I. FCC Implements Cable Reform Rules

On March 29, 1999 the FCC adopted an Order implementing provisions of the Telecommunications Act of 1996. The FCC refers to these as “cable reform” provisions. The FCC was required to issue rule modifications in the 1996 Act although it has taken in excess of three years to complete the task.

Among the key elements of the Order are the following:

1. Technical standards. Perhaps the most significant issue addressed in the FCC’s Order relates to technical standards. The 1996 Act confirmed the FCC’s ability to establish minimum technical standards for cable system technical operation and signal quality and stated that no state or franchising authority may “prohibit, condition or restrict a cable system’s use of any type of subscriber equipment or any transmission technology.” The FCC’s Order concludes that Local Franchising Authorities (LFAs) may exercise oversight and enforcement of the FCC’s technical standards but LFA’s cannot impose technical standards different from FCC standards. The FCC also found that “transmission technology” includes, for example, an operator’s use of digital or analog transmissions and its use of coaxial cable, fiber optic cable, or microwave facilities. In addition the FCC also acknowledged municipalities role in determining local needs and access channel requirements, institutional network requirements, as well as a review of an operator’s qualifications and management of public rights of way.

2. Rates. Under the 1996 Act rate regulations for the cable programming services tier, also known as the expanded basic tier, sunset March 31, 1999. The FCC has concluded that it will continue to process complaints (submitted via Form 329) regarding rates for services provided prior to March 31, 1999. However, it is questionable what benefit such a review may provide given that cable operators remain free to increase rates for the cable programming services tier for any reason or no reason beginning April 1, 1999.

3. Uniform rates. The order clarifies that cable operators can respond to competition in individual multiple dwelling units (i.e. apartments buildings, etc.) by offering lower prices. The Order concludes that a cable operator can offer a discount directly to residents of a multiple dwelling unit and need not negotiate the rate with the owner of the multiple dwelling unit.

4. Notice of rate changes. The FCC’s Order speaks to the authority of both the FCC and municipalities to determine if a cable operator’s written notice of service and rate changes is “reasonable.”

5. Small systems. The order clarifies the status of small cable operators and the ability of those operators to implement rates changes (on the basic tier and associated equipment) if their status as a small operator changes.

6. Competition. The Order clarifies how disputes over “effective competition” will be addressed. Effective competition exists when either a local exchange carrier (i.e. your local telephone company) or another multichannel video programming distributor provides competitive cable television services in a community. Disputes regarding effective competition will be heard by the FCC under the FCC’s special relief procedures.

The FCC’s Order will no doubt have a profound impact on franchise renewal negotiations between cable operators and LFAs particularly relating to technical standards. While the FCC’s interpretation of “transmission technologies” went beyond the positions taken by most LFAs around the country, the FCC appeared to go out of its way to emphasize the important role LFAs retain in the cable franchising process. In particular, the FCC stated that Section 611 of the Act affirms the ability of LFAs to establish and enforce franchise provisions concerning facilities and equipment related to PEG channels and for educational and governmental use of channel capacity on institutional networks. In addition, the FCC emphasized that Section 621(b) (3) (D) of the Act allows LFAs to require an institutional network. Finally, the FCC emphasized that their regulations enable LFAs to establish and enforce construction schedules and other construction related performance requirements.

The questions which remain unanswered in light of the FCC’s order are exactly what an LFA can include in a franchise with respect to a system upgrade/rebuild. While it appears the LFA can specify a particular channel capacity level based upon “community needs,” i.e. 79 channels or 110 channels, it does not appear that the LFA can specify whether that channel capacity requirement can be met through a true system rebuild or simply by using digital compression technology. Digital compression is far less expensive to the cable operator but uses substantially the same antiquated system already in place.

II. Cable System Transfers Sweep the Nation

1. The largest operators. There may still be some small cable operators providing cable television service in the country, however, it appears clear that there may soon be no medium-sized cable operators left. The cable industry is in the midst of a dramatic consolidation. As of today, TCI/AT&T remains the number one cable operator with approximately 13 million subscribers. Time Warner Cable is number two with 12 million subscribers. The number three operator Comcast and number four operator MediaOne have announced a merger which will create a cable operator with over 11 million cable subscribers. Adelphia will soon be the fourth largest cable operator with just under 5 million subscribers as a result of its purchase of Century Communications. Cox Communications is fifth with four million subscribers and Paul Allen’s Charter Communications is sixth with three and one-half million subscribers as a result of the combination of Marcus and Charter.

The mergers and acquisitions over the last two years have resulted in a highly concentrated subscriber base among the top six cable operators which now control approximately seventy percent (70%) of all cable television subscribers. To put these numbers in context, there are about 100 million households in the United States which have television sets. The cable industry has wires which pass by nearly 96 million of those homes. Of the homes that are passed by cable, nearly seventy percent (70%) subscribe to cable service. This results in annual cable revenue of about $34 billion for the 11,000 cable systems operating in the United States, however, the top six cable operators account for over $24 billion of that total.

It appears likely that the wave of mergers and acquisitions will continue as the large multiple system operators position their holdings into large clusters which can then take advantage of economies of scale and operating efficiencies. It is also likely that the industry will see system trades and swaps where the larger operators attempt to solidify their markets by acquiring all cable operations in a given region.

2. The price of transfers. Just when it appeared the acquisition price for cable systems could go no higher, new deals have been announced at levels not conceived of 12 months ago. In late 1997 and early 1998 acquisition prices ranged from $1,400 to $1,900 per subscriber. By the end of 1998 those prices came close to doubling in the TCI/AT&T deal and it now appears in the recent wave of mergers that the price per subscriber has increased beyond $3,000. Given that a state of the art cable system can be constructed for less than one-third (1/3) that per subscriber rate, there is no question but that these operators will face steep challenges in addressing their debt service obligations particularly if the anticipated new sources of revenue from cable modems and local telephone service do not emerge.

3. What’s the appropriate review. The question is what impact do these transfers have on municipalities and their local franchises. One problem is how to review whether the proposed applicant is legally, technically and “financially” qualified. Since federal law provides no guidance with respect to an operator’s financial qualifications and most accountants are unwilling to offer an opinion about the financial stability of a proposed transferee, the city is faced with the difficult challenge of how best to conduct a prudent review of a transfer. Cable operators often refer to industry standards when making comparisons with respect to financial qualifications although the standards of the industry, with the exception of a few cable operators, offer little comfort. This is particularly true when reviewing common financial characteristics such as debt to equity ratio, operating ratio, operating margin, current ratio and annual cash flow.

4. Impact on renewal. The review of a purposed transferee is made more difficult for many municipalities that are also in the midst of franchise renewal proceedings. Often when a transfer is announced it may be six to eight months before the deal actually closes, placing the system in limbo with respect to material changes in its operation or contractual requirements. Cities which have negotiated in good faith with representatives of the existing cable operator are now introduced to a new cast of negotiators which may or may not embrace the same positions and philosophies of the existing operator. Moreover, decisions often must be approved by both the existing operator and the proposed transferee before any commitment can be arrived at resulting in significant time delays and cumbersome negotiations. Many cities simply delay negotiations until a transfer is concluded resulting in delays in obtaining commitments from the operator on items such as the timing for system upgrades/rebuilds or requirements for local programming. Cities served by operators with social contracts with the FCC also face the question of whether those social contract obligations will be honored by the new transferee. This is particularly true for municipalities served by Time Warner and MediaOne.

5. Watch for proposed resolutions. In many recent transfers a trend has developed where the incumbent cable operator (seller) will suggest a consent resolution to be adopted by the franchising authority to approve the proposed transfer. Typically these resolutions include broad recitals including that the “franchise is in full force and effect without default thereunder” or that the seller has “complied with each and every term and condition as set forth in the franchise and that no breach or default has occurred or is continuing under the franchise.” These consent resolutions will often also include a stipulation that the city give prior approval to the proposed transferee (buyer) to “assign or transfer or otherwise convey one or more liens or security interests in its assets, including its rights, obligations and benefits in and to the franchise.” While this language works to the benefit of the cable operators, it presents significant problems for cities. Resolutions offered by the cable operator should be carefully reviewed to ensure the city is not waiving its rights under the franchise or to approve a subsequent transfer.

6. What to do. When reviewing a proposed transfer the cable operator will typically submit to the city FCC Form 394 which will trigger a one hundred twenty (120) day timeline within which the city must review the proposed transfer. Form 394 will often be accompanied by supporting documentation that is supposed to evidence the buyer’s legal, technical and financial qualifications to own and operate the system. Under federal law the city has thirty (30) days within which to review Form 394 and determine if it has been completed properly. Cities may seek supplemental information regarding the transferee’s qualifications and can review the actual transfer instrument between buyer and seller to determine if there are any particular requirements in that agreement which may have an adverse impact on the municipality and its residents. In the end, the city should pay close attention to the provisions in any resolution acting on the proposed transfer and insure that the proposed transferee does not start with a “clean slate” with respect to compliance under the existing franchise.

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Brian T. Grogan is a shareholder with the Minneapolis law firm of Moss & Barnett. Brian represents entities throughout the country on franchise renewals, transfers of ownership, telecommunications planning, right of way issues, First Amendment issues, litigation and other related communication matters. Brian is a frequent presenter at state and national conferences regarding communications law. Brian is a member of the American Bar Association (Forum Committee on Communications Law), National Association of Telecommunications Officers and Advisors, International Municipal Lawyers Association, and is Chair of the Communications Law Section of the Minnesota State Bar Association.

For a complimentary copy of one of Mr. Grogan’s presentation papers regarding: 1) Competitive Overbuilds; 2) System Transfers, or; 3) Franchise Renewal, please feel free to contact Terri Hammer at 612-347-0349.

The materials in this Cable Communications Update have been complied from a variety of sources and address only a portion of the relevant issues contained within hundreds of pages of regulations and decisions. We have not addressed many important points which may apply to your situation. You should consult with legal counsel before taking any action on matters covered by this Cable Communications Update.

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