HomeMy WebLinkAbout1985-10-02 City Council Summary MinutesOPT
COUNCIL
MINUTES
ITEM
Special Meeting
October 2, 1985
CITY
Ore
MI()
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Item #1, Selection of a Cable Franchisee 6364
ADJOURNMENT: 11:30 p.m. 6385
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Special Meeting
October 2, 1985
The City Council of the City of Palo Alto met on this date in the Council
Chambers, 250 liamiltun Avenue, at 7:30 p in.
PRESENT: Bechtel, Cobb, Fletcher, Klein, Levy, Renzel, Sutorius, Woolley
ABSENT: Witherspoon
SELECTION OF A CABLE COMMUNICATIONS FRANCHISEE(PRE 7-3) CMR: 517:5
Mayor Levy said this evening they would continue with the discussion of
financial characteristics, move on to a discussion of ownership and structure,
aed services and rates. He commented to his colleagues. that there were
several representatives of Pac Bell there and if there were questions of Pac
Bell, they should be directed to Pac Bell as a corporate entity rather than
any individual representative of Pac Bell and they will determine who of their
representatives will be most qualified to respond to the specific question.
Woody Britton, representative, Price Waterhouse; said he wanted to address an
issue which he felt caused some confusion last night and as a matter of
intrepretation. Recalling one of their charts they had talked about both
firms having total revenue for the first seven years, $58.8 million, and City
Cable Partners pointed out• they thought Price Waterhouse intrepreted their
data incorrectly in terms of which year they considered to be the first year
of their forecast. He lookea at it again and it had been intrepreted
incorrectly. Essentially, the City Cable Partners projected 1986 as the first
year of their projection through 1985. He presumed that by year one they
meant 1985. In that year they had very little revenue and after further
analysis, it became clear they intended that 1986 be their first year. He
proceeded to review the charts which correctly lined up what Cable Co-op and
what City Cable Partners intended as their first year. Looking at the Cable
Co-op .cumulative revenue column in 1992, you see $58.8 million, and for City
Coble Partners $46.8 million. There is roughly a $12 million dollar
difference. Looking down one number below $46.8 million0there was the $58.6
million again, so both companies within approximately one year of one another
estimated the system was going to generate a total of $58.8 million. But
precisely stated, City Cable Partners thought it would take roughly a year
longer than Cable Co-op thought. i hoped that cleared up the confusion and
set the record straight. Focusing on City Cable Partners there were
significant changes as a result of realignment, number of households, average
number of subscribers, and the penetration rate changed downward slightly.
The next change was because 1992 was interpreted as another year from their
projection. Looking at operating expenses, Cable Co-op had projected in 1992,
$7.7 million and City Cable Partners, $7 million. When intrepreting �:he
difference between those two numbers, the fact that the biggest difference is
in the line called origination and the source of that biggest difference is
related to the cost of paid programming should be considered. Cable Co-op has
assumed a flat percentage that 40 percent of the revenue generated from paid
programming would go to the paid programming supplier. However for
comparative purposes, the more they projected in revenue the more that cost
was going to he. He suggested not to read too much into that but to focus the
comparison on the service, selling, general, and administrative lines. In
cumulative total operating expenses, City Cable Partners went down, the reason
for that was the recasting of the right years- they had generated or projected
a lot less revenue. consequently a lot less expense. The interest costs for
Cable Co-op essentially remained unchanged' from last night, City Cable
Partners went down -slightly from $9.9__ million to 8.9 million. In source of
continuous equity, nothing had changed there;; source of continuous debt,
nothing had changed, order of magnitude of revenue reduction at which debt
service, i.e.,- interest payments cannot be paid 1986-1992, Cable Co-op stayed
the same, City Cable Partners went down slightly. There is a slight
difference as a result of the recasting to intreprete their first year as they
projected it to be in 1986 as opposed to 1985. He commented on some elements
of risk. First, the City was in a position of having two companies which both
presented an order of magnitude of risk lower than what many cities of this
size were presented with when they took applicants and it was consistent with
the staff's recommendation that both fit the requirements of the financia)
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claim as required le the franchise agreement. further, Cable Co-op's 15
percent factor as calculated meant if you were to reduce their $33 a month by
that 15 percent, Cable Co-op would have to achieve $28 per month per household
at a penetration :level. of approximately 33 percent. With respect to City
Cable Co-op's contract with Pac Bell, it was apparently for a fixed price so
one portion of the variability that could impact this mi'yt be the interest
payments involved in the lease were fixed, so theoretically unless as Mr. Cobb
suggested that one way or another change orders crept into the process, and
the costs went up, their interest costs would be fixed and Vat would not be a
factor which would impact the 15 percent or further reduce that 15 percent.
With respect to City Cable Partners, as opposed to Cable Co-op which has some
risk associated'with ongoing operations as does every other company, City
Cable Partners risk focuses on raising the limited partnership equity. He
felt it was important to note the absolute amount of the equity they were
proposing to r2ise was not a large amount in the context of limited
partnership offerings and the market place was such that it was being kept, at
this point, by whatever turned out to be the tax laws. ' In summary, he felt
the City was being presented with the desirable situation of having two
compainies which had a level of risk which was probably an order of magnitude
below what was apparent in many other situations.
Councilmember kenzel confirmed with regard to what year one was for each of
the companies, financially, that their year would begin in 1986 or did that
mean constructon of the system began: in 1986.
Mr. Britton said the general time schedule, as specific as it needs to be for
this purpose, was that both companies had assumed they would start
construction in 1986 and actually hook-up customers that generated revenue it
1986. Cable Co-op had projected they would generate $1.4 million and City
Cable had projected they would generate $310 thousand in revenue. Being a
conservative accountant these were projections, • and it was likely they would
not be exactly the way they were and should not be interpreted as such.
Mayor Levy asked about the order of 'magnitude revenue red» ;tion figures. He
translated those two percentages, 15 and 25 percent into aoilars and he warted
to confirm if they were accurate for Cable Co-op the reduction at which debt
service could not be paid with the 85 percent of $58 million or $50 million,
and then for City Cable it would be 75 percent, $46.8 million or $35 million
or another way of looking at that.was if the average revenues for Co-op
dropped from $33 to $28 then for Partners they would drop from $27 by 25
percent or about $20.
Mr. Britton replied yes.
Vice Mayor Cobb asked if he took 75 percent of the 43-1/2 percent eenetration
that Cable Partners showed that brought them down to a 32 percent penetration
to get to that same level that was the equivalent to the $28 for subscriber
fees that Co-op had before they started getting into problems of paying their
debts back.
Mr. Britton said that was correct.
Councilmember Renzel said it sounded as though one of the applicant's was
anticipating having the system on the ground sooner. If one of them began at
the beginning of 1986 and one at the end of 1986 so that one of them projected
revenue for the year and one did riot in terms of the number of years of
operating the system, they would be back to yesterday's chart.
Mr. Britton said yes, as far as equivalency in terms of risk over a period of
time. He restated that Cable Co-op had projected $1.4 million .in the year
1986, City Cable, $310 thousand. From those bare gross numbers one could
assume that CO1e Co-op was planning to hookup subscribers faster than City
Cable Partners, not necessarily meaning physical construction, they were
planning to get money from more people faster than City Cable was planning to
get money or at least their projections presumes'! that.
Councilmember Woolley asked if the order of magnitude could be in terms of
operating expenses.
Mr. i ritton said with respect to the operating expenses as a whole, the
variances were comparable numbers to the 15 and 25 percent were 18 and 36
percent.
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Mr. Britten responded in answer, to a question from Councilmember Bechtel,
looking at 1992, $58.8 million dollars on the Cable Co-op cumulative revenue
line and for 1993 the equivalent number for City Cable Partners, so an
accurate statement throe 1993 Was the two projections were esti,i,ating the
same amount of revenue but one projected that it would get to it a little
faster than the other. In subsequent years, Cable Co-op started to project
substantially more revenue than City Cable Partners.
Counclimember Bechtel said she understood the point about the approximate one
year difference in the $58.8 but looking at each year starting in 1987, for
example, there was et least $1 million difference consistently, was that
realistic.
Mr. Britton stated Cable Co-op had assumed a slightly higher inflation rate
than City Cable Partners which accounted for some of that difference. But as
stated yesterday, the assumption of the $33 per household and the difference
between that and the $28 per household, A difference of the number of
households, the penetration rates, etc., accounted for that difference. It
was stated that it appeared the predominate best systems were doing in the $28
range, there were systems doing in the low $30 range right now and we cannot
expect that Cable Co-op had been more optimistic than City Cable Partners.
Vice Mayor Cobb asked how much of that optimism just referred to linked to
assumptions regarding two-way communication generating revenue during that
time period.
Mr. Britton said none of it, Cable Co-op had not included any revenues in,
their projections, any advance services or two-way communications. The`
penetration rate did increase over time and there was also a little
variability in addition to inflation and the revenue projections, revenue per
household.
Mayor Levy said there are no more questions of Council and would like to turn
to call on City Partners first, who did not make their general overall
comments on finances last evening and any comments on their latest data. He
would then call on the Co-op to make any comments they had on the data. From
there they wou I come back to the Council.
Lynn Simpson, City Cable Partners, thanked Mr. Britton for the clarification,
it was very helpful, Mayor Levy, and members of the Council. City Cable
Partners had been cautioes and prudent in all financial categories. The
conclusion that was drawn was that City Cable Partners' financial structure
and projections had produced a safety net or contingency margin which was
almost double that of the Cable Co-op. The only financial question concerning
City Cable Partners' ability to perform under the franchise was whether the
company could raise the $9.2 million in equity financing. She read from a
letter from Brian Applegate, a general partner of Burr, Egan, Deleage &
Company of San Francisco and Boston in response to that issue (which is on
file in the City Clerk's office). We wanted to briefly discuss the elements
of risk that had been raised,. She introduced Edward Bennett, Executive Vice
President of Viacom Cable Division.
Edmond Bennett, Executive Vice President, Viacom, said one of the confusions
in looking at that revenue was Cable Partners seemed to be nine months out of
sink. If they compared months to months, which was how their business was
based, they would add in another nine months of subscriber revenue. In the
out years, it came in at $1 million a month, that would account for close to
$9 million. The bottom line still stood that the risk factor for City Cable
Partners was almost twice as high in terms of withstanding the risk than Co-op
-- that was a vary important point. The fact remained that Cable Partners
withstood more r;k, there was a lot of integrity in their numbers in dealing
with the revenue numbers. If they looked in the year 1990 and compared the
two reeenue numbers there was - a $2 million variance. If Cable Partners` was
right iii their $27 per subscriber and their penetration numbers, the 15
percent contingency was gone. They were still going along at $8.6 million and
protecting their 25 percent contin9ency. Looking at revenue per subscriber,
it was based on actual operating experience of 18 cable television systems and
Cable Partners had large urban systems and had systems in the Bay _?tea. The
most revenue Cable Partners generated was $27. Cable Partners was' optimistic
but also very realistic. - Mr. Britton had pointed out that Cable Partners was
conservative on expenses, whereas the Cable Co-op was optimistic and the
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Council's response was what was realistic. Cable Partners operating expenses
were realistic because they were based on actual operating experience. Cable
Partners had been operating cable systems in this area, for example, Mountain
View or San Francisco, and were using ratios that were more optimistic than
they were currently operating under. First of all, service business required
higher leve s of customer service. It was a very capital intensive, people
intensive service business, they needed people to answer phones and handle
service calls. The Co-op suggested they needed approximately 36 people, cable
Partners was suggesting 60 because that was what it took to get the jcb done.
Based on experience, they could enot do it without denying or withholding
certain essential services from the subscribers.
Mr. Bennett said the risk on\expenses alone could be $1.7 million. If they
were to use their expenses and hold the revenue numbers to be essentially the
same, the expenses alone would eat up that contingency actor.
John Kelley, Cable Co-op said the first point he would like to make was the
analysis had been conducted on the previously submitted numbers and did not
reflect current numbers that relty Cable was basing its projections upon, that
was a point the Council might consider.
Tom Graves, Heritage, said he was very concerned about the partnership issue.
Partnerships were being done today but not the traditional tax -oriented
partnerships that Heritage Communications, for instance, once sold. Heritage
had done nine partnerships, they had raised a lot of money in those
partners:rips. They were today trying to raise $100 million in Dallas. The
deal in Dallas assumed a e5 percent tax rate and no ITC after 1985. Those
were not the assumptions that were found in the information submitted by City.
Cable Partners. New builds today had a bad reputation in the partnership
market because of cases like Boston where the company had to seek concessions
with the City. New builds were more risky than acquisitions because there
could be cost overruns in construction and because losses were uncertain.
Most important was the acceptance of the saturation level was un mown. In the
saturation level, the two [yids, City Cable Partners" saturation level was
consistently higher by a factor of about ten percent than the Co-operatives.
Current new builds often had guarantees from the general partner or they were
purchased in part by the general partner. City Cable Partners could sell a
partnership, it would net, infact, be the financial deal they were showing
you in their numbers on the board -- it would be a different kind of
arrangement.
Councilmember Sutorius said he eould like to direct some questions to the
appropriate representative of Pac Bell, that had to do with the status of the
FCC tariff filing that would be built under the agreement. Ceisiderable
design and even engineering work was probably well underway. There would need
to be an FCC tariff on this, and asked if a preliminary filing had been made,
what was the comment period that would be involved, and what were any of the
situations that might effect the approval of the tariff.
Bill McDonald, representative, Pac Bell, said with respect to the specific
question on the FCC filing, it was called the 214 filing, one was filed
prematurely in advance of their previous bid and was withdrawn. At the time
et had expired its comment period with no consents from the industry or
public. The current filing had been prepared and was standing by because, in
essence, Pac Bell had no design to lay forth. It was the design of the two,
customers that they had been negotiating with the entire period. They had
prepared the filings, they just required minor changes and release from their
Council. He„expected the process'would take 30 to 45 days and they would know
a !Vitus.. In the areaof the second question, they had conducted extensive
design and redesign, not just from previous work because both of the
competitors had been very vigorous in their scenarios they had proposed, At
one time, they had 12 difference scenarios for design -and were negotiating
with each party every week. It was exhaustive but worthwhile .because all the
cost factors and of l _ the drivers were out on the table and were understood by
all the parties.
Councilmember Sutorius said they were getting into an area of construction and
design., that was beyond what he needed to explore because they are in the
finanr 1 area. He understood there was approximately a 30 to 45 day period as
far As the filing process, what he wanted to know was the nature of the 214
Tariff and what that implied with respect to the latitudes on the billing that
was associated with a tariff of this nature.
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Bonnie Packard, Attorney for Pac bell, said with respect to the 214 Tariff
Filing and the rates that Fac Bell could file with the FCC, the rate structure
that they chose to associate with this service was a rate structure that they
would negotiate with the cable customer.; and that was the rate structure they
put in their tariff that would be filed attached to the application.
Councilmember Sutorius confirmed that the latitudes based on any differences
between the two agreements as to the actual design and the costs associated
with them and then the manner of coming to agreement with respect to how that
would be billed and paid for, was also an independent opportunity betweenlPac
Bell and the applicant under this kind of a procedure.
Ms. Packard replied that was correct and the rates that would be filed as a
result of the negotiations were the agreements with the cable customer, and
would state there would not be any rate increases unless it was negotiated
with the cable customer.
Ms. Packard added there had just been two other 214 Filings that could be used
as examples and experience before the FCC; the Wisconsin Bell and Chesapeake
of the Potomac in Washington,. D. C . and she was not aware of any concern on the
part of the FCC on the different types of rate structures or there was not any
formula the FCC seemed to expect on 214 Filings of that nature.
Councilmember Sutorius asked if Ms. Packard was aware of any pending FCC
matters that might in any way intrude upon the authority of Pac Bell and
either of the applicants with respect to the proposed agreements.
Ms. Packard said no, this type of application to construct a cable
distribution facility was fairly straightforward, the rules were set out in
the federal regulations. In response to 'a question from Councilmember
Sutorius, she was not aware of any common carrier cable items that were of any
pending concern. There was a 30 day comment period for interested parties to
raise issues and anything could happen in that time.
Councilmember Sutorius said he wanted to understand in looking at the
comparison of the financial plans, was that in the event City Cable Partners
were in fact to be the applicant that succeeded and if in fact they did
negotiate an agreement and that agreement was implemented, what; were the
characteristics of it as they affected the application and financing:- He gave
some presumptions and asked if City Cable could respond to how wrong he might
be in his assumptions: 1) it would be a 465 mile service area, the entire
service area; 2) it would mean there would be no line extension process; 3)
that you have the latitude and under the process that had been described, it
would be a fixed price type of contract, obviously with provision for change
orders, etc.; and 4) if it were a fixed price contract for work and was of the
same number of miles and same breakout in underground and aerial, but without
certain features activated, provision of casing for amplifiers but no
amplifiers provided, that it might seem reasonable to estimate it would be at
some amount of money less than it would be if the amplifiers were first
provided at the time of implementation. The manner in which this would be
atforded was also subject to negotiation and agreements, such that not
necessarily should we assume that the payback process would be parallel to the
payback process that existed in the other agreement and which they understood
would have a variety of options they might come to agreement on: 1) City Cable
could use their commitment from Bank of America to pay the entire thing off on
day one; or 2) some variations between that type of a process and a leaseback
process at a particular interest rate with some kind of flexibility for
whether they had an interim period, a balloon payment, etc. if City Cable
could give him the answers to whether any of his assumptions were correct and
if not which ones were incorrect. He wanted then to understand how that might
affect the financials because it could have a potentially significant effect.
Julia 8aigant, Ware, Fletcher & Freidenrith, Attorney for City Cable Partners,
said staff had received the draft contract that Pac Bell had delivered to us.
It was only a draft at this point, and so in the process of negotiations, they
had marked it confidential for that purpose.
Councilmember Sutorius said he hoped the public and all involved understood
that he in;roducted the subject in a very vague way last night and through the
course of the evening had been aware that -responses were made about the status
of the negotiation and he had the understanding from Pac Bell and City Cable.
that this kind of a discussion was not inappropriate.
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City Cable Partners said they were still in the process of negotiating but
would now attempt to answer the question. Taking the first two assumptions as
an answer to one point; an assumption of 465 miles and an assumption of no
line extension. It was important to note that they had committed to serve all
homes in the areas of at least 40 homes per mile which caused all of Atherton
to be completely wired. The areas not to be initially wired would be
approximately 138 homes and 30 miles within the plant. The areas not to be
wired initially included upper Page Mill Road, part of Alpine Road, Los
Tranquis Road, and virtually all of the 138 homes in that area. The two other
areas not be be initially wired included part of Menlo Park near the Dumbarton
Bridge with no homes and the second part was the Stanford Industrial Park, all
with no homes. That resulted in a slight .difference in both mileage and a
very minor amount in terms of homes passed. That would be the only difference
in the assumptions on those two items.
Councilmember Sutorius clarified that the approach utilizing Pac Bell would
not expand`the build to the full 455 miles.
Mr. Guite replied what was built into the financial model at this time and the
negotiations with that were still ongoing and they were not prepared to
discuss it beyond what was in their financial plan.
Councilmember Sutorius said the financials and the materials that were before
the Council were based on a construction plan the, also was placed before the
Council. The agreement ..ity Cable was working on now apparently comtemplated
a larger area and if that was not a fair area to get into, he would drop it
and accept the answer that there was no change in service area, phasing, and
line extension from the materials and that included the revision from 50 to 40
homes per mile.
City Cale Partners said the price quote City Cable received from Pac Bell for
$11,3 million was for the full 460 miles. The anticipated outcome from
negotiations was to propose that City Cable build_ 430 miles and cause a pro
rata cutback in the total $11e3 million cost. The price quote for $11.3
million also included full activation up to a plant throughout all the
franchise area. City Cable believed from the negotiations they could have the
cost reduced by some appropriate amount to reduce the two-way component to
that level which was now built into their existing franchise agreement, so the
price they had from Pac Bell was given to City Cable also as a good faith
gesture on their part to demonstrate apples to apples, the identical price was
being offered to cost as to the`Cable Co-op for the identical plan. City
Cable then would anticipate through either change orders or through
negotiations to have the appropriate reductions made in the cost of that
plant. The financials that were filed with the Council several days ago in
request to a city staff request to City Cable to come up with completed
financials with Atherton included, showed a pro rata cost per mile of $14,500
for the aerial plant with Pac Bell and 45,000 for the underground plant which
reflected that which was included in the $11.3. million. Essentially, they
took the per mile cost, plugged that into the actual miles to be built, and
then ran the financial model with that.
One of the other concerns Councilmember Sutorius had was the manner in which
the payback process would occur and he felt Councilmember Sutorius stated
exactly what City Cable's intention would be in the way the financials were
presented. They would attempt to purchase the entire value of the plant build
on day one from Pac Bell. They had no interest in leasing from them. City
Cable felt they could arrange better financing than was indicated on the
materials last night and the interest rate for the City Cable as two points
over prime, 1.75 over prime or 11.25 vs. the 15.5 implicit rate in the Pac
Bell lease. The financials indicated the iterate process whereby there was a
debt to equity funding of that plant cost based on the Pac Bell numbers and
that was the document Council had received that past week.
Councilmember Sutorius asked if they purchased the beneficial ownership on day
one, that was inclusive would it be City Cable's intent that the maintenance
would be performed under that contract by Pac Bell or were they looking at
another maintenance process.
City Cable Partners said they were getting into some of the negotiation areas
but according to Mr. Guite the maintenance would be Pac Bell exclusive.
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Vice Mayor Cobb directed a question to City Cable Partners regarding the
various numbers that had been gone over by Mr. Britton. One could conclude
that in terms of construction costs and in terms of the average rate to be
paid by each of the subscribers that City Cable had been conservative. The
one number that seemed at odds with that was z.he penetration number. He
needed to understand why that number seemed to be optimistic and all the
others were conservative and he needed to understand why they believed that 41
percent or 42 percent was really a legitimate number. Also, how that number
compared to th3 actual experience in Mountain View which he understood to be
quite lower.
John Dolan, Viacom, CATV Mountain View system, said there was more than just
one element to look at on penetration. Looking at the projections, one was
'tomes passed and one was penetration. Look at the Co-op numbers of 56,000
homes passed, 33 percent penetration carefully. The City Cable numbers were
approximately 52,000 homes and 42 percent penetration. They wanted a bigger
number of a smaller pie. If the out use projections in the City Cable numbers
in Mountain View were compared out, they would see they were more optimistic
and there was good reason for that. The Mountain View market was extremely
different, with a very high incidence of multi -unit buildings in the market,
it's approximately two out of three units and those required separate
negotiation with owners and it was difficult to get the penetration in Palo
Alto's multi -unit market. So it was not an apples to apples comparison
between that market and this market in penetration, they felt the penetration
numbers that were projected were realistic.
Vice Mayor Cobb was nut sure his question was answered. Granted the Mountain
View situation was different, but he still did not understand how Viacom could
justify the higher penetration or at least the basis for them doing the higher
penetration. There must be some basis for believing they were going to get 41
percent where other people said it was lower. He needed to understand what
evidence Viacom had that supported the 41 percent.,
Edmond Bennett, Vice President, Viacom said Mr. Dolan's experience in Mountain
View certainly merited some information, but he pointed out a couple of
factors that influenced the thinking. In Mountain View they had first of all
two markets to consider; the single family homes and themulti-family dwelling
units. Their penetration levels are dramatically different. In single family
homes their penetration was higher and their turn was lower. In multi -family
dwelling units their turn was incredibly high and the penetration was
incredibly low. Factoring that mix of the type of household then, you tame up
with an overall penetration rate. Viacom attempted to use that kind of
thinking here. In terms of the single family homes, he mentioned a new market
such as the Cleveland suburbs where they had just completed construction 12
months ago. The penetration levels were at 50 percent. The Cleveland suburbs
bore a lot of the same demographics in terms of household income, occupation,
and percent of the work force that were involved in technical managerial
positions. They had a lot of confidence in that penetration number for the
Palo Alto market, baeed on experience of not only in the single family home
section of Mountain View but also in Cleveland. Mr. Dolan had earlier
referred to dwelling units which he assumed would not b_ marketable for some
period of time. That paralleled the experience in Mountain View where
landlords and owners of buildings actually denied Viacom access. So what we
had done again was be conservative, by reducing the base available at the
market, projecting what they believed to be a reasonable rate, and then
against that lower number projecting a penetration rate that was higher.
Vice Mayor Cobb said he was reminded there was a similarity between Cleveland
and Palo Alto. He asked if some other examples could be sited besides
Cleveland that might have some demographic parallels to Palo Alto where over
40 prcent had been achieved in penetration.
Mr. Bennett replied Viacom had' recently built a 108 channel system in the
suburbs of Milwaukee, roughly there were 18 communities there. They had
35,000 subscribers and were at approximately 50 percent penetration and the
turn was fairly low which was very encouraging. Viacom's average revenue per
subscriber was running about $25 per month for all: services and'he would be
glad to share some of the; demographic and psychographic information that
comprised that. market. In Seattle, they were at roughly 46 percent
penetration. In San Francisco, which was a very difficult market and had a
very high move rate, the penetration was approximately 42 percent. It had
very divergent communities,- a lot of Chinese communities, a Vietnamese
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community, it was.very difficult to market an area like San Francisco, yet
they had achieved 42 percent. He had just been told that San Jose was at 48
percent, however, one thing to bare in mind was when the penetration went up,
the experience showed that the average revenue per subscriber went down
because in order to achieve ;.hose penetration levels which entailed the paying
incremental subscribers, most of those incremental subscribers tended to take
fewer services. In order to succeed in marketing cable and making it
available to everybody it appealed to older households and households not
interested in pay television, they were not interested in taking as many
levels of pay television service and with that came lower revenue per
subscriber.
Vice Mayor Cobb asked looking at the down side and assuming that the
penetration was now at 36 percent, what did that do to Viacom's financials.
Mr. Bennett replied the strategy in operating their cable system was to
provide a high quality service, the kind of a service which would assure them
penetration. That was why their expenses were a lot higher than Co-op.
Viacom believed the driving element was providing superior programming and
customer service, being able to answer telephones, being able to service
people very quickly when they called with service problems, etc. What
invariably happens with cable companies with low penetration and new builds in
their urban markets is they start to cut back on expense. This ways an
understandable situation and one of the reasons some cable companies were sold
or cable operators went after the city saying the revenue was not there and
they must either cut back on capital or expenses. That was a realistic
picture and he felt Viacom had a contingency in their plan to allow for such a
reduction in penetration.
Vice Mayor Cobb said he would prefer to have a ballpark figure on that if they
were willing to do that. His calculations were the low 30's and still be able
to pay their debt. There was probably some number higher than that where they
would start getting uncomfortable in terms of investors, and he wanted to at
least get a feel as to what that was.
Mr. Bennett replied that mathematically the number was broadly 30 percent to
break even without cute Ing "Joel on the quality vi service which he felt was a
consideration.
Councilmeslber Bechtel directed her question to Cable Co-op concerning revenue
projections and cost and she asked to hear from members of Cable Co-op on what
basis they got to the average revenue per subscriber, from what experience or
how they reached that, and then to the question concerning the essentially
higher revenue projections they were projecting year after year to the cable
and how you get started.
Mr. Kelley commented that in compiling the proformas they followed the
inflation assumptions that were given originally from RFT. The spread in the
gross revenue projections that as seen in the numbers chart of gross revenues
was largely for the difference in inflation factors that were sent in the two
proposals. In 1992, the Co-op was projecting a total cumulative inflation of
1.51 vs. City Cable's 1.42. The only other difference for the most part was a
slightly higher revenue per subscriber projection and a slightly different
assumption about the number of households in the area. The important point in
all of this was to understand there was a balance reached between penetration
and the rates that were charged. City Cable had made an assumption that they
are going to have relatively higher penetration. He showed an illustration of
the difference in the penetration rates of the two proposals. The difference
became quite considerable, St ranged from 29 pe cent in 1986 to 35 per ent in
the mid 1990's and dropped down again to the low 30's. If City Cable were to
achieve only the penetration rates that Cable Co-op had been projecting, there
would be a considerable annual accumulative shortfall of projected revenues
totalling $36 million. ie on the other hand City Cable was correct and Cable
Co-op achieved that penetration, Co-op would have additional income of $52
million of the life of the franchise.
Councilmember Bechtel said Cable Co-op were raising money from the sale of
member shares and she wanted to know: 1) how many members they presently had
and how much money. She asked if they could confirm -the $23,000 and also that
they were projecting raising $3 million from member sale of shares. She asked
if Cable Co-op would elaborate on how many members they proposed to have per
million and what would be the total cost per member to get fV the $3 million.
6 3 7 1
10/2/85
Mr. Kelley confirmed that they currently had slightly over 300 members. They
had total equity right now of about $24,000. They were protecting that
approximately 75 percent of the subscribers would become member; of the Co-op
and participate in the member equity plan. This was consistent with the
experience at Davis. They hid been getting 70 percent.
Councilmember Renzel referred to the figures that were used in Mr. Britton's
report for the penetration rate in 1992 for the Cable Partners which was 41.3
percent but the figure ir. Cable Co-op's seventh year for the revised low
density figure was 47.5 percent. Was that the now corrected figure based on
Cable Co-op's new policy.
Mr. Kelley replied they did show a high penetration rate in the out years.
They began at about the 20 percent, growing over time to a 50 percent level in
the out years and in 1992 it was in the 47.5 percent range.
Mr. Kelley said part of the reason for the change in the penetration was
reflected in the rate structure that was in the financials. He referred to a
chart regarding the monthly subscriber rate comparison. They tried to
identify what the potential subscribers were going to pay based on package
cost. For instance, for basic and satellite service a member in the Co-op
would pay $28 a month, a subscriber for City Cable paid between $17.45 and
$19.45 in 1986 which was a rate difference of over $8. There was also a
sizable difference in the -revenue per subscriber per month, from $8.90 in 1986
growing to $12 or $13 in 1988. There was a substantial risk factor involved
which was why they showed a higher penetration rate.
Councilmember Renzel said in Mountain View about a year ago, Viacom asked for
a rate increase from $9.95 for basic service up to the $5 over a period of
time which took it well above what Cable Cc -op was considering for a starting
rate and she asked how economically they can make that work out.
Mr. Dolan said in the initial numbers in the earlier years of the process, it
was more important to have lower rates than the figure penetration. In
Mountain View the rates for the basic satellite service went from $9.95 to
$12.45 which in a nature market was still a fairly low price.
Mayor Levy said it was not easy to differentiate rates and services from
financials and Council should focus its questions and leave the rates until
latter on during the section related to discussion of rates and services.
Councilmember Renzel recalled that in the original proposals from City Cable
they had two sets of numbers that related to a low density and a medium
um
density installation before Atherton was being included in those numbers. At
that time the distinction was that you had lower rates and higher penetration
figures for the higher density area. With new numbers it looked like they
still had the low rates but low density penetration.
Mr. Guite replied higher costs to the cable operator meant higher rates,
higher rates drove down penetration levels, penetration levels that were lower
meant that you had to have a higher average revenue per subscriber to
survive. What they initially looked at was the additional 2 million cost of
building Atherton which was approximately $19,000 per mile. Subsequently, Pac
Bell offered City Cable a price of $14,500 per mile. That effect was a drop
in costs for construction of about $2 million which came to approximately the
same cost as wiring up Atherton. So that when they used the lower costs for
wiring Atherton and found that they were still able to maintain the same rate
structure as before. they maintained the primary objective which was the
lowest possible rate to achieve the highest possible penetration level.
In answer to a question `ram Councilmember Renzel, ,Yr.. Guite replied that if
Pac Bell was unable to fulfill the obligations that it in good faith had
indicated it could complete, then that would presumably affect either the
Cable Co-op or City Cable Partners because they would both be put in the
position of being una="l to do what either had in good faith offered to do.
Councilmember Renzel said her question now was that Cable Co-op had a firm
agreement with Pac Bell and City Cable was still negotiations. As she
understood from me. Suite City Cable was expecting to realize conclusions in
that negotiation by not installing two-way immediately but installing the
system that had a full two-way. but rather the system that you had
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10/2/85
contemplated when you were building it yoerseif and that you were also
contemplating that Pac Bell would sell you the system in year one -- that
would be part of your agreement. Now Pac Bell may not want to agree with you
on the sale. She did not feel that was what Pac Bell had in mind in getting
involved in the system, so if they are unable to contract with Pac Bell, then
the question was, what numbers were they dealing with.
Mr. Dolan said there were a couple of options, one might be to raise more
local equity to cover the difference in the cost, the other made it also
incumbent on City Cable Partners to negotiate the best poss le deal with the
same third party people to try to overcome that shortfall. Any plan that
anybody put together had surprises and when those surprises came up they had
to be dealt with the best way possible.
Councilmember Woolley asked Mr. Britton in regard to a letter Council got from
City Cable Partners Monday night setting forth five questions, she was
interested in question #2 regarding both the staff, Price Waterhouse, City
Cable Partners, and the Co-op identified a $4,880,000 error in the ;projections
for the Co-op if Council was just beating around the bush talking about
figures that did not really, mean anything if there is a $4,880,000 error on a
$22 million system which sounds like a very significant error.
Mr. Britton responded that Council should not be over concerned about that.
The history of that error was that in the plan that Cable Co-op submitted they
had a math error. The line that represented their cost for office space and
rental of possibly origination facilities was overlooked. It was there but
not added into the total. They had discovered the error and consequently in
the staff report the numbers that were reflected with an adjustment for that
error. They readjusted their debt repayment schedule within the flexibili;:y
and the parameters of their agreement with the National Co-operative Bank to
absorb the math error they made. If they just added up the numbers that were
deleted on face value_ for 14 years, it was that absolute number which was
presented in City Cable's document, Cable Co-op had made acceptable
modifications to their plan in the parameters of their overall plan which
nullified the impact.
Councilmember Woolley asked when the charts were prepared, were those changes
included and did they feel comfortable with the changes in the financing which
were made to accomodate the error.
Mr. Britton replied yes.
Councilmember Woolley asked if there were industry norms that Council should
be using to judge the two penetration rates or average revenue per subscriber
that would be helpful.
Mr. Britton replied both revenue per subscriber and penetration rates were
localized, they were very sensitive to the particular demographics and
marketplace in which they were competing. There were systems that literally
got 95% penetration but they have a declrabie characteristic which was you
could not get a television signal without cable television. If they were to
take rough national norms, both of them were within the high -end of that, City
Cable had not projected the highest penetration in the 40's. It was below the
national norm. If they were to take all of the big cable system operators,
add UP all df their systems, irrespective of where they were, what size they
were, etc. they would get a number that was in the high 40's. A localized
analysis and sensitivity to that wasthe appropriate one, not those national
norms.
Councilmember Woolley said City Cable partners said they were comparing apples
and oranges because they were figuring the rate on a different basis, and
would it be possible to compare apples to apples.
Mr. Britton taking into consideration the differences between the two,
comparin l the numbers that were presented for revenue per household per month
and within reasonableness of tolerance, that was accomplished. The nubmers
shown on he slides were comparable penetration rates not revenues per
households passed.
Councilmember Woolley askf if it was the revenue per household per month that
was of real importance.
:6 3 7 3
10/2/85
Mr. Britton said yes, not revenue per household passed but reveue for some
basic subscriber. The overall consideration was the total amount of revenue
that would be generated by the community and the total revenue number was one
that should be looked at and the fact that it appeared that one group was
possibly more optimistic in timing than the other with respect to revenue but
both were going to have capable experienced operators and one would hope that
they would both maximize their marketing and revenue to be what it was going
to be.
Councilmember Woolley agreed in that the two aspects of achieving the revenue
seemed to balance out. However, she did not feel the operating expenses were
of the same nature. City Cable partners had questioned whether the staffing,
and particularly in terms of the technicians and marketing were sufficient, in
other words whether the operating expenses were really too low for Cable Co-op.
Mr. McDonald said Pac Bell was responsive +r< of t. f
responsive to the :l l.t'rrrar r=id the requests of
each of the companies they had been negotiating with and their role and offer
was to maintain the plant from head -end to the subscriber drop, on the pole
where it started and where it dropped off into the home.
Councilmember Woolley asked where most of the problems occurred in the
maintenance, between the head -end and the drop or between the drop and the
television set in the house.
Mr. Dolan responded the average for this area was 75% of the total service
calls occurred between the tap and the back of the television set. The vast
majority were located right there. Pac Bell as they pointed out did not take
care of that from the service aspect.
Mr. Graves replied that 75% was accurate. The one question you had to ask
yourself was how much time and how much personnel i L took to fix 75% of the
problem vs. 25% of the problem where severe outages tended to be a problem in
the distribution pOen, that part of the plan that Pac Bell would be
maintaining.
Councilmember Woolley asked in light of that was the staffing for maintenance
purposes for the heritage Co-op part of the maintenance sufficient or wa3 that
a low amo'int of staff.
Mr, Britton replied that was a very difficult question to answer without
seeing some sort of detailed deployment plan that would possibly develop at a
later time. He could comment on industry norms. He had seen staffing ratios
which were based on the number of subscribers per em,oyee which incorporated
all types of employees, marketing, sales. etc. It c'id not get specifically to
the issue of service but those rations ranged from 335 subs per employee up to
540 in some certain kinds of systems. There was a wide range and within that
range, it was vet+y difficult to say where they would fall without a specific
deployment plan cable Co-op numbers, if you take those norms, would be
toward the lower ecd of that just on face value but they needed to have
specifics of their deployment plans.
Council; ber Woolley asked if their marketing staff was on the lower end.
Mr. Britton said that was another difficult judgment and there was a comment
in the staff report that said, "that probably is an area that is not exact,
but its probably an area that merits some additional attention and
consideration by Cable Co-op, just in terms of thinking about the fact that
you have to continue the marketing to maintain your penetration rate."
Councilmember Woolley asked if there was some problem and they were off 25% of
the number of employees what was the s.' z , , of the addition then to the
operating(�'�(�j( expenses, it sounded like the; might be talking about $100,000 or
$200, 0 00 .
Mr. Britton replied he was hesitant to comment on those very specific
categories because every system had a different approach, a different plan,
and that was very hard to pin point.
Councilmember er Fletcher said in the City Cable Partners appendices it said
there were no residential units in Menlo Park east of Bayshore freeway. She
did not agree there was quite a residential community east of Men)o Park.
6 3 7 4
10/2/85
Mr. huite responded that the plan extension policy documentation sKe was
referring to was only that portion of Menlo Park close to the Dumbarton Bridge
where there were no homes. Certainly East Menlo Park was fully within the
service area and would be fully serviced.
Councilmember Fletcher said getting back to penetration rates, it was siad
that in Mountain View there was a high level of multi -family and yet there was
also a high level of multi -family in San Francisco yet, there was such a
difference in penetration. Somehow that argument needed some explanatio.
Mr. Bennett replied ,the current penetration levels in San Francisco was merely
an indication of time. They were looking at a moving target. -Viacom had only
been operating in Mountain View for four years and in San Francisco for
fifteen years, so it took a while. Until a lot of additional progamming came
along in San Francisco, they were stuck in the upper 30's and for many years
had flat penetration. When the additional programming came along,
importantly, some of the satellite services, ESNPN and MTV, and when the
additional pay services came along, the penetration moved accordingly.
Councilmember Fletcher said if they took into account the high multi -family in
Menlo Park and East Palo Alto, and Palo Alto itself had about 40% of rentals,
they were comparable to Mountain View. Regarding the Impact's concern about
institutional coverage and wanting to know how much they projected the cost to
be of each drop site including the converters, they were concerned there was
not enough set aside to provide the institutional drops.
Mr. Kelley suggested holding off on that until they got to services and rates.
Councilmember Fletcher aske 'ac Bell or Co-op to confirm her understanding
that there was a very firm agreement.
Mr. Kelley said that was correct. They had signed 'n agreement to execute
upon the award of the franchise and they nad a deal with Pac Bell and would
confirm t'at for her. The only thing that was left open was if there was any
need to change the final Pac Bell agreement to incorporate changes that might
be made in the draft franchise agreement. If there was a change in the
franchise agreement, they needed to nail that down in their agreement with Pac
Bell. They reserved the right to do so.
Recess from 9:30 p.m. to 9:50 p.m.
Mayor Levy said in regard to the limited partnership funding issue he had done
some Investigation of his own and was satisfied in today's climate that
limited partnrships were presently being sold in many different contexts. He
asked City Cable Partners how long they expected it to take to fund the
limited partnerships and thereby going beyond that, how ion they expected it
to take to get started with the construction of their system.
They expected the placement of the limited partnership funds would take th.'ee
to four months and it would have no effect on the construction schedule as
proposed.
Mayor Levy asked when they saw the system being constructed. If a franchise
were to be granted by the first ef November, how many months would it take tc
do everything necessary to begin serving the first household.
Mr. Dolan responded the pole rearrang nt, construction planning, and design
process typically took approximately SCA months. The beginning of constructon
would be approximately March or April and, the first household serviced would
probably be a couple months after that. They needed to build a certain phase
10 or. 15 miles to actually get the continuity together before they could
actually fire up and prove that first section.
Mayor Levy asked glean the fact that limited partnrships sold a lot better at
the end of the year when people where more tax rinded then at the beginning of
the year, how did that affect their plan.
Mr. Dolan replied 'they did not expect any problems having the limited
partnership funded or' subscribed to, that had been indicated by their
consultants and they had indicated there would be nn problem in funding on a
timely basis. J
6 3 7 5
10/2/85
Mayor Levy asked Cable Co-op what their timetable was,
Mr. Kelley said they had submitted a fairly detailed timetable to the City and
were not furl whether that got copied into all of the appendices that were
submitted but they were projecting right now that they would actually break
ground on February 10.
Councilmember Renzel said with regard to the limited partnership funding,
there was an earlier. letter from one of the companies that did the placement
or at least the financial advisers suggested that you wait about six months to
understand what was going to happen in the tax reform, etc. before {ssuing the
funding. Were they now feeling that was no longer valid advice.
Cable Co-op ::aid it was their understanding this had been indicated by their
financial consultants, that the tax law changes would not occur this year and
the effect of the tax law changes would not affect the type of funding they
were attempting to achieve in this project. The other aspect was they were
also looking at several different variations of a limited partnership
structure and that made it very easy to tailor it to the specific market and
according to the time it would be hitting the market.
Councilmember Renzel said there was a letter tonight from Burr, Egan and
Deleage to the Mayor on behalf of city Cable Partners proposal indicating that
the attractiveness of the investments was no longer based largely on tax
benefits rather based on upsight gain and the appreciation of cable systems
and the rapidly\ increasing cash flow from a well managed system. As she
understood partnerships, the people wanted their money out fairly quickly like
in 7 or 8 years. If the first investors wanted to cash out at year 7 and they
were depending on a rapid appreciation of the system, how did that affect the
ongoing operation of the system after the sale.
Mr. Britton replied if there were a recent occasion or refinancing as it was
in the 7th or 8th year, the ongoing operations could be impactee in a number
of ways but to distinguish operations in terms of delivery of services, there
probably would be no"effect in terms of how the profit and loss statement was
comprised_ ; there might be more or lass interact And that wnuld be the only
impact.
Councilmember Renzel asked theoretically if a system was valued for purposes
of construction and tax benefits at a certain price now, and if every 7 years
it turned over for financing purposes, if each of those beginnings of those
seven years was expecting a major'Appreciation that somehow the revenues had
to go up from the system in order to generate that appreciation, was that not
a reasonable deduction of that circumstance.
Mr. Britton said in the broadest terms that was probably an accurate
deduction, but they did in fact project an increase in revenue. Tht only way
that they could justify the recent occasion at a higher price and therefore
provide the earlier investors with appreciation, would be if the economics are
favorable. Revenues had gone up and the cash flow available for distribution
was there, so the overall deduction process 4as correct.
In answer to a question from Mayor Levy, Mr. Britton replied they had not
reflected in the actual proformas for the impact of a resyndication, what they
did was say if they were to undertake a limited partnership, and in the
limited partnership offering talk about that kind of appreciation, it would
yield a rate of return which would be attractive to a limited partner but they
did not run through their numbers the actual execution of a resyndication
change in the financing structure and then continue on for a number of years.
Councilmember Renzel asked in terms of theCo-op system, how the appreciation
of the system was affected over time, what effect it had in terms of financing
and how structure impacted that particular issue.
Mr. Kelley, said they had no intention! of selling the system unless there was
no need for them to show that sort of appreciation. They had shown their
f i nanc i al i st they would refinance the system to carry out the lease pasyments
to Pac Bell. That was projected upon the cash flow that was generated in the
system in that year and felt very comrfortablethat the_ cash flow they were
projecting would be sufficient to carry out ther refinancing. .The question he
really wanted to address was why they had not proposed one of the partnerships
such as -he City Cable was proposing and whether, in fact, that was the type
of proposal that could be carried out.
6 3` 7 6
10/5/85
Vice Mayor Cobb said he had read in some of the paperwork that Mountain View
was loosing money and there was some danger that Palo Altos' system might have
to makeup fbr that loss. Was Palo Alto protected against that eventuality.
City Manager William 7aner
Mountain View.
rare i ne3 uese 0 _ 7..
IIiu+G�i I,Ue(I`. U1
Councilmember Woolley said Council had the research report from Peabody on
Heritage and were given high marks for having above average operating margins
and Peabody went on to explain why this was so. They were operating systems
in small to medium size communities of 20-35 charnels in chiefly non-urbe
communities and there tended to be a high degree of demand in those
communities or cable television because of the signal. Th-s was ve:j unlike
Palo Alto. In regard to the cost of installing drops, he was very impressed
with all of the research that was done and the awareness that there were going
to be tremendously different costs for installing drops to a city in Iowa, to
a city in Texas, to Palo Alto. That had been taken all into consideration in
terms of tt,e staffing, was similar research done and did they feel confident
that even though the staff considered their numbers to be a little on the low
side were they really going to be able to do an adequate job.
Mr. Kelley said they were. This is a complicated issue and being critized for
the rate structure and what they really were talking about- was an inflation
rate assumption given to us by the City which was used and in wh th the other
bidder did not. They were being attacked in the number of staff positions
they had because they filled an indepth and sophisticated financial projection
that included those staff positions where as with City Cable partners they
really did not show a clear picture of what sre_fing they were going to do.
Cable Co-op had taken a hard lo' at the employee ratio question and compared
it to a few cities which wou be comparable to that of Palo Alto. He
urlderst' d how` expensive Palo A1..o was. They compared Southbend, Indiana,
'another college community; Clinton, Iowa which would be roughly the same size
subscribers as Palo Alto's system; and Iowa City where the University of Iowa
was located and would be roughly the same size. In Southbend, they hid 517
subscribers per position; in Clinton 715 subscribers per,,positicn; in Iowa
city, 560 subscribers per position. Of the major systems they hail. an average
of about 590 subscribers per employee. Palo Alto in 1988 showed about 555
subscribers per employee. They based those numbers on ongoing negotiations
with Pac Bell in which they hoped Pac Bell would actually be responsible for
more of the plant then it was. This would be a significant difference in the
financials, it would not be as significant as if they found out that City
Cable Partner's numbers on pay television costs were considerably lower or
that would be a bigger problem for`them if they were wrong.
Councilmember Woolley asked about the risk that was involved, would a
commercial bank make the loan which the Co-op Bank was making to Cable Co-op.
Financial Planning Administrator Gordon Ford said the Co-operative Bank would
wore with the Co-operative a little bit more than a commercial bank would.
However, a bank had to lookat the financials and make a determination based
on those financials. So he would have to assume that some banks would also
look favorably upon the proposal.
Councilmember Woolley said it had been suggested some people were concerned
with the track record of the Co-op market. She understood they were two
entirely different business entities, but she would like to hear Cable Co=op's
comments. They all rect;gnized there had been some problems with the market,
some had closed and one being sold in order to raise capital.
Mr. Kelley said the biggest difference between the Co-op markets and the Cat=le
Co-op was they were different companies -- independent corporations. Cable
television was very difference from the food industry._. The food Industry was
highly competitive and at the present time the Co-op market was suffering very
intense competition from larger chains particularly, Safeway, many of whose
markets had really made a large intrusion upon the markets. Cable television
was a'most exactly the inverse, it was a monopoly. The reason they felt very
strongly about the need for co-operative, ownership of this monopoly was there
was not goingto be the opportunity to compete, provide efficient service.
The biggest difference between these two markets, these different .industries,
in that respect, was the operating margin that both companies projected. In
the food industry it was typically operating with a margin of about ore -half
percent which meant that Safeway if they could get a deal on better Coca Cola
6377
10/2/85"
or hamburger iiieat was wine to do a lot better than the Co-operative market.
In the industry, Cable Co-op achieved most of their economies, by operating
with a multiple system operator, such as Heritage. If they operated an
efficient system, sold hard; and made it a profitable system, . thiv : ` V b-
1 w
operating at the end of the term rranchise with a profit margin of about 30
percent, 30 times greater than that which you would see in the food industry.
This different end margin was going to be what ultimately was mast important
to consumers because if they attained those operating margins, money would go
back to subscribers or wale, be reinvested in the plant.
Mayor Levy asked regarding the refinancing of both systems, what staff's
feeling was about the refinancing plans, what the level of confidence was for
the refinancing p'ans of both systemse both of which are scheduled to take
place approximately 8 years down the roadway.
Mr. Britton replied in the case of City Cable Partners, the r-efinancine or the
appreciation that they were showing as would be reflected in the gray they
projected to the limited partners that they earn their return, they would show
the anticipated appreciation that would happen in the system and if it
happended they would benefit in the matter. There was no obligation that they
would have to refinance that system if, in fact, the appreciation did not
occur if the cash flows were not there to allow for that refinancing or
resyndication. They would probably have some disgrundled investors but no
legal obligations to make up any short fall in return. In the case ,of Cable
Co-op, the refinancing they contemplated and they had discussed with the Co-op
Bank was to make a big lease payment to Pac Bell, i-e., a catch up payment. They had in their agreement a clause which said if they encountered severe
financial difficulties they would have the right to a 30 percent roll over,
that was taking 30 percent of the lease payments forward, and secondly, it
might not be in the interest of Pac Bell to want to force legal action if they
could not refinance and make that big payment. If often occurred in the
business world that if that situation arose they work out a new schedule that
was satisfactory to both.
Mayor Levy assumed if the law changed and Pac Bell was allowed to operate a
franchise, they might be in a position, if the lease payments could not be
made, to take over the franchise.
Norm Sinel, Attorney, Arnold and Porter responded the agreement provided that
the Council had the right to approve a transfer of ownership, they would have
to see what the Pac Bell lease with the Co-op would provide as to their rights
to take over the system as a creditor, but essentially, they held the power to
grant the franchise to whomever they chose and may or may not decide to grant
the franchise to Pac bell if they had the right to operate a cable system.
Mayor Levy asked if Council had the right to then reject, for example, the
sale of either one of those systems to anybody else if they were sold to a
legitimate cable operator under the current status of the law.
Mr. Sinel replied they had a right to reject it if the rejection was based on
reasonable terms that would stand up in the litigation that would pursue: the
rejection if the company went belly up. Yes, they did but Council Night not
have the right to make a rejection based on, for example, the notion that the
potential purchaser owns a television station in the area which was a right
they might have had in the past. The Cable Act prohibits looking at the
+akership of other media interests but Council certainly had the right to do
an analysis like this to determine whether or not the potential purchases
would serve the public.
Mayor Levy asked if Council had the right of first refusal on any see of
either one of the systems.
Mr. Sinel said no.
Councilmember Fletcher asked in regard to what level perc3ntage of the funds
raised would be costly.
Mr. Britton said that level could vary significantly depending on the manner
in which a limited partnership offering was placed. If it was a venture
capitalist orif it was placed with one of two large investors it may not be
that significant. If it started to take on more of the characteristics of a
6378
10/2/85
public/private offering, then they could he larger. Percentage wise, the
numbers changed. Not knowing what was quoted, arrangements would be worked
out so there would be no fixed percentage..
In answer to a question from Councilmember Fletcher, Mr. Britton replied he
was -not prepared to say what that bottom percentage would be, there were
arrangements which could be made. He did not know what their proposed
arrangements were with their investment bankers.
14) their_ financials on the limited partnership aanalys : s, they had assumed a
cost for the debt equity funding and that was based on their current or last
negotiations with their financial consultants. they had given them a dollar
figure that should be used for the analysis based on the amount of equity
involved.
Mr. Sinel stated he would like to make a correction, there was a right of
first refusal in the agreement in the -event of a transfer and that would be
with either applicant.
Councilmember Fletcher confirmed it was Section 14.1 of the agreement.
Mr. Lacier said going back to a question Councilmember Cobb asked previously
with regard to whether or not there would be any kind of cross-substituty
between the Palo Alto system and the Mountain View system, if Mountain View
ran into any kind of financial difficulties. His response was the systems
were independent, that was true, but there was a possibility however, that
.f
r t�vw�.,r�Gt ;.t1Qti. f F
the Mountain View system were to fail and creditors for the Mountain View
system attached any other assets in the Mountain View system, and if we were
sharing a head -end, we might then have some problem that might affert the Palo
Alto system. His second comment was following the line of questioning -that
Mayor Levy raised earlier with regard to the timing for the limited
partnership, it might be of interest to the Council to understand what the
timing was for the construction of the system. In accordance with the
agreement, once the agreement was signed the successful franchisee had five
months within which to present to the City a complete engineering plan and the
City had an unlimited amount of time to review that elan and approve it. once
that plan had been approved, the applicant then had 18 month, to complete the
system. There were built into the timing agreements some stages during which
the applicant was required to complete a certain percentage of the system by a
certain dare, but basically there is a five month period and than an 18 month
period with some opportunity for extension if there were extenuating
circumstances.
Councilmember Renzel said back in 1983 when Viacom withdrew from the
franchising process n Palo Alto, a press release was issued saying the expense
of building and operating a cable system of that size and technical
sophistication required by the RIP made a reasonable return on the companies
investment unlikely during the life of the franchise and it was for that
economic reason that Viacom withdrew whit changed that brought Viacom back
into the process and found it economic now.
Lynn Simpson, City Cable Partners, pointed out the agreement that was reached
with the City had. really changed substantially from the original agreement.
The realities of the systems were much more f ilar to them now that it was a
much more economic system proposed by both applicants.
Mr. Bennett reiterated the requirements had changed. Originally they were
quite difference. Not having a local investor group was a handicap in their
case. There was also another element which was the relationship between
capital costs and penetration, _revenue for subscribers and the financial
success of the system. With the rate to rate regulation it allowed more
flexibility and freedom on the part of the cable television company to adjust
rates to cover risk. Now although the capital costs were lower in this
particular case, having rate to regulation did help because the operator was
free to pricer the product according to the market place.
Mayor Levy asked staff to address the ownership structure.
Deputy City Manager, Larry Moore said he would begin with the structure of the
corporations. With respect to City Cable partners, it was a privately held
company with a five member board of directors. It was owned by approximately
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70 shareholders each holding between one and approximately twenty-three
hundred shares. Directors were elected by stockholders and each stockholder
had one vote per share. Comparatively for the Cable Co-op it _was a
ereoperative nnen to mamaharship by anynnp__Iehn paid the 110 440mherchip fee,
Each member was entitled to one vote toward electing the Board of Directors.
The Board of Directors consisted of 15 members elected from and by the
membership. Wits: respect to the management agreement, first with City Cable
Partners, they would contract with Viacom to manage the day-to-dey operation
of the system. Policies would be established by a management committee. The
management committee majority would be appointed by City Cable Partners and
Viacom would have at least two representatives. The principle lenders -of the
partnership, might appoint one member. e With respect to payments for Viacom,
Viacom would recieve three- percent of gross monthly revenues derived from
operating the Palo Alto system. City Cable Partners would recieve two percent
'of gross monthly revenue fee. Additionally, Viacom would receive
reimbursement for the Mountain View system head -end and telephone facilities
and leasehold equipment, i.e., $25,000 in the first year, $50,000 in the
second year and $75,000 in the third year and thereafter. With respect to the
term o; the agreement between City, Cable Partners and Viacom, it was a 15 year
agreement with a six month cancel ration notice and termination could occur at
any time. Comparatively, the Cable Cn-op'would contract with Heritage to meet
the systems day-to-day operations. Policy would be established by the Cable
Co-op's Board of Directors. With respect to payment, Heritage would receive a
fee of five percent of the gross revenues of services overseen by Heritage.
Additionally Heritage would receive a six percent of an amount by which all
system revenues exceed a pre -established amount during the first three years
of service. Additionally, Heritage would receive eight percent of gross
revenues from\advanced and data services during the first three years of such
services and six percent of the same thereafter. With respect to the terms of
agreement between Cable Co-op and Heritage it was an eight year agreement with
a one year cancellation notice and termination could occur for cause at any
time. With respect to City participation and ownership which was reflected.in
Appendix K provided by use of the applicants amity Cable Partners for City
Cable Partners, thecompany would exercise its best efforts for the City to
acquire 60 percent of the limited partnership interests. Additionally
included in City Cable Partners Appendix K was that both parties had the
ability to enter into discussions at other times to agree upon a purchase and
sale of the system or interest in ownership of the system, on terms and
conditions agreeable to Moth parties, Comparatively for the Co-op, the City
could acquire four percent interest in the system on reasonable prior written
notice to the, company at any time during the term of the franchise at a price
to be determined.
Vice Mayor cobb asked to what extend was the fact that the Cable Co-op had
offered the City up to a 40 percent buy in down stream a factor in the staff's
decision to recommend Cable Co-op to the Council.
Mr. Moore said it did not affect the recommendation and reiterated the Council
instructed staff to have provisions in the agreement in the appendices which
either the applicants or city participation in the ownership at some point.
Mayor Levy opened discussion with the franchisees.
Walter Hewlett, City Cable Partners, referred to their proposed ownership
structure and management agreement with Viacom. City Cable was structured as
a limited partnership. The general partner was, City Cable Partners, Inc., a
California Coperation. City Cable Partners Inc. would own 40 percent of the
partnership and the limited partners would own CO percents They. were planning
to sell a special class of city Cable Partners Inc. shares to the public.
Those class A shares would contain certain rights and restrictions. One must
be a resident of the. JPA,& nities to buy class A shares. Owners of class'A
shares might sell them to other members of the public but they must agree to
sell them only to other residents of the JPA communities. That restriction
would last for five years. They anticipated that class A shares would carry
some small yearly return probably not to exceed four percent. There. were no
plans over the 15 year life of the franchise for any cash payouts on current
City Cable Partner shares. The owners of class A shares: would have the right
to elect two members of the City Cable Partners inc. Board of Directors. That
would bring the size of the Board to seven. City Cable Partners anticipated
raising about $1,000,000 in equity from the offering. The class A shares sold
would account fjr approximately one-third of thegeneral partnership. The
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franchise that was awarded to City Cable Partners was not awarded to the
limited partnership as a whole. When the limits were brought out in year
seven, the general partner kept the franchise and retained sole operating
authorti e City - Cable Partners _ anticipated _ L __l_ ._. t .limited
-- :
,� . - v ...,� Cable �. Partners r:iGl a {lie v 1 �, 1 wa�icu LxUy Ill�j uut the i 7ifi i fed coroner:
and not going, into another syndication. He would summarize the advantages of
their ownership structure. No one was under any pressure to invest. Risk was
taken only by those who wanted to take it. People could sell their shares at
any time for what they were currently worth. Limited partners would be taking
the majority of the risk which meant no risk to the community. Class A
shareholders were guaranteed representation on the Board of Directors. The
management structure was outlined in the block diagram. City Cable Partners
Board of Directors was elected by. the shareholders. The Board of Directors
had ultimate authority over the business. Viacom Cable Vision was to manage
the system. City Cable. Partners had ,an agreement with Viacom to set-up a
management committee consisting of two executives from Viacom and three
members of City Cable Partners Board of Directors. The system manager would
report to the management committee. The. structure would ensure responsiveness
by the manager and at the same time give Viacom substantial input to
management dicisions. City Cable Partner's management agreement with Viacom
and their affiliation with the Mountain View system offered substantial
advantages over the agreement reached between Co-op and Heritage. The
management fee with Viacom was three percent of gross revenues while the Co-op
must pay five percent of gross revenues to Heritage. In addition they
projected substantial cost savings in sharing facilities and personnel with
the Mountain View system. For example, in the year 1988, the Co-op projected
paying Heritage a management fee of nearly $400,000_ In the same year City
Cable Partners expected to pay Viacom $305,000 in management fees and in
addition to realize operating savings of $450,000 a net difference of $540,000
in 1988. City Cable Partner's association with Viacom not only have them
access to experienced local cable T.V. management but also provided real cost
savings for their system. City Cable Partners offered the most reliable
choice at the lowest possible risk to the community.
Mr. Kelley said the primary advantage of the Co-operative structuee was to
keep the rates reasonable, In light of deregulation there was no upper limit
on rates in future Hewlett had indicated, r.. the and 1'ii • had City Cable Partners
would be owned and operated as a private corporation. Cable Co-op was also a
private corporation. The difference was their shareholders would be
subscribers to the system. And as Mr. Hewlett had pointed out that was not
necessarily true with City Cable Partners. It was very difficult to predict
what the effect of deregulation would be. However, in a monopoly situation
they felt it was likely there would be a tendency to try to increase the rate
of return for the system and thus ultimately subscribers would end up paying
monopoly rents. That was a simple matter of economies. Cable Co-op planned
to offer its subscribers more than the choice of just whether or not to take
or leave a service. The subscribers would have the epportun 4y. to elect the
entire Board of Directors. Cable Co-op expected that if they met the
projections that we had set forth, they would end up paying their subscribers
about a 12 percent dividend annually.
Tom Graves, Heritage Company, said after working three; years with Co-op, they
were very impressed. There was. real local interest. There was a wide -spread
participation from the comimiun i cy and a real commitment to the system. The
Board members were enthusiastic, cared more about serving Palo Alto than
anything else. The job of ensuring economic v1ebility to the system was
Heritage's responsibility. He was very impressed with'the structure and the
way they worked. He thought the community wouldbe proud to have Cable Co-op
as a cable operator.
Councilme ber Woolley asked the Cable Weop to evaluate the extent the Board
of Directors would control the system. She assumed the Board would decide -how -
the profits would be used.
Mr. Kelley said they did not have an annual; operating report from Heritage.
There was an annual planning process with Heritage. The way the annual
planning process worked was the Cable Co-operative Board set out the basic
objectives that should be met for the system. Heritage in e000eration with
the people designated by the Co-operative Board, principally our management
committee, would develop the annual pl apt . The plan was then submitted to the
Board for approval and the Board Might 'direct; that changes be made in the
plan. Heritage was thereto advise Cable sl
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_l Woolley asked i, the Board would have an additional control.
CC�f3i'i�, � �fiiiiiiu�r' �
Mr. Keeley said the Board would have the final authority to see whether or not
Heritage was doing its job properly. The two most important areas in which
the Board would oversee was the development of advanced services and to work
with the CAO to develop viable community programming in the community. There
was an advanced services development committee on which four people designated
by the Board would sit along with two members designated by the City and one
by the CAO. That would be a separate committe,a separate budget and would be
a component of the annual planning process. Similarly, there would be a
corresponding community programming committee which would represent the
Cooperative in working with the CAO.
Councilmember Woolley asked if the Co-op would own the distribution system at
the end of the 15 years.
Mr. Kelley said someone from Pac Bell might want to elaborate on that. It was
his understanding that Pac Bell could never sell the system to anyone.
Ownership in the formal sense would always remain with Pac Bell. Cable Co-op
had negotiated the right to renew the lease agreement for approximately
$1,000,000 per year plus an annual infidtion factor after that point.
Bonnie Packard, Pac Bell, said this was
building a cable distribution system
California so for Pac Bell it was an
constructing and maintaining the system
to the task.
the first time that Pac Bell would be
for a cable television system in
exciting project. Pac Bell would be
from certain equipment in the head -end
Councilmember Woolley asked who would be building it.
Ms. Packard said it would be Pac Bell's responsibility for the construction,
and as with our other telephone plant, they would seek outside contractors for
various elements.
Councilmember Woolley asked Pac Bell to confirm that they could not sell the
,system.
Ms. Packart'vesponded traditionally the California Public Utilities Commission
restricted them from selling any plant which was used in order to provide
tervice to the public. The FCC had the same ty a of rule. However, it was
possible in the future that the legal analysis on that kind of restriction
could change and there could be some interpretation that would allow them to
sell the system if they were receiving any revenue from it or no longer
changing rates. In 15 years however, the regulatory environment could be
entirely different. If the City were interested in buying the entire cable
television system, she d:d not see anything that would prevent that.
Councilmember Sutorius said he wanted to address some questions to City Cable
Partners. It related to their agreement with Viacom and he asked for the
specifics that were involved in a notice procedure and the response procedure
in the event Viet Viacom wanted to dispose of the Mountain View franchise.
Mr. Guite said if Viacom wanted to dispose of the Mountain View franchise
there was a reciprocal agreement with City Cable Partners which would allow
for discussion with Viacom.
Councilmember.Sutorius said in the event Viacom gave City Cable Partners the
notice and there was some reason City Cable would not be able to exercise the
purchase, chat were your protections if a third party would purchase that
Mountain View franchise.
Mr. Suite responded the protections were specified in the, contract. In the
event a new buyer purch ,sed the Mountain View' system, presumably they would be
motivated as Viacom to maintain the seaoe kind of agreement with City Cable
Partners which wouldbe economically advantageous to all parties.
Councilmember Sutorius'sand it seemed to him in any meeier organization must be
a whole variety of internal performance measurements looking at how the
operation stacked up against goals that had been set with rasp& t to costs,
service quality, productivity, etc. He asked how did Viacom in Mountain View
stack up in the system of Viacom operation.
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Mr. Guite said Viacom of Mountain View performed up to our expectations for
the cable system since it was a three year old cable system growing in
subscribers and penetration, To compare Mountain View with our other cable
systems was not as fair because Viacom had i7 percent Penetration_ and had been
operating for over, 15 years. Viacom was in its third year of operation in
Mountain View and was very optimistic About the future of the system as it
related to the enormous potential that would be obtained by the energy between
Palo Alto and Mountain View.
Vice Mayor Cobb said picking up on Councilmember Sutorius' last question that
if either Viacom was bought out or the Mountain View system was backed up for
whatever reason, what protection did City`Cable partners have with respect to
the head -end facilities in the operation of your system.
Mr. Dolan responded basically the way it was arranged there was a head -end in
Mountain View which would feed hub to Al} If for the
a into Palo Alto. If i some reason �r�+�
head -end of Mountain View no longer was available, they could replace the hub
with a full head -end.
Councilmember Sutorius said Cable Co-op intended to start out with a selected
Board of Directors. Subsequently, those Directors would be elected from the
membership or the subscribers. The concern was what protection was there
against a situation where a Board was elected from the activists from within
that membership and begin to make political decisions, political being defined
in terms of what kindofprogramming they thought appropriate for Palo Alto --
how would Caole Co-op protect themselves from the politicizing of the
operation and its perhaps negative impact on the bottom line operation.
Mr. Dolan responded he had confidence in the people of this community. In the
event that a so-called politicized Board were to endeavor to do something that
would threaten the viability of the system, each member as a shareholder would
have recourse under the Corporate Law of California to discharge that Board.
The City in some sense had an interest in the system under the franchise. As
Mr. Sinel expressed, those remedies would be contractual.
Vice Mayor Cobb said he also had faith in the people of the community but
sometimes the most well intentioned people could get themselves in the wrong
place in terms of their decisions. In terms of compliance with the contract,
the corrective action take place fast enough to prevent permanent damage to
the operation of the system.
Cable Co-op said to initiate a lawsuit does not take much tine, To get any
relief that was meaningful might take years. In that kind of action it would
either be going into state or federal court to seek remedies as a
shareholder. He felt some form of relief was possible.
Councilmember Klein said if the budget showed there was $100,000 available and
there were two, competing interest and Heritage, for example, needed more
market people. For $100,000 they could add two more marketing people.`: Then
if there was a majority of the Board that said no, since that would be a
matter of judgment call what would be done to\resolve that dispute.
Cable Co-op said the issue would be resolved by a majority vote of the Board
of Directors that would determine what would be done. Probably the more
important issue was what weight would the Cable Co-operative Board give to
Heritage's judgment. He said their ultimate incentive had been and would
continue to be to provide service to the entire subscriber community. It was
simply not a question of ignoring what was sound advice. He said the best
indication would be to continue to listen. The advantage of having a Board
and the advantage of having a large Board, a fifteen member Board as opposed
to a small Board, was to get the considered judgment of a number of people.
Councilmember Renzel said with r+gard to the potential of eventually acquiring
a share in the syste , she asked Mr. Sinel what would be the City's best
effort to acquire 60 percent of shares to both.
Mr. Sinel said 'they were referring to the Appen4 i x K of City Cable: Partners'
prcjposal . City Cable P rrtners' proposal was in two parts. One wa 3 that when
it carne to refinancing: .they were prepared to mace their best efforts to, ,sell
the City 60 percent of the: limited partnership. share. --It was unlikely .that
the City would want to be a limited partner in the cable company other thin
,6 3 8 3
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for the upside potential of financial investment, since limited partners could
'lot participate in the management of the company or in any of its processes.
The second part of the offer was essentially the same as the agreement to sit
down and discuss with the City whether or not there were any terms in the
agr eeeeen . udder ivh eh the two parties wished to do business( Arnold &
Porter's view was that a business deal only made sense if both of the parties
felt it was a reasonable business deal.
Mayor Levy asked Cable Co-op indicated they planned to pay 12 percent annually
to each of their members. He asked them to comment on that because their
financials did not indicate they would be in a position for that to happen.
Cable Co-op, said their intent was that at the end of the term of the
franchise if they were meeting their financial projections, they expected to
pay a dividend of approximately 12 percent. Paring the intermediate period if
they exceeded their projections, there could he dividends, but nothing was
guaranteed during that period.
Mayor Levy confirmed the 12 percent would be paid at the time their financials
permitted it.
It was elaborates that in a co-operative corporation dividends were based upon
patronage. It was a function of the amount of patronage that was transacted
in any given year. The figure they represented was the 12 percent return of
the purchased services in those years at the end of the term of the franchise.
Mayor Levy asked what happened to a member who ceases to be a subscriber. As
he understood it, a member joinee the Co-op in two ways, either by paying a
$10 flat fee or by paying .4,300 over a period of approximately 12 years. If
the member ceased to be a member either by terminating his or her subscription
or by moving ou* of the area than the Co-op would return the funds back to the
member dollar for dollar over the eame period that they paid them in. He
asked if that was correct.
That was correct.
Mayor Levy said it had also been indicated that most of the members who
terminated would seek a lump sum pay out which would be discounted.
It was responded that was correct. lc other words the member payed $300, left
the community, and wanted their membership` _terminated, how much of the $300
would be discounted.
It was responded that approximately $175 - $200 if they assumed 7 percent and
if it had been paid in over five years,
Mayor Levy said City Cable partners proposed seven directors, two of those
directors would be elected by the Class A shareholders the new class of
shareholders who were limited to residents of the JPA.
Mr. Hewlett responded that was correct. The other five directors would be
elected 'by the shareholders of the current City Cable Partners. The A
shareholders would be assured of . being able to elect two of the seven
directors.
Mayor Levy said first of all, it was a proposal the Council had not seen. He
asked if it was City. Cable Partners' intent to make the proposal a binding
part of their agreement with the City.
Mr. Hewlett said they were prepared to do that.
Mayor Levy asked what would the cost of the shares be that would be made
'mailable to the A directors or to the A shareholders.
Mr. Hewlett said .approximately $i0--$12 per share. They would be esily
affordable to anyone who wanted to buy them.
Mayor Levy asked would there be some kind of limitation of the maximum number
of shares that a shareholder could buy..
me. Hewlett said their objective was to have the shares owned by as wide a
group as possible.
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Counciimember Fletcher asked each applicant how the subscribers and or
shareholders would have a`rale in the decision.
'Cable Co-op, said it had been in existence for very close to five years now
and the board of Directors had met regularly throughout that period of time.
At the beginning of each of our Board meetings they introduced everyone who
came to Cie meeting. It was the tradition of the organization. In the cable
industry, the most important fact was to keep close contact with the
subscribers and the market. As the cable system developed there might be new
technical means of communicating with their subscribers.
Mr. Hewlett said the cable operator had a sizable investment in the plan. He
had a sizable marketing investment in order to gain customers so the last
thing they wanted to do was to alienate a customer. There were 70
shareholders and a much wider participation was expected. The Board of
Director`s' members were open to nePtings: In adajtinn, there was an advisory
board that had been very useful.
Mayor Levy said there were shareholders who were not residents of the service
area and he asked if those shareholders would be forced to s€.11 their shares.
Mr. Hewlett responded ::o. The current shareholders were not in that special
class. The shares that would be offered as Class A shares needed to go to
residents of one of the JPA communities.
Vice Mayor Cobb asked Cable Co-op if it was true that in fact, within five or
six years the only way they could reach th.~S.r financial- objectives was to sell
the system off and get out of it.
Mr. Hewlett said after five or six years, the general partner did not really
own very much. There would be no incentive for selling. They were in the
process for the long haul.
Mayor Levy said he wanted to understand the membership concept of the Cable
Co-operative, He asked could an individual be a mreweer of the Cable
Co-operative without being a subscriber to the system.
Mr. Kelley responded yes. It was their intention to change their bylaws to
require that the members be subscribers.
Mayor Levy questioned whether or not they could sell their membership on the
open market.
Mr. Kelley said no. It was basically backed by the corporation.
Mayor Levy said it worried him that individuals who were original members of
the Co-op would be losing money and would not have an opportunity to share in
the profits of the system for perhaps 12 years. The person who joined the
system in year twelve on the other hand, would make a profit because in year
twelve, and so, the Cable Co-op would be extremely profitable. So in a sense,
the original members Auld be penalized.
Mr. Kelley said to a certain extent that was true. There was a free rider
problem. What they tried to do was match the equity contributions to gain in
the penetration. It did not eliminate the free rider effect entirely but they
tried to ameliorate the problem.
ADJOURNMENT:
The meeting was adjourned to Thursday, October 3, 1985 at 7:30 p.m.
ATTEST:
Ai?PROVED:
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