
increased to $$$$$ on XXXXX, from $$$$$ on XXXXX, after giving effect to
retirements but before deducting accumulated depreciation on such dates. Annual construction expenditures for XXXXX
were $$$$$.
9. The FCC’s Notice of Proposed Rulemakingof
XXXXX, proposed a dramatic change in the method of regulating the interstate
rates of dominant telecommunications common carriers. In XXXXX, citing the growth of competition in the market for
various interstate services and alleging a number of deficiencies in the
traditional regulatory approach, the FCC suggested replacing it with a “price
cap model” of regulation.
10. There is increased recognition of
competitive market forces at the federal level and also growing awareness of the
structural changes in the local and state telecommunications market. Increasing consumer sophistication, larger
numbers of choices, the availability of user-friendly technology, and more and
better integrated systems are primary motivators in the movement towards
greater competition among suppliers of both traditional telecommunications
service and newer information products.
The company remains a major participant in both the traditional and
newly emerging markets.
11. Following the mailing of the valuation
notice, on or about XXXXX XXXXX filed a timely Petition for Redetermination
with the Commission in which it alleged that the Original Assessment was
erroneous and excessive. XXXXX further
alleged that its Utah operating property should be assessed at XXXXX% of its
fair market value in the same manner as property assessed by county assessors
pursuant to what was then Utah Code Ann. §59-2-304(1).
12. A portion of the claim of XXXXX was based
upon a closely related issue (the “Amax Issue”) which was then pending
before this Commission in the matter of Amax Magnesium Corp.v. Tax
Comm’n,796 P.2d 1256 (Utah 1990), appeal after remand, 874 P.2d 840
(Utah 1994). Pursuant to a Joint
Stipulation of the parties, dated XXXXX, this Commission entered an order on
XXXXX, staying the proceedings in this appeal until the related issue in the Amax
case was fully resolved. Following the
legislative amendments to Utah Code Ann. §59-2-304(1), which became fully
effective XXXXX, XXXXX voluntarily withdrew the Amax issue. The formal hearing in this matter was then
set to begin on XXXXX.
13. Because XXXXX Utah property is operated as
part of an integrated, XXXXX telecommunications system, the fair market value
of the Utah property of XXXXX is best determined under the unit approach to
value. Under the unit approach, the
value of the entire system of XXXXX is first determined as a going
concern. A portion of the system value
determined under the unit approach is then allocated to the state of Utah. The unit approach does not mean that
nontaxable or intangible property is subject to property taxation.
14. All parties agreed that the allocation
methodology recommended by the XXXXX may properly be applied to the determined
system value of XXXXX. The allocation
factor to allocate a portion of the total value to the State of Utah, agreed
upon by the parties and accepted by this Commission, for the XXXXX tax year is
XXXXX%.
15. In determining the value of XXXXX entire operating
system, the standard to be applied is “fair market value,” which is the price “at which [the] property
would change hands between a willing buyer and a willing seller, neither being
under any compulsion to buy or sell and both having reasonable knowledge of the
facts.” Utah Code Ann. §59-2-102(2).
16. XXXXX is a telecommunications utility
subject to traditional rate base/rate of return regulation at the federal and
state levels.
17. The interstate telephone operations of XXXXX
are regulated by the Federal Communications Commission (“FCC”). The intrastate telephone operations of XXXXX
are regulated by the Utah Public Service Commission (“PSC”) and its
counterparts in the other XXXXX in which XXXXX operates (collectively with the
FCC, the “Regulatory Commissions”).
18. The Regulatory Commissions all require XXXXX
to maintain its financial records in accordance with the FCC’s Uniform System
of Accounts. These standardized
accounts are used by the Regulatory Commissions both for reporting purposes,
e.g., as the basis for XXXXX annual report to the FCC on Form M, and for
purposes of establishing the authorized rate base and overall allowed rates of
return on rate base for XXXXX.
19. The accounting procedures followed by XXXXX
under the Uniform System of Accounts in preparing its Form M reports can differ
from the accounting procedures followed by XXXXX under Generally Accepted
Accounting principles in preparing its annual Form 10-K report filed with the
Securities and Exchange Commission.
20.
The objectives of traditional rate
base/rate of return regulation are to provide universal access to service at
reasonable rates, while affording the utility the opportunity to earn a
reasonable rate of return on its investment.
21. The investment base on which the utility is
afforded the opportunity to earn a return is typically referred to as its “rate
base.” The calculation of the amount of
the utility’s authorized rate base begins with the original or historical cost
of its operating property on the date it was first placed in service, sometimes
referred to as the date the property was first devoted to public service. Regulatory Commissions limit the amount and
type of costs that may be included in the utility’s authorized rate base to
those costs deemed reasonable and necessary to provide utility service and
those costs that the Regulatory Commissions determine as a matter of policy
should be borne by the customers or ratepayers of the utility.
22. From the original or historical costs
allowed in the rate base, the Regulatory Commissions then deduct amounts
attributable to accumulated depreciation.
For regulatory purposes depreciation is calculated on a “straight-line”
basis over the useful life of the asset, again as determined by the regulatory authorities. As a result, regulatory depreciation rates
can and typically do vary substantially from depreciation rates allowed for
income tax or general accounting purposes.
APPRAISAL EVIDENCE
23. At the formal hearing, three expert
appraisals were presented: one by XXXXX for XXXXX, one by XXXXX for the
Division and one by XXXXX for the Division.
24. XXXXX prepared his appraisal using five
separate indicators of value: Historical Cost Less Depreciation (HCLD) cost
approach indicator adjusted for obsolescence; a rate base cost approach
indicator; two income approach indicators, one utilizing a projected income
based on authorized rates of return on rate base, and one projecting expected
income from historical earnings patterns; and a business segments stock and
debt approach.
25. XXXXX appraisal calculated six valuation
approaches: an adjusted HCLD cost approach; direct capitalization of both net
operating income (NOI) and net cash flows based upon market multiples; a
discounted cash flow approach based upon projections from the historical
earnings of XXXXX; a stock and debt approach which calculated the value of the
equity of XXXXX through the application of various ratios; and a stock and debt
approach adding an estimated “mergers and acquisitions” premium to the traded
stock price.
26. XXXXX prepared his appraisal using four
valuation approaches: an historical cost less depreciation (HCLD) cost approach
adjusted by a market to book ratio derived from the seven RBOC’S; a direct
capitalization income indicator; a discounted cash flow approach based upon a
range of estimated percentage increases in the historical earnings of XXXXX;
and a stock and debt approach based upon a direct estimation of the value of
the equity of XXXXX using market multiples derived from the RBOC’S.
XXXXX APPRAISAL
27. XXXXX prepared his appraisal using five
separate indicators of value as has been set forth above.
28. While preparing his appraisal, XXXXX
reviewed two analyst reports for the stock and debt indicator. No other market analyst reports were
reviewed or considered.
29. XXXXX rate base cost indicator of value was
calculated on Appendix A, Table 4a of Exhibit 30. In that estimate of value, XXXXX began with the Gross investment
in telephone property from the books of the company of $$$$$, and deducted
depreciation and amortization of $$$$$, accumulated deferred federal income
taxes (DFIT) of $$$$$, and land development and construction deposits of $$$$$,
then added materials and supplies of $$$$$ to arrive at a system valuation,
which was equal to rate base, of $$$$$.
30. In XXXXX adjusted rate base indicator of
value for the cost approach, he makes two additional reductions from his
original rate base indicator of value calculated above which are set forth on
Appendix A, Table 4 of Exhibit 30.
First, XXXXX deducted an amount of $$$$$ for “inadequate earnings
power.” XXXXX asserts that this adjustment is necessary to reflect the
“economic obsolescence caused by regulatory treatment of licensing revenues and
certain operating expenses that imposes a limitation on earnings from the
cost-regulated utility property so that the realizable rate of return is less
than the average rate of return allowed by regulatory authorities.” (Footnote 10, Appendix A, Table 4 to Exhibit
30). The position of Respondent is that
ninety percent (90%) of this adjustment is caused by XXXXX deduction of
advertising revenues, and the remaining ten percent (10%) of the adjustment is
caused by XXXXX deduction of operating expenses, such as charitable and
community contributions which are not allowed by regulators in calculating rate
base or in the calculation of the revenue requirements of the utility. The second adjustment to the rate base was
for “inadequate allowed rate of return on fixed income securities.” The adjustment was in an amount of $$$$$,
and represented the difference between the imbedded debt rates and the market
debt rates. After the deduction of
those two items, XXXXX determined the rate base, or adjusted system value based
on the cost approach to be $$$$$. Due
to a small calculation error, the deduction for inadequate allowed rate of
return on fixed income securities was reduced by approximately $$$$$, thereby
increasing the indicator to $$$$$.
(Appendix A, Table 4, Exhibit 31).
31. In XXXXX estimate of value based upon the
income approach and utilizing the expected earnings model, he made an estimate
of the projected earnings of XXXXX.
That estimate was based, not upon the past earnings of the company, but
instead upon the rate base which he had calculated in the cost approach (XXXXX)
multiplied by XXXXX% which he said was the expected earnings rate on net
investment. The expected earnings rate
of XXXXX% was the average of the rates of return allowed by all regulatory jurisdictions. (Appendix A, Table 3 of Exhibit 30). From the expected earnings of $$$$$, XXXXX
deducted the net licensing revenues after taxes of $$$$$ because he claims that
when regulatory authorities include those licensing revenues in net income for rate
making purposes, it imposes a limit on the actual revenues to be derived from
telecommunications properties. He also
deducted an amount of $$$$$ from those expected earnings for additional
operating expenses which he says were “certain prudent operating expenses which
are not chargeable to customers for rate making purposes.” (Footnote 13, Appendix A, Table 3 of Exhibit
30). Thus, the expected income to be
capitalized was reduced from $$$$$ to $$$$$.
That income was capitalized by XXXXX at a rate of twelve percent (12%)
to arrive at an estimated system valuation based upon the capitalization of
expected earnings of $$$$$. (Appendix A, table 2 of Exhibit 30). XXXXX also testified that if the same method
had been used but the directory revenues and additional operating expenses had
not been deducted from the projected revenues, then the capitalization of the
projected revenues of $$$$$ at 12.0% would produce a value of $$$$$.
32. In XXXXX estimate of value based upon the
income approach and utilizing the historical earnings model, he used the net
operating income for Petitioner for XXXXX from the annual Form M filed with the
Federal Communications Commission (F.C.C.) in an amount of $$$$$. From that amount, XXXXX deducted the same
licensing revenues and additional operating expenses as discussed above, but
added $$$$$ for income from telephone property under construction, to arrive at
income to be capitalized of $$$$$. (Appendix A, Table 3a, Exhibit 30). That income was capitalized at 12.0%
(Appendix A, Table 2a, Exhibit 30) to arrive at an estimated value of
$$$$$. If that same approach was used
without the deduction for directory revenues or additional operating expenses,
then the value would calculate to $$$$$.
33. XXXXX also made an estimate of value based
upon the stock and debt approach, which he entitled “Stock and Debt Market
Price Approach” (Appendix A, Table 5,
Exhibit 30). XXXXX took the gross value
of all of the debts, obligations, and securities of XXXXX, primarily as of the
end of XXXXX, although some matters, such as the bond prices, were averages for
the year. In addition, for other
liabilities, he only included 50% of the amount of other liabilities as of the
end of the year. XXXXX apparently
attributes approximately 50% of the total consolidated net income of XXXXX to
the activities of XXXXX, and has therefore apparently allocated the other
liabilities on the basis of the contribution of XXXXX to the net income. (Exhibit 507 (A).) XXXXX determined a gross value for all securities and other
obligations of $$$$$. XXXXX then
deducted the non-operating property in a total amount of $$$$$ to arrive at the
total system value based upon the stock and debt approach of $$$$$.
34.
In arriving at the estimate of value based upon the stock and debt approach,
XXXXX only included the value of the common stock of XXXXX after deducting from
the value of XXXXX the values of all other subsidiaries. To determine the amount which XXXXX would
include in common stock for the stock and debt approach to value, he began with
the total value of the common stock of XXXXX as of XXXXX of $$$$$ (No. Of
Shares times the average selling price for XXXXX), and then reduced the
aggregate stock price by the following items in the following amounts:
A)
$$$$$ for XXXXX (determined by placing the value of $$$$$ per share on the
stock of XXXXX set forth in the XXXXX prospectus).
B)
$$$$$ for the “loss subsidiaries”
(based on the book value of subsidiaries with losses during XXXXX).
C)
$$$$$ for XXXXX (based on a price/earnings multiple developed by using XXXXX as
a comparable).
D)
$$$$$ for XXXXX, which was based upon book value.
E)
$$$$$ for the remaining “profitable subsidiaries” (based on the book value of
profitable subsidiaries). (Exhibit 507
(A)).
35. The remaining XXXXX (XXXXX) was allocated
among the XXXXX telephone companies (XXXXX, XXXXX, XXXXX) based on net income,
of which XXXXX% or $$$$$ was allocated
to XXXXX. To this common stock value
was added the market price of the funded debt, current liabilities, and other
liabilities, yielding a gross stock and debt value of $$$$$. This amount was reduced by current assets of
$$$$$, an imputed value for directory advertising revenues of $$$$$, other
assets of $$$$$, investments and funds of $$$$$, and approximately $$$$$ in
miscellaneous physical property, resulting in a system value of $$$$$. XXXXX did not give any weight to the stock
and debt approach.
36. By calculating the estimated stock and debt value
of XXXXX in the manner which XXXXX did (i.e., by starting with the total values
for XXXXX and then deducting the estimated values of several other companies
and functions to show the value of XXXXX at whatever is left after those
deductions) any and all errors made in calculating the values of any of the
other subsidiaries would flow through to cause an error in the value of the
property of XXXXX. Therefore, the
Commission finds that the stock and debt values determined by XXXXX for the
stock and debt approach is of questionable reliability. However, since XXXXX did not give any weight
to the value determined by this approach, such a finding would not modify the
final values recommended by XXXXX.
37. The overall correlated system value
determined by XXXXX was determined by giving one-third of the weight to the
adjusted rate base indicator, and two-thirds of the weight to the expected
earnings model adjusted for the small calculation error. The final estimate of value of XXXXX was
$$$$$. Based upon the allocation
percentage of 12.63% agreed to by all parties, XXXXX allocated $$$$$ of the
total value to the state of Utah.
XXXXX APPRAISAL
38. XXXXX, a registered state appraiser
developed six (6) indicators of value.
He prepared a traditional historical cost less depreciation (HCLD) cost
indicator, two income indicators based on direct capitalization, and three
market indicators including a traditional stock and debt approach, a mergers
and acquisition approach, and a financial forecast approach. Unlike XXXXX and XXXXX who used the FCC Form
M, XXXXX took his numbers from the SEC Form 10K. There was testimony that the differences between the FCC’s Form M
and Form 10K, are approximately 2-3%.
In preparing his appraisal, XXXXX reviewed and considered numerous
analyst reports.
39. XXXXX cost approach was a historical cost
less depreciation (HCLD) or net book cost indicator with the present value of
construction work in progress (CWIP) added pursuant to Tax Commission
RuleR884-24P-20. He arrived at a value
based upon the cost approach of $$$$$.
40. In his two income indicators, XXXXX utilized
the direct capitalization model. This
model is used extensively by the Division in assessing properties each year. The model is based on a conversion of income
into value in one step through the use of market derived ratios. The algebraic formula to determine value as
used by XXXXX is:
Value = NOI
RATE
where:
NOI = Normalized
Forecast Net Operating Income
Rate = Blended direct
cap rate of debt and forecast
E/P rates
41. XXXXX developed his direct capitalization
rate of XXXXX% analyzing industry capital structures and determined a market
structure of XXXXX% debt and XXXXX% equity.
His debt rate of XXXXX% was based upon yields for XXXXX publicly traded
debt maturing after XXXXX. The earnings
to price (E/P) rate was developed through a three (3) tiered analysis of
comparable companies. XXXXX based his
analysis largely upon Value Line for companies in the telecommunications
industry. Twenty-two companies were
chosen, nearly all of which had SIC codes of XXXXX, meaning they were telephone
companies. XXXXX then estimated the
degree of similarity to XXXXX based upon revenues, size, foreign domicile, and
degree of regulation. This second analysis
narrowed the list to fourteen. Finally,
XXXXX compared the financial characteristics of these fourteen companies with
XXXXX, and included historical growth trends, profitability, bond ratings and
common financial ratios. These fourteen
companies were narrowed to six. Five of
the six companies selected by XXXXX wereXXXXX, nearly identical to those
selected and used by XXXXX, and XXXXX.
Also included in his analysis with the XXXXX was XXXXX.
42. Having selected his guideline companies, XXXXX
compared earnings to price (E/P) and cash flow to price (CF/P) ratios. These ratios were based upon forecast
earnings and forecast cash flows. Based
on this comparison, XXXXX selected an E/P rate of XXXXX% and a CF/P rate of
XXXXX%, both of which were higher and more conservative than those of the
selected guideline companies. Applying
the debt and equity rates to his selected capital structure, XXXXX derived a
direct capitalization rate based on NOI of XXXXX% and a direct capitalization
rate for NOI plus depreciation (cash flow) atXXXXX%. (Schedule I/1 and I/2 of Exhibit 531).
43. In developing a yield or discount rate for
discounting construction work in progress, (CWIP), XXXXX developed his equity
rate by considering the capital asset pricing model (CAPM), the dividend growth
Model (DCF Model), and a risk premium model.
Based on this analysis, XXXXX selected XXXXX%. Blending that rate with the cost of debt of XXXXX%, XXXXX
developed a yield rate of XXXXX%.
44. XXXXX developed a forecast normalized NOI by
analyzing historical trends from the company since XXXXX coupled with analyzing
future forecasts made by analysts. He
selected $$$$$ as the forecasted NOI.
That forecast income was then capitalized at the direct capitalization
rate of XXXXX% indicating a value based upon one of his income approaches of
$$$$$. (Schedule I/1 of Exhibit 531).
45. XXXXX also developed an income approach
based upon a forecast normalized NOI plus depreciation, (cash flow) by
analyzing historical trends of the company since XXXXX, coupled with future
forecasts, and adding depreciation. He
concluded that there would be $$$$$ of normalized NOI plus depreciation. This number was capitalized at the direct
capitalization rate of XXXXX% leading XXXXX to conclude a value based upon his
normalized NOI income approach of $$$$$.
(Schedule I/2 of Exhibit 531).
46. In XXXXX traditional stock and debt
approach, he determined the stock value (equity value) allocated to XXXXX by
first calculating the stock value of XXXXX. XXXXX analyzed stock price movements toward the end of the year
and selected $$$$$ per share. The
equity value of XXXXX was allocated to XXXXX based upon XXXXX contribution of
net income to the total company resulting in an imputed value allocated to XXXXX
of $$$$$. (Schedule 5/1 of Exhibit
531). XXXXX added long-term debt and
other liabilities to this stock value resulting in a gross stock and debt value
of $$$$$. Non-operating property was
then removed by applying a ratio of XXXXX% resulting in a final estimate of
value based upon the stock and debt approach of $$$$$. (Schedule 5/1 of Exhibit 531).
47. In his mergers and acquisition market
approach, XXXXX analyzed the common stock in light of an assumed control
premium. XXXXX studied typical mergers
and acquisitions and concluded that when the assets of a company have been
sold, a control premium has typically been paid during the sale. In analyzing this premium, XXXXX selected a
control premium of XXXXX%, which was based upon the median premium paid in
XXXXX and XXXXX for companies whose stock was originally selling for XXXXX to
XXXXX times earnings. Applying this
control premium to the stock value allocated to XXXXX resulted in a stock value
of approximately $$$$$. This amount was
added to long-term debt and other liabilities and adjusted for non-operating
property, which resulted in a value based upon the mergers and acquisitions
market approach of $$$$$. (Schedule
M&A/1 of Exhibit 531).
48. In his financial forecast model, XXXXX
analyzed the common stock value based upon a five-year forecast of dividends
and a terminal value which used the E/P rate he had developed for his income
indicators. These future estimated cash
flows to equity holders were discounted to a present value. That present value of the estimated cash
flows was added to long-term debt and other liabilities and adjusted for
operating property indicating a value based upon the financial forecast model
of $$$$$. (Schedule DCF/1 and DCF/2 of
Exhibit 531).
49. In reconciling the indicators, XXXXX placed
no weight on the cost approach, some but little weight on the mergers and
acquisition market approach, some weight on the financial forecast model, some
weight but more than the financial forecast model was placed on the income
indicator of NOI plus depreciation, and significant weight was placed on the
NOI direct capitalization indicator and the stock and debt approach. Based upon the values indicated by his
analysis, XXXXX concluded that the fair market value of the assets of XXXXX was
$$$$$, with XXXXX% or $$$$$ being allocated to Utah.
XXXXX APPRAISAL
50. XXXXX, prepared four indicators of
value. He prepared a cost indicator, a
direct capitalization income indicator, a yield or DCF income indicator, and a
stock and debt indicator. In preparing
his appraisal, XXXXX reviewed a number of analyst reports.
51. XXXXX cost approach was based upon
historical cost less depreciation (HCLD), adjusted by a market to book (M/B)
ratio of XXXXX. That market to book
ratio was developed as a composite weighted market to book ratio from the
market to book ratio for common stock of XXXXX and the market to book ratio for
debt of XXXXX as calculated by XXXXX.
(Table 2 of Exhibit 539). The
market to book ratio of XXXXX% for common stock was developed by analyzing the
equity market to book ratios of the seven comparable XXXXX. Each market to book ratio was adjusted to
account for the effects of deferred federal income taxes (DFIT) as a source of
zero cost capital. A market to book
ratio at the low end of the range was selected because XXXXX market to book
ratio was the lowest of the comparable companies. The market to book ratio for long term debt of XXXXX% was
calculated by dividing the market prices by related book values of XXXXX securities. The composite or blended market to book
ratio for debt and equity was based on the company’s market capital structure
of XXXXX% debt and XXXXX% equity, and was determined to be XXXXX%. Applying this ratio to HCLD resulted in a
value based upon the cost approach of $$$$$.
(Table 3 of Exhibit 539).
52. For his income indicators, XXXXX used both a
direct capitalization and a yield capitalization model. XXXXX developed his direct capitalization
rate by selecting the company’s market capital structure of XXXXX% debt and
XXXXX% equity. The debt rate of XXXXX%
was calculated by dividing the proforma interest expense ($$$$$) by the market
price of XXXXX long term debt securities ($$$$$). (Table 4 of Exhibit 539).
The direct capitalization rate for common stock was derived by comparing
the E/P rates of the XXXXX.
53. In analyzing the XXXXX, XXXXX was aware of
their cellular subsidiaries. Some of
the analyst reports he reviewed believed that cellular values were not
reflected in the stock prices of the XXXXX.
However, other analysts concluded there could be some cellular influence
that ranged from XXXXX% to XXXXX% during the fourth quarter of high and low
average common stock prices on average for the XXXXX. He concluded that the average cellular price as a percent of the
fourth quarter average stock price was about 13%. XXXXX potential cellular value was among the lowest at 10%. XXXXX adjusted the stock prices for cellular
influence and calculated an E/P rate of 11%.
By applying his debt and equity rates to the capital structure, he
developed a direct cap rate of XXXXX%.
54. XXXXX forecasted NOI by applying several
expected growth rates to XXXXX XXXXX NOI.
Some of the analysts expected only a small increase in income for the
local exchange companies, including XXXXX.
Accordingly, XXXXX projected modest growth rates ranging from XXXXX% to
XXXXX%. Using this range of growth
rates, the direct capitalization model indicated a range in value from $$$$$ to
$$$$$. (Table 5 of Exhibit 539).
55. In his discounted cash flow (DCF) model,
XXXXX estimated future cash flows for the company and discounted them to
present value using two models; one based on company plans, and one based on
more modest growth estimates. The
discount rate was developed by weighing the equity discount rate with the debt
discount rate based upon a typical industry capital structure of XXXXX% debt and XXXXX% equity. An imbedded debt rate of XXXXX% was used,
which corresponded to the average yield to maturity of XXXXX long term debt
securities. The equity discount rate of
XXXXX% was developed using the traditional equity models including the dividend
growth model(DCF) and the capital asset pricing model (CAPM). The equity rates were adjusted for cellular
influence, resulting in a discount rate ranging from XXXXX% based on earnings
growth to XXXXX% based on dividend growth.
The equity rate was selected after considering that many analysts
believed that cellular values were not reflected in the stock prices. The resulting weighted average cost of
capital or discount rate was XXXXX%.
56. XXXXX considered financial forecasts by
XXXXX in its business planning for the first five years of the projection
period in estimating future cash flows.
He also estimated cash flows based on XXXXX forecast, but with a more
modest growth expectation (XXXXX%).
XXXXX placed greater reliance on this latter estimate of cash flows
because it was less aggressive and appeared to him to be more realistic than
the business planning documents suggested.
XXXXX analyzed investment reports and developed the opinion that local
exchange telephone company revenue growth would approximately track general
economic and population growths in the XXXXX% to XXXXX% range. Each of the discounted cash flow models
contained a value matrix based on a range of terminal growth rates, and a range
of discount rates from XXXXX% to XXXXX%.
Applying these matrices to the range of growth, and adding the terminal
growth rate indicated a range of values based upon the discounted cash flow
model of between $$$$$ and $$$$$. (Page
30 of Exhibit 539).
57. In his stock and debt indicator, XXXXX
averaged various ratios applied to the common stock value of XXXXX to determine
the stock value of XXXXX. He used a
price to revenue (P/R) multiple of XXXXX, a price to cash flow multiple (P/CF)
of XXXXX and a price to equity book value multiple (P/B) of XXXXX resulting in
an equity value of $$$$$. This number
was added to long-term debt and adjusted for non-operating property resulting
in a value based upon the stock and debt indicator of value of $$$$$.
58. In correlating a final opinion of value,
XXXXX placed little weight on the cost indicator of value, but significant
weight was placed on both the income indicator of value and the stock and debt
indicator of value. XXXXX concluded
that the fair market system value of these assets was $$$$$. That value would result in an allocation to
the State of Utah of $$$$$.
ANALYST REPORTS
59. Fair market value (FMV) is the amount at
which property will change hands between a willing and knowledgeable buyer and
seller. It is the most probable price
at which the property would change hands.
See The Appraisal Institute, The Appraisal of Real
Estate, Edition, 1993.
60. In preparing a fair market value appraisal,
the Division and Counties argue that it is necessary to analyze reports from
market analysts. Both XXXXX and XXXXX relied heavily on their
review of analyst reports, especially for understanding market trends, growth
rates, expected cash flows and the cellular influence. The Division and Counties contend that these
reports influence the actions of market participants (including large
institutional investors) who buy and sell the
securities of these companies, which in turn directly influences the
value of the underlying assets. These
reports provide meaningful information to an appraiser.
61.
XXXXX, through XXXXX, on the other hand, considered only two reports.
[Tr. Pp. 873-874} These two reports were from XXXXX, and were of a general
industry type.
62. Based upon the evidence, the Commission
finds that where the assets of a company are publicly traded through their
securities, the study and analysis of market analyst reports are an important element
of the appraisal process to properly value the underlying assets of a
company. These reports provide
meaningful information about financial forecasts, growth trends, etc. for the
companies which influence the prices paid by market participants who buy and
sell the securities of these companies.
63. Although the study and analysis of market
analyst reports are an important element in the appraisal process, it is not
the only element in that process and is likely not the most important element
in that process. Numerous external
forces which are not related to the expectations of investors for a particular
company will have an influence on the selling prices of the securities of that
company. Also, different analysts may
ascribe different reasons for changes in the selling prices of the securities
of a particular company, and they likely do not all agree on whether various
aspects of the business of a particular company are all being considered in
determining the price at which the securities of a particular company should be
bought or sold. In this case, there was
not unanimity among the analysts as to whether the “cellular influence” of
XXXXX was fully reflected in stock prices of the parent company, XXXXX. Further, even among those analysts who agreed
that there was some “cellular influence” in the stock prices, there was not
unanimity among the analysts as to the amount of that influence, in terms of
dollars, on the securities prices for the parent company.
64. Accordingly, an appraisal may be a valid
appraisal even if it is not focused upon analysts reports. These analyst reports may have an important
part to play in the appraisal process, but they do not necessarily control the
total appraisal process.
ROLE OF REGULATION
65. XXXXX contends that in determining the fair
market value of the assets of a regulated company such as XXXXX, that
regulation plays a predominant role and that the rate-making process determines
value. [Tr. p.498] XXXXX argues that rate base is the beginning focal point for
determining value.
66. XXXXX prepared two cost indicators of value
which were both related to rate base.
Both income indicators of value relied heavily on XXXXX view of the
actions of regulators. For example, the
cash flows which XXXXX determined and utilized in his estimates of value based
upon the income approach were essentially a function of rate base. Further, the yield capitalization rate which
was developed by utilizing the average of the allowed returns on equity for all
regulatory jurisdictions which regulate the business of XXXXX, in essence, lets
the regulatory agencies determine the capitalization rates.
67. The Division and Counties agree that
regulation influences value. However,
the Division and Counties contend that the effects of regulation on value are
directly recognized and accounted for in the financial performance of the
company and the market prices of securities.
They assert that regulation and its impact on value is directly accounted
for in the activity of market participants and is reflected in market prices
paid by market participants after analyzing the financial performance of the
company.
68. The Division and Counties argue that it is
not necessary to review rate design proceedings or tariff filings or calculate
rate base in order to value a regulated utility. XXXXX testified that there is no basis for assuming that
investors will always expect a firm’s income to equal the allowed return
multiplied by the estimated rate base.
It may be lower or it may be higher (XXXXX Report, Exhibit 513, pp.
22-23.) Rate base and authorized rates
of return are not tightly sealed constraints that absolutely limit the income
of XXXXX.
69. The Division and Counties contend that XXXXX
takes an overly restrictive and narrow position when they argue that regulation
creates value rather than influences value.
The Division and Counties have argued that as a matter of law the value
for ad valorem tax purposes and value for rate-making purposes are not the same
and that Rate base is not a surrogate for fair market value.
70. This debate over the role of regulation in
the valuation process is a fundamental distinction between the appraisal
presented by XXXXX and the two appraisals presented by the Division and
Counties.
71. The position of Petitioner is set forth in
the appraisal prepared by XXXXX, which clearly focuses on the effects of
regulation and the performance of the regulators. The starting point and total focus of the appraisal of XXXXX is
upon the rate base and the regulatory process.
XXXXX did state that “rate base does not equal value,” but his entire
appraisal is premised upon rate base and the rates of return authorized by
regulatory agencies constituting the foundation, starting place and focal point
for all value determinations.
72. The position of Respondent is that the
market place and market information form the foundation, starting place and
focal point to ascertain the fair market value of the property, and that the
effects of regulation are reflected in that market information. The two appraisals prepared by XXXXX and
XXXXX both used the market place and market information as the foundation,
starting place and focal point for their appraisals.
73. In theory, if both valuation approaches are
properly analyzed, they should yield essentially the same value. The critical question centers on the nature
and the degree of the necessary adjustments.
However, since the Commission is being asked to determine the fair
market value of the property of XXXXX as measured by the open market, the
Commission is more comfortable starting from a market point of view rather than
a regulatory point of view. That does
not mean that regulation is not an important consideration. It is.
Nevertheless, in principle, the general affects of regulation should be
recognized by the market place and reflected in the corresponding stock
prices. The nature and effectiveness of
regulators may argue for adjustments to stock prices or they may impact the confidence
which appraisers may have in a particular appraisal methodology. However, if reasonably comparable stock
market information can be obtained, and the necessary adjustments can be
calculated, then the fact that the property being valued is for a regulated
entity does not mandate a “regulation-based” starting point.
74. The Commission finds that the rate base
function is not a market function. To
the degree that market information has been properly interpreted, adjusted and
employed, market information would be a more appropriate foundation, starting
place and focal point for determining the fair market value of the property
than would be the rate base and regulatory treatment of the company.
75. Regulation influences and impacts value, but
regulation does not determine the fair market value of property for ad valorem
tax purposes. The regulatory
environment is also shifting to one of less regulation, so it is likely that
regulation will have less influence and impact on value in the future than it
does for the year at issue in this proceeding.
76.
Rate base as determined by regulators is not necessarily equal to or
determinative of the fair market value of property for ad valorem tax purposes.
DIRECT CAPITALIZATION
VS.
YIELD CAPITALIZATION
77. Direct capitalization is one of the most
common methods of estimating the value of an income producing property, it
assumes that the value of a property is determined by the income which it will
produce. That anticipated income is
then capitalized at a rate which is reasonably expected to satisfy the
expectations of investors for a reasonable return on their investment. Under this method, the value of the property
is determined by dividing the income by the capitalization rate, and it is
algebraically expressed as:
Value = Income
or V = I
Rate R
78. Direct Capitalization is a simple income
method to use and is normally a reliable indicator of value if it is based upon
an accurate determination of income, and a capitalization rate that has been
calculated from comparable properties that are nearly identical to the property
which is being valued. To the extent
that the comparables may not be identical to the property being valued, there
may be distortions in the value determined by using those comparables. Small distortions in the capitalization rate
can cause substantial distortions in the total value.
79. Yield capitalization is also a very common
method of estimating the value of an income producing property by attempting to
estimate the present worth of the future benefits of the property, i.e., the
anticipated income stream of the property.
The formula for estimating value based upon the yield capitalization
approach is expressed as:
V = I1 + I2 + IN
1+y (1+y)2 (1+y)N
where V is the present value, I is income (or
cash flow), Y is the appropriate discount (or yield) rate, and N is the number
of periods.
80. In the calculation of yield capitalization
rates, there are many factors, such as the degree of risk and the nature and
estimated length of the income stream, that affect the overall capitalization
rates. In the calculation of direct
capitalization rates, there are also many factors that affect the overall
capitalization rates. However, in
direct capitalization there is the added problem of trying to ascertain whether
each of the those factors has had the same impact and influence on the
comparables as it has had on the property being valued.
81. For appraisals made using the direct
capitalization method, if capitalization rates have been calculated from an
analysis of the performance of the securities of comparable companies, the
Commission has always been concerned with whether the comparable companies are
truly comparable to the company being valued.
That concern is not just with whether the comparables are the “most
comparable” companies available, but with whether they are truly comparable in
all respects. That decision must
include an analysis of the factors that may cause the comparable companies to
be different than the company being valued, and to therefore cause investors to
treat differently the securities of those companies.
82. In this case, each of the appraisers
utilized certain information from the XXXXX in making their appraisals,
especially in their use of the direct capitalization method. The Commission finds that the utilization of
the XXXXX provides the best comparables to XXXXX that are available, but there
are still concerns about the comparability of those companies. Those concerns relate to the comparability
of the business operations, subdivisions and subsidiaries of the comparable
companies that are not directly related to the telephone operations of the
company, and whether those non telephone operations may distort the
comparability of those companies with XXXXX.
However, the existence of the seven XXXXX which had recently come into
existence prior to the lien date in this case, and the common fact that the
overwhelming preponderance of the activities of each of the companies was associated
with telephone company operations, is sufficient to validate the use of the
XXXXX as comparables to XXXXX in this case.
83. The Commission, consistent with general
appraisal theory, has taken the position that if values are made using both the
direct capitalization method and the yield capitalization method, and if the
market information for comparable companies is properly selected, adjusted and
interpreted, then the values calculated under each method should be close in
terms of total value. The Commission
continues to maintain that position.
However, in this case, the Commission does not have complete confidence
that the selected market information is for sufficiently comparable companies,
or that it has been property adjusted or interpreted. The Commission is fully aware that it may not be possible to
properly adjust and interpret the market information for the selected
companies.
84. The Direct Capitalization method has some
limitations, primarily related to the difficulty in making the needed
adjustments from the comparable companies to the company being valued. The adjustments to be made to the
comparables are to a high degree subjective adjustments which rely upon the
judgment of the appraiser. Therefore, as the number of required adjustments
increases, the Commission’s confidence in the reliability of the determined
values decreases.
85. The direct capitalization income approach
has been relied upon by the Commission and has been given moderate weight in
its final reconciliation of values.
However, because of the concern of the Commission regarding the complete
comparability of the XXXXX, and because the Commission has greater confidence
in the values determined by the yield capitalization income approach, greater
weight will be given to the yield capitalization values.
CONSTRUCTION WORK IN
PROGRESS (CWIP)
86. The parties have raised as an issue the
proper treatment of Construction Work in Progress (CWIP) in the determination
of the value of Petitioner’s property.
The primary issue is whether all CWIP should be added to the value
otherwise determined, or only the “growth” portion of the CWIP, thereby
eliminating the “replacement” portion of the CWIP. Utah Administrative RuleR884-24P-20.E, requires CWIP to be added
to HCLD in the cost and income approaches, but does not mention a delineation
between “growth” and “replacement.”
Prior orders of the Commission, in A T & T, et al. V. Property
Tax Division of the Utah State Tax Commission, Appeal No. 90-1322, and Union
Pacific Railroad vs. The Property Tax Division of the Utah State Tax Commission,
Appeal No. 89-0967, have defined the
delineation of “growth” and “replacement.”
However, the composition of the Commission has changed since the
issuance of those decisions.
87. Consistent with their prior positions,
Commissioners Tew and Pacheco are of the opinion that only the “growth” portion
of CWIP should be added to the income and HCLD cost indicators of value. In their opinion, the CWIP that will replace
existing plant and equipment should not be added to the value because part of
the existing plant in service or equipment will be removed or written off at
the time the CWIP is completed and placed into service.
88. Commissioners Oveson and Shearer are of the
opinion that all CWIP should be added to the income and HCLD cost indicators of
value because it is part of the total investment in property made by
Petitioner.
89. Because of the lack of a majority position
on this issue, the position of the Commission in its prior decisions, that only
“growth” CWIP will be added to the value, will remain the governing principle
for CWIP.
90. The amount of replacement CWIP must
therefore be removed from the income and HCLD cost indicators of value as
utilized hereafter. The amount of that
deduction will be calculated substantially from Exhibit 68 presented by
XXXXX. Pursuant to that Exhibit, the
amount of all CWIP is $$$$$, and the growth CWIP is $$$$$, leaving a difference
for replacement CWIP of $$$$$. XXXXX
would then have reduced that amount by a market to book ratio of XXXXX to
arrive at a replacement CWIP of $$$$$.
DEFERRED FEDERAL INCOME
TAXES
(DFIT)
91. Deferred Federal Income Taxes (DFIT) are
created by differences in the period a tax liability is recognized by the
utility using the straight-line depreciation rates allowed for rate making
purposes by the Regulatory Commissions and the period when the tax liability is
recognized by the utility using accelerated depreciation rates allowed for
income tax purposes by the Internal Revenue Service (the “IRS”). These book/tax timing differences produce
the deferred income tax liabilities that are recorded and tracked in the DFIT
account.
92. During the initial years of an asset’s
useful life, use of the accelerated IRS depreciation rates results in less
income tax being due than would be payable if the straight-line, regulatory
depreciation rates were used. During
the later years of the asset’s life after all accelerated depreciation has been
taken, this process reverses with more income tax becoming due than would have
been payable under the regulatory, straight-line depreciation rates. This DFIT account appears on the same (right
hand) side of XXXXX balance sheet as XXXXX liabilities. It is similar to an accrued liability that
may be canceled because the tax benefit will reverse after a few years.
93. Regulatory agencies do not allow XXXXX to
include DFIT in its rate base and DFIT must be deducted from its assets. Therefore XXXXX is not allowed to earn a
rate of return on funds represented by DFIT.
94. Because the ratepayers who would receive the
benefit of the reduced taxes in the early years of the asset’s life in the form
of lower rates may not be the same ratepayers who will be required to pay the
increased taxes in the later years of the asset’s life in the form of higher
rates, each of the Regulatory Commissions requires XXXXX to “normalize” the
amount of income taxes paid by the ratepayers of XXXXX. Normalization means that during the early
part of an asset’s life when accelerated depreciation is available, the
ratepayers pay the utility company rates that include taxes that will not be
due until some future period. When the
process reverses in the later years, ratepayers are not then required to pay
rates which include the increased amount of taxes actually paid by the
utility. The deferred taxes paid by the
ratepayers to the utility because of these timing differences creates the
source of funds known as DFIT. Because
XXXXX is constantly replacing its operating property, DFIT always exists.
95. Similarly, under the applicable regulations
of the Internal Revenue Service, XXXXX is not allowed to claim accelerated
depreciation for federal income tax purposes unless the Regulatory Commissions
either deduct the full amount of this DFIT from rate base of XXXXX or treat it
as interest-free or “zero cost,” capital in arriving at the total cost of
capital used to determine XXXXX authorized rate of return on rate base.
96. As of XXXXX, the Utah Public Service
Commission assigned a zero cost of capital to DFIT reserves. This treatment had essentially the same
financial impact on XXXXX as the alternative then being followed by each of the
other Regulatory Commissions of deducting the full amount of DFIT from the
authorized rate base of XXXXX.
97. For purposes of simplifying their
presentations, all of the witnesses at the hearing presented their calculations
of the authorized rate base/rate of return for XXXXX as if the Utah Public Service
Commission deducted DFIT from rate base in the same manner as the other
Regulatory Commissions. The
calculations presented in these Findings follow this same convention. We note that the Utah Public Service
Commission has now changed its practices to conform with those of the other
Regulatory Commissions and currently requires the deduction of DFIT from rate
base for all regulated utilities.
98. The treatment of DFIT required by the
Regulatory Commissions is designed to ensure that all cash flow benefits
attributable to DFIT timing differences benefit the ratepayers in the form of
lower rates and that there is no net cash flow benefit to the investors of
XXXXX.
99. In the Original Assessment for XXXXX, the
Division deducted the full amount of DFIT from the net book value of XXXXX in
its HCLD cost approach.
100. For tax year XXXXX, it was represented by
Petitioner, and uncontroverted by Respondent, that the Division allowed similar
deductions for the full amount of DFIT in its HCLD cost approach for every
other rate base/rate of return regulated utility operating in the state of
Utah. However, in this case, the
Division gave zero to little weight to the HCLD cost approach in making its
reconciliation of the three approaches to value to arrive at a final opinion of
value. Therefore, even though for XXXXX
the full amount of DFIT was deducted from the net book value to determine the
HCLD cost approach value for the other rate base/rate of return regulated utilities,
the impact on the final value of all other rate base/rate of return regulated
utilities would not have been substantial, and was likely only of minimal
impact in arriving at the final values for those companies for that year. Nevertheless, the Commission finds that such
a deduction should be allowed to XXXXX for XXXXX to equalize XXXXX and place
them in a uniform position with other similar companies for that year. Further, if the Commission were to accept
the position of XXXXX that the cost indicator of value is to be given
substantial weight, then the deduction of DFIT for that year would become much
more important.
101. If XXXXX is not allowed a deduction under
the HCLD cost approach for the full amount of its DFIT, it will be the only
rate base/rate of return regulated utility in the state of Utah assessed by the
Division not allowed this deduction for the XXXXX tax year.
102. The additional revenues for taxes paid to
the utility by the ratepayers in the early years through “normalized” tax rates
provide a source of additional capital for the utility. These funds become part of the common “pool
of funds” available to the utility for its general purposes.
103. Because the utility’s investors did not
provide the additional source of capital represented by the DFIT reserves
created through normalized rates for the utility’s future tax liability, the
Regulatory Commissions do not allow the utility to earn a return on these
amounts for its investors. Instead, any
value associated with the temporary use of this additional source of capital is
required to be passed back to the utility’s customers in the form of lower
rates. Even though this treatment is
designed to ensure that there is no net cash flow benefit to the utility’s
investors from DFIT, the Regulatory Commissions would find it imprudent for the
utility not to take advantage of accelerated depreciation to lower the rates
charged to its ratepayers.
104. In the case of Northwest Pipeline Corp.
V. Property Tax Division of the Utah State Tax Commission, Appeal Nos.
85-0074 and 86-0255, the Commission approved the position advocated by
Petitioner in this proceeding, i.e., that DFIT should be deducted from the HCLD
cost approach indicator of value. In
that case, the Commission stated that, “an informed investor would not be willing
to pay full cost as measured by net book for Petitioner’s operating system
because that amount exceeds the value of the rate base upon which the investor
would be allowed to earn.” The
Commission therefore ruled that, “the net book value should be reduced by the
amount of DFIT.” That decision has also
likely been implemented in other decisions of the Commission.
105. Since the time of the Northwest Pipeline
decision, two of the Commissioners who signed that decision are no longer
members of the Commission, and the Commission is now equally divided as to
whether DFIT should be deducted from the HCLD cost indicator of value.
106. The position of Commissioners Tew and
Pacheco is that the reduction in utility rates which results when regulatory
agencies require the deduction of DFIT from rate base has effectively dedicated
the DFIT portion of the property of XXXXX to the public sector. Therefore, in the opinion of Commissioners
Tew and Pacheco, if XXXXX cannot earn a return on that (DFIT) portion of its
property, then XXXXX should not be required to pay taxes on that (DFIT) portion
of its property.
107. Because of the regulatory restrictions on
earnings associated with DFIT, Commissioners Tew and Pacheco would require a
deduction for DFIT to the extent that it reflects impaired earnings associated
with regulation beyond its value as zero-cost capital, although they
acknowledge that the exact amount of DFIT attributable to impaired earnings is
not ascertainable from the information presented in this case.
108. Commissioners Tew and Pacheco believe that
DFIT is similar to government imposed rent controls where a governmental agency
has limited the earning potential of a property. These limited earnings by way of governmental mandate have
effectively taken a portion of the bundle of rights of the property and
assigned that portion of the rights to the public. Therefore, Commissioners Tew and Pacheco believe that Petitioner
should not be required to pay taxes on property that is owned by the Public and
is not owned by the company.
109. Commissioners Tew and Pacheco are further of
the opinion that the regulatory earnings limitations imposed by regulatory
agencies because of DFIT are a legitimate form of economic obsolescence, they
therefore believe that it may be preferable for the impact of DFIT and other
regulatory limitations to be reflected in an economic obsolescence adjustment
to the HCLD cost approach indicator of value.
110. Commissioners Tew and Pacheco base their
opinion on the fact that virtually all appraisal texts and theory recognize the
concept of adjusting for economic obsolescence, and they therefore believe that
such an economic obsolescence adjustment is required. This view is applicable to this area of DFIT as well as later
discussion relating to the economic obsolescence views of Commissioners Tew and
Pacheco.
111. Because of the absence of any studies by the
Property Tax Division to account for any economic obsolescence, including
regulatory impacts, Commissioners Tew and Pacheco feel that they are left with
the only position available to them to account for the economic obsolescence
caused by DFIT being to support the deduction for DFIT in the HCLD cost
approach indicator of value.
112. The position of Commissioners Oveson and Shearer
is that the “value” which is associated with the funds which are booked by the
utility as DFIT have been effectively transferred to the utility’s ratepayers
in the form of lower utility rates. If
the value of income producing property is determined by the future income to be
produced by the property, then a portion of the value of the property of XXXXX
resides with the utility and will be returned to the utility in the form of
future income, but another portion of the value of the property resides with
the ratepayers and will be returned to the ratepayers in the form of lower
utility rates to those ratepayers.
Commissioners Oveson and Shearer further believe that to determine the
total value of the fee simple interest of the property, the portion of the
total value belonging to XXXXX must be added to the portion of the total value
belonging to the ratepayers. The Utah
Constitution and the statutes of the state require that “All tangible taxable
property shall be assessed and taxed at a uniform and equal rate on the basis
of its fair market value....” (Utah
Code Ann. §59-2-103(1).) If DFIT is
deducted from the HCLD cost approach value, then in the opinion of
Commissioners Oveson and Shearer, the property is being taxed at less than its
fair market value. Commissioners Oveson
and Shearer would determine that DFIT
should not be deducted from the HCLD cost approach indicator of value.
113. XXXXX cost approach adjusted net book (HCLD)
value by subtracting the full amount of DFIT in the same manner ordered by the
Commission in Northwest Pipeline and followed by the Division in its
original assessments of XXXXX and all other rate base regulated utility
companies in Utah for tax year XXXXX.
If the Commission did not allow the deduction of DFIT to XXXXX for
XXXXX, it would be faced with an equalization issue. Since all other rate base/rate of return regulated utilities had
their HCLD cost approach values determined by deduction of DFIT from the net
book value for the taxable year XXXXX, then XXXXX would be treated
discriminatorily if it were not allowed the same deduction for DFIT. Utah Code Ann. §59-2-103(1), supra,
which requires that property be assessed at its fair market value, also requires
that property must be assessed “at a uniform and equal rate.” Therefore, the Commission determines that
for XXXXX, and any other years for which DFIT, was deducted in determining the
HCLD cost approach value for other rate base/rate of return regulated
utilities, the uniform and equal provision must supersede the requirement to
value the property at its fair market value.
Accordingly, for any such years, DFIT should continue to be deducted
from the HCLD cost approach value of the property of XXXXX.
114. In view of the equal division of the
Commission on the issue of the deductibility of DFIT, however, the equalization
issue for this case becomes moot. The
lack of a majority position on the deductibility of DFIT will leave intact the
prior decision of the Commission as set forth in Northwest Pipeline Corp. V.
Property Tax Division that DFIT should be deducted from the HCLD cost
approach indicator of value.
ECONOMIC OBSOLESCENCE
115. XXXXX and XXXXX maintain that the HCLD cost
approach value of the property of XXXXX should be reduced for items of economic
obsolescence which they maintain have occurred. They maintain that economic obsolescence has occurred anytime the
utility is precluded from earning a market rate of return, and they have identified
several factors which they maintain reduce the income stream to investors, and
thereby result in economic obsolescence.
Although the Commission does not necessarily agree that all of these
factors are appropriately denominated as economic obsolescence issues, they
will be dealt with herein only because that is the way these issues were framed
by Petitioner. The factors which were
identified by Petitioner as economic obsolescence issues are:
A. Telephone Directory revenues derived from
non- operating or intangible property.
B. Charitable and Community contribution.
C. The limitation to the earnings of XXXXX to
the level required to pay the embedded interest costs or its debt rather than
the higher current market costs.
D. Construction and land deposits for future
construction.
E. Amortization of abandoned construction
projects not allowed in rate base and required to be borne by investors.
These
factors are each discussed and explained in more detail below.
A.
Telephone Directory Revenues Derived from Non- Operating or Intangible
Property.
116. XXXXX entered into an agreement with XXXXX
whereby XXXXX agreed to publish telephone directories for XXXXX. XXXXX also agreed to pay XXXXX a subsidy. XXXXX contends that these net revenues
should be excluded for one of two reasons. First, he argues that it is not the
function of the telephone operating system to produce this income because there
is no physical relationship between this income and the property and equipment
of the utility. XXXXX cites a XXXXX
Court decision, Matter of Mountain States Tel. and Tel., 745 P.2d
563 (Wyo. 1987) to support this argument.
Secondly, XXXXX claims that income from directory revenues is derived
from an intangible of the company and is thus exempt.
117. The Division and Counties contend that
income from directory revenues is directly attributable to the local network of
XXXXX and is part of the economic benefits associated with that network. It is so closely associated with the company
through name recognition, publishing of the white pages, common billings,
related network management functions (i.e., the timing of changes in subscriber
numbers affecting value and usefulness of both white and yellow pages), and
historical association as to be considered “de facto” part of the operating
network. (XXXXX Report, Exhibit
513.) The position of the Division and
Counties is that regulators classify directory advertising and sales revenues
as “operating revenues”. (Exhibit 80.)
118. The Division and Counties further contend
that as a subsidy to XXXXX, directory revenues keep telephone rates down. Without this subsidy (for example if the
assets of XXXXX were sold separate from this subsidy), XXXXX would still be
allowed a fair return, meaning telephone rates would have to go up to
compensate for this lost subsidy.
Hence, with or without these revenues the company will maintain its
revenue requirements.
119. Regarding the alternative claim by XXXXX
that the income from directory revenues is derived from intangibles, the
position of the Division and Counties is that XXXXX has not met its burden of
proof. The Division and Counties claim
that XXXXX has not shown that the assets relating to these directory revenues
can be sold or marketed separate and apart from the remaining property of
XXXXX. Petitioner did not meet its
burden of proof on this issue and did not persuade the Commission that these
revenues are from intangibles or that the value represented by such revenues should
be exempt from ad valorem taxes.
120. It is clear from the publishing agreement
that one of the service functions of XXXXX is to make available to its
telephone subscribers an alphabetical listing of names, addresses and telephone
numbers of telephone company subscribers.
Indeed, providing a listing of telephone numbers is “part and parcel of
the ‘service to or for the public’”. Matter
of Mountain States Tel. And Tel., 745 P.2d at 570. However, unlike the Wyoming court in Matter
of Mountain States Tel. and Tel.,
which dealt with regulation of these revenues, this Commission is not concerned
with whether the yellow pages portion
of a telephone directory constitutes a monopoly requiring regulatory
oversight. Instead, it is concerned
with determining the fair market value of taxable assets.
121. We find that directory revenues are closely
associated with XXXXX network and should be considered part of the operating
network. We are further persuaded by
the subsidy argument stated above, i.e., that with or without directory
revenues, the cash flows of the company will remain unchanged. Thus, even if directory revenues they were
not deemed to be part of the operating network and removed in a subsequent fair
market sale, the revenue requirements (and thus cash flows) of the company
would remain unchanged. The Commission
determines that an adjustment for directory advertising revenues is not
appropriate.
B.
Charitable and Community Contributions.
122. XXXXX made an additional adjustment to his
adjusted rate base in the form of operating expenses which he maintains are
made by prudent management but are not allowed by regulators for purposes of
calculating revenue requirements to determine utility rates. These operating expenses included such items
as charitable and community contributions.
123. The Division and Counties argue that the
deduction of such contributions and expenses from value is inappropriate for
purposes of determining the value of the property. Such expenditures are discretionary or “below the line” expenses,
which are paid from the net operating income (NOI) of the company. Those items are not deducted to determine or
arrive at the NOI of the company. They
are not allowed as operating expenses for rate making purposes because the
regulatory agencies have determined that ratepayers should not be required to
bear such costs. The Division and
Counties argue that in negotiating the price of a sale, a prudent seller would
not permit a discretionary expense to reduce the value of his or her property
by the reduction in cash flow.
124. The Commission determines that this
deduction is not appropriate in determining value and finds that although such
expenses and contributions may be common, they are discretionary, and should
not have the effect of reducing the value of property for ad valorem tax
purposes. These items do not constitute
economic obsolescence to be deducted from the HCLD cost indicator of value.
C.
The Limitation To The Earnings of XXXXX To The Level Required to Pay the
Embedded Interest Costs on Its Debt Rather Than The Higher Current Market Costs.
125. XXXXX also suggested an adjustment to his
adjusted rate base indicator (HCLD cost approach) for what he describes as the
inadequate allowed rate of return on fixed income securities. XXXXX claims that because the coupon rates
of XXXXX bonds (embedded debt) were less than current market rates, an
adjustment for this inadequate return must be made to the HCLD cost indicator.
126. The Division and Counties assert that this
adjustment is nothing more than an income shortfall adjustment or obsolescence
adjustment which makes the cost indicator circular with the income indicator
and which has been rejected by the courts. Pacific Power & Light v.
Dept. Of Revenue, (Oregon Court); Northwest Pipeline Company, (1987 Commission
Decision); Investigative Report in the Matter of the Review of the Property
of Wyoming Rural Electric Cooperative Utilities. Exhibit 513, p.21. The
Division and Counties assert that the value of a company’s assets is neither
reduced (obsolescence) or enhanced (appreciation) when the embedded debt rate
differs from the market debt rate because debt rates are simply passed on to
the ratepayers by the regulators.
127. The Commission is unpersuaded that such an
adjustment is necessary or appropriate, and therefore, finds that the
adjustment for economic obsolescence for the limitation to the earnings of
XXXXX to the level required to pay the embedded interest costs on its debt
rather than to allow the higher current market costs is not an appropriate
adjustment.
128. We also find that such an adjustment is
improper because debt rates are simply passed on to the ratepayers of a
utility. The change in debt rates does
not affect the value of the property of XXXXX.
D. Construction And Land Development
Deposits for Future Construction.
129. XXXXX deducted land development and
construction deposits from the HCLD cost approach value. His reason for this deduction was because
regulatory agencies will not allow the utility to earn a return on these deposits
because it constitutes deposits, or free capital, which has already been
provided by the utility ratepayers. The
reasoning of regulatory agencies is that the ratepayers should not be required
to pay a return on funds which they have provided.
130. In the opinion of Commissioners Tew and
Pacheco, if a rate base regulated utility is not allowed to earn a return on a
portion of its investment, then there has certainly been some economic
obsolescence. The very meaning of
economic obsolescence is that the property is not able to earn a reasonable
rate of return. Since the construction
deposits are prohibited by regulatory agencies from earning any return, then in
the opinion of Commissioners Tew and Pacheco, there is economic
obsolescence. Although there are
reservations about the method of calculating the correct amount of economic
obsolescence, the only testimony from which the Commission can calculate a
deductible amount is the testimony of XXXXX.
He testified that the amount of such obsolescence is $$$$$. (Appendix A, Table 3, Exhibit 30).
131. Commissioners Oveson and Shearer believe
that even though the utility is not allowed to earn a return on those
construction deposits, the property purchased with those deposits, still
constitutes property on which ad valorem taxes should be paid. In their view, to allow a deduction for
economic obsolescence is to tax only a portion of the bundle of rights and to
violate the Constitutional and statutory mandate to tax the full fair market
value of the property.
132. Rule R861-1A-5.E, Utah Administrative Code
will prevail. That rule provides in
part:
If the Commission vote
results in a tie vote on any matter, the position of the petitioning taxpayer,
will be deemed to have prevailed, and the Commission will publish the
decision.”
133. Again, because of the lack of a majority
position on this issue, the position of the taxpayer will prevail and an amount
of $$$$$ will be deducted from the HCLD cost approach indicator of value.
D.
Amortization of Abandoned Construction Projects Not Allowed in Rate Base and
Required to be Borne By Investors.
134. Regulatory Commission policies have not
allowed XXXXX to include in the costs of service, which are passed through to
its ratepayers, the unamortized acquisition costs of certain properties or
construction projects acquired for future expansion, but ultimately not used
because of changes in the demographics of its customer base or technological
advances. Therefore, even though
Petitioner still owns these properties, they are not allowed by the regulatory
agencies to include those properties in the rate base, and they cannot earn a
return on those investments.
135. The position of Commissioners Tew and
Pacheco with respect to these items is identical to their position on
construction deposits; i.e., that there is economic obsolescence if a return
cannot be earned on that investment, and it should therefore, be deducted from
the HCLD cost indicator of value.
136. The position of Commissioners Oveson and Shearer
is that if and when the property is disposed of by XXXXX, then it would be
removed from the value of XXXXX property for ad valorem tax purposes. Until that time, the value should be
included for ad valorem tax purposes.
137. It is also the position of Commissioners
Oveson and Shearer that there was no evidence presented as to whether the
property alleged to have been abandoned was ever taken out of service and
locally assessed. It is their position
that if the property has not been taken out of service and become locally
assessed property, then it should continue to be included as property of the
utility and its value should not be deducted from the values otherwise
determined.
138. Again, because of the absence of a majority
position on this issue, the position of the taxpayer will prevail and an amount
of $$$$$ (Tr. 548) will be deducted from the HCLD cost indicator of value.
CONCLUSIONS OF LAW
1. “All tangible property in the state, not exempt
under the laws of the United States, or under this Constitution, shall be taxed
at a uniform and equal rate in proportion to its value, to be ascertained as
provided by law.” Utah Const. Art.
XIII, §2(1).
2. “[E]very person and corporation shall pay a
tax in proportion to the value of his, her or its tangible personal
property.” Utah Const. Art. XIII,
§3(1).
3. “All tangible taxable property shall be
assessed and taxed at a uniform and equal rate on the basis of its fair market
value, as valued on XXXXX, unless otherwise provided by law.” Utah Code Ann. §59-2-103(1).
4. “By May 1 of each year,” all taxable
property of public utilities “shall be assessed by the commission at 100% of
fair market value, as valued on XXXXX,” Utah Code Ann. §59-2-201(1).
5. “Fair market value” “means the amount at
which [the] property would change hands between a willing buyer and a willing
seller, neither being under any compulsion to buy or sell and both having
reasonable knowledge of the facts.”
Utah Code Ann. §59-2-102(7).
6. Because the Division elected not to present
or defend its Original Appraisal, and based upon the pre-hearing stipulation of
the Parties and the order of this Commission, XXXXX, has the burden of
providing “a sound evidentiary basis for reducing the original valuation”. Utah Power & Light Co. v. Utah
State Tax Comm’n, 590 P.2d 332,335 (Utah 1979) and Hercules Inc. v. Utah
Tax Comm’n, 877 P.2d 169,172 (Utah Ct. App. 1994).
7. None of the appraisals presented by either
the Division or by the Petitioner is entitled to any “presumption of
correctness.” The Commission will
review all evidence presented under a simple “preponderance of evidence”
standard. Hercules, 877 P.2d at
172.
DISCUSSIONS AND ANALYSIS
The
Commission has carefully reviewed each of the appraisals together with many
additional documents which were submitted by the parties. In performing that review, it is very
evident that XXXXX, XXXXX, and XXXXX each approached their appraisal from a
very different perspective and point of view.
The Commission has attempted to take each of the different approaches to
value used by each of the appraisers, and
make a reconciliation of those appraisals by adding or subtracting
amounts where the Commission has determined that adjustments or factors
considered by particular appraisers were not, in the opinion of the Commission,
appropriate. However, because the basic
approach for each of the appraisers was so significantly different, such a
reconciliation was not possible.
Therefore, the Commission must try to determine which portions of the
three appraisals are most acceptable to the Commission, and which appraisal,
in the opinion of the Commission, is
the most reliable indicator of the fair market value of the property of XXXXX.
The
appraisal of XXXXX was to a very substantial degree based upon the assumption
that the fair market value of the property of XXXXX is tied directly to the
rate base and rate of return determined for XXXXX by the regulatory agencies. As has been stated above, this Commission
does not accept the premise that rate base is equal to the value of the
property. Further, the Commission does
not feel that because a regulated utility is being valued requires a
“regulation based” valuation methodology.
Notwithstanding
this view, the Commission lacks a majority position on the issue of the
deductibility of DFIT from the HCLD cost approach indicator of value. This leaves intact the prior position of the
Commission that DFIT should be so deducted.
Also, the Commission has determined that for the year in question
Deferred Federal Income Taxes (DFIT) should be allowed to this taxpayer because
it was allowed for all other similarly situated taxpayers, so DFIT will be
deducted from the HCLD cost approach indicator of value.
The
assumptions of XXXXX relating to rate base also forms a substantial basis for
at least one of his income approaches to value, by including in income only
that income which would generally be allowed on the rate base by the regulatory
agencies. Further, in XXXXX stock and
debt approach, by including only the value of the common stock of XXXXX, after
deducting from the total value of common stock all of the other subsidiaries of
XXXXX, it leaves any errors in the valuations of any of those companies in the
value of the company being valued herein.
Therefore, the Commission does not have substantial confidence in the
stock and debt approach utilized by XXXXX.
Accordingly, the Commission has determined that in its opinion, in this
case, the appraisal of XXXXX does not accurately determine the fair market
value of the property of XXXXX, and the Commission finds that it is not a
reliable indicator of value for this case.
The
appraisal of XXXXX was made by placing
heavy reliance upon stock market information. In the cost approach, the division of the assets between the
various companies and subsidiaries of XXXXX was made by XXXXX utilizing stock
market information, and in the income approach the capitalization rate was
calculated strictly from companies which XXXXX felt were comparable. Further, in the stock and debt indicator of
value utilized by XXXXX, most of the divisions of the liabilities and the
securities between the various companies and subsidiaries of XXXXX were made
based upon stock market information.
XXXXX mergers and acquisition approach is more aggressive than the
Commission is willing to accept as a reliable indicator of the fair market
value of the property.
While
there is no question that the stock market information utilized by XXXXX is
very important and is frequently a reliable indicator of value, it is not
always the complete or best determinant of value, and in some cases it may not
be the most reliable indicator of value.
The primary issue is one of comparability of the companies used as
comparables. In this case, XXXXX
utilized primarily the RBOC’s as the comparables. Even though it is likely that those companies are the most
comparable companies which are available to be utilized for XXXXX, it is a fact
that each of the XXXXX has a different mix of subsidiaries and business
operations, including real estate companies, directory advertising, cellular
companies, telephone manufacturing companies, and numerous other diverse
holdings and operations. Therefore, it
is extremely difficult to determine whether the factors which are gleaned from
a comparison of those companies is or is not applicable to the operations of
XXXXX. Accordingly, the appraisal of
XXXXX, made by XXXXX, appears to be a reasonable appraisal, but the Commission
does have some reservations about the reliability and the comparability of the
data utilized in that appraisal in comparison to XXXXX.
In
the opinion of the Commission, the most reliable appraisal received in this
proceeding was that which was prepared by XXXXX. Although XXXXX appraisal also places substantial reliance upon
stock market information, the overall appraisal and the rationale of XXXXX
provides better support for the conclusions.
The data used by XXXXX tends to be conservative but very reasonable.
The
cost approach estimate of value made by XXXXX was $$$$$. However, as has been indicated earlier in
this decision, the Commission determined that it must deduct the Deferred
Federal Income Taxes, replacement CWIP, Land Development and Construction
Deposits, and Abandoned Construction Projects from the cost approach to arrive
at the net cost approach to be used in this decision. The DFIT adjustment testified to by XXXXX for the XXXXX
appraisal, on Exhibit 69, was
$$$$$. That adjustment leaves an
estimated value based upon the cost approach of $$$$$. The replacement CWIP adjustment is
$$$$$. The Land Development and
Construction Deposits adjustment is $$$$$, and the Abandoned Construction
Projects adjustment is $$$$$.
XXXXX
utilized three different income approaches to value. The first income approach was his direct capitalization
approach. In that method, he arrived at
four different values depending upon the expected growth from XXXXX to
XXXXX. In the opinion of the
Commission, a 2% growth rate is reasonable, but still very conservative. Based upon that growth rate, the value
determined by XXXXX under that approach was $$$$$.
XXXXX
calculated two separate yield capitalization estimates of value, and under each
method, he included numerous alternatives depending upon the terminal growth rate which was
assumed and the discount rate which was assumed. The first discounted cash flow utilized by XXXXX was based upon
XXXXX forecast of future income.
However, XXXXX testified that the forecast of XXXXX was very aggressive,
and he believed that a more realistic estimate of growth was XXXXX which he
utilized in Table 8 of his appraisal.
XXXXX testified that the actual discount rate for the company which he calculated
was XXXXX%, and based upon that assumption with a terminal growth rate of
XXXXX%, the value of the company based upon a discounted cash flow would be
$$$$$. Replacement CWIP in an amount of
$$$$$ must also be deducted from the income approach values.
For
the market approach, or stock and debt approach, XXXXX prepared an estimate of
value and determined that the stock and debt indicator of value would be
$$$$$. The Commission has determined
that each of those values is a reasonable estimate of value, and that they
should all be utilized in arriving at the fair market value for the property of
XXXXX for the year XXXXX.
The Commission has further determined to
correlate the different values by assigning very little weight to the cost
approach, ( XXXXX in his appraisal did not give any weight to the cost
approach), so the Commission believes that 10% weight is adequate for the cost
approach. The Commission has further
determined to assign 25% of the weight to the value determined by XXXXX under the
direct capitalization approach, 40% to the value determined under the yield
capitalization approach, and 25% of the value is to be based upon the market or
stock and debt approach. Based upon the
assignment of those weights, and the calculation of the respective value
determined thereby, the Commission has determined that the fair market value of
the property of XXXXX for XXXXX is $$$$$.
Based upon an allocation of that value to the State of Utah, the value
of XXXXX for XXXXX allocated to the
State of Utah is $$$$$.
It
is so ORDERED.
DATED
this 22nd day of November, 1995.
BY ORDER OF THE UTAH STATE TAX COMMISSION.
W. Val
Oveson Roger
O. Tew
Chairman Commissioner
Joe B.
Pacheco Alice
Shearer
Commissioner Commissioner