Bell atlantic maryland, inc. Statement of dr. James h. Vander weide


Q. Are investors primarily concerned with current or future expected competition when they assess the investment risk of BA-MD?



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Q. Are investors primarily concerned with current or future expected competition when they assess the investment risk of BA-MD?

A. Investors are primarily interested in future expected competition when they assess the investment risk of BA-MD because expected future competition is a primary determinant of volatility in the expected returns on their investment.


Q. Is competition for the provision of local exchange services likely to be even greater in the future than it is at present?

A. Yes. Local exchange service competition is initially focused primarily on large business customers in urban markets. These customers are particularly attractive targets for competitors because they account for a large percentage of LEC revenues and profits and a small percentage of LEC costs. With interexchange companies like MCI offering service a much larger segment of the local exchange market is now being targeted. In addition, as the cost of wireless technology declines and the cable TV companies begin providing local exchange service, competition will exist in all segments of the local exchange market. The risk of local exchange service is even greater with full facilities-based competitors such as MFS and TCG operating in the local exchange market.



Q. Is BA-MD able to compete on equal terms with competitors in the local exchange?

A. No. BA-MD has a number of disadvantages in its efforts to compete in a fully competitive local exchange market. As the incumbent LEC, BA-MD has the obligation to provide telecommunications services to all customers, even those whose revenues fail to cover the cost of providing service. Telecommunications prices have historically been set to provide subsidies to high-cost customers in low density geographic areas. Such subsidies are inconsistent with the competitive framework of the Act. Although both the FCC and this Commission are in the process of considering alternative mechanisms for subsidizing universal service, there is a fundamental difficulty of the task. In truly competitive markets, there are no sources to subsidize prices that are lower than cost. Investors are concerned that incumbent LECs may have to continue to provide service in high-cost areas, while its competitors are free to serve only the most profitable markets.


In addition to its unique obligation to provide universal service, BA-MD has limited ability to change prices and service offerings as rapidly as competitors. BA-MD is required to file tariffs for many of its services that contain a complete description of the services along with a price schedule. Unlike its competitors, BA-MD has a much more arduous task in obtaining Commission approval either to change tariffs on rate-regulated services or to offer new competitive services.

Finally, BA-MD's competitors are able to offer a full menu of telecommunications services, including inter- and intraLATA toll, local exchange, wireless, and video.


Q. What is the impact of rapidly changing technology on telecommunications competition?

A. Rapid advances in telecommunications technology are a primary driver behind the increasing level of competition faced by the local exchange companies. Advances in semiconductor technology have both increased the capability and lowered the cost of telecommunications equipment, so other firms can compete more easily with local exchange companies. Breakthroughs are also occurring in fiber optic technology. The capacity of fiber optic networks is increasing dramatically, thus allowing fiber-based competitors to offer more services. As SONET (Synchronous Optical Network) standards are implemented, the price of installing a fiber optic network will fall, further increasing competitive pressures. In sum, technological developments have substantially eroded the competitive advantage once enjoyed by local exchange companies.


Q. How does rapidly changing technology affect the risk of investing in local exchange companies such as BA-MD?

A. Rapidly changing technology increases the LECs' risk in two ways. First, it threatens their ability to recover the cost of their embedded equipment. Second, it reduces the cost of entry for competitors. Rapid advances in fiber optics and multi-media transmission technologies, for example, have shortened the economic lives of the LECs' current investments in copper-based facilities and allowed cable TV and interexchange companies to compete efficiently to offer local exchange service. Advances in wireless, satellite, and computer technologies further threaten the LECs' heavy investment in landline telecommunications service.


Q. How does regulation affect the risk of BA-MD?

A. Since regulation impairs BA-MD's ability to compete on the same terms as its competitors, regulation increases the risk of investing in BA-MD.


Q. What risks are involved in the leasing of unbundled network elements?

A. To lease unbundled network elements, one must first invest in the facilities and software required to provide unbundled network elements. Since the network elements to be leased are essentially all the elements of the local exchange, the risk of leasing unbundled network elements is identical to the risk of investing in the local exchange network of BA-MD. The risks of investing in the local exchange include high operating leverage, competition, rapidly changing technology, and regulation. As I have previously noted, local exchange networks require a large commitment to fixed costs in relation to variable costs; thus, the investment involves high operating leverage. Furthermore, recent advances in telecommunications technology and changes in regulation have greatly increased competition in the local exchange. In fact, BA-MD's long-run incremental cost study is based on the assumption that the local exchange is already fully competitive. Since the investment portion of BA-MD's long-run incremental cost study is based on the assumption of a fully competitive local exchange network, the cost of capital must also be based on this assumption.


Q. In summary, how would you characterize the risk of investing in BA-MD in a competitive environment?

                  1. Prior to the advent of competition, BA-MD was considered to be a relatively low risk company operating in a monopoly environment. By opening BA-MD's markets to the full effects of competition, the Act has dramatically increased the risk of investing in local exchange companies such as BA-MD. BA-MD now faces significant competition from well-financed competitors such as AT&T, MCI, Sprint, and the major cable TV companies, who have greater name recognition than BA-MD and offer a wider variety of services. (BA-MD is not permitted to offer interLATA toll service.) In addition, BA-MD's competitors have the flexibility to operate only in the most profitable markets and to price based on market demand, while BA-MD is forced to provide universal service in both high-cost and low-cost areas. In today's environment, BA-MD's investment risk is at least equal to that of the average industrial company.

III. BA-MD's Cost of Capital Estimate

Q. How did you calculate the cost of capital that you recommend for use in BA-MD's long-run incremental cost studies?

A. I calculated a weighted average of the cost of debt and equity, using a cost of debt equal to 7.6 percent, a cost of equity equal to 14.9 percent, and a capital structure containing 23.8 percent debt and 76.2 percent equity



Q. How did you determine your 7.6 percent cost of debt?

A. I used the average rate of newly-issued debt for Aa-rated industrial firms for August 1996, as reported in the September 1996 Moody's Bond Record. Because BA-MD's long-run incremental cost study is forward looking, it requires the use of a forward-looking, rather than an embedded, cost of debt.


Q. How did you calculate your estimated 14.9 percent cost of equity?

A. Since BA-MD's long-run incremental cost study is based on the forward-looking economic expenses and capital costs of companies operating in a competitive environment, the cost of equity must also be reflective of companies operating in a competitive environment. The forward-looking cost of equity for companies operating in a competitive environment can be estimated by applying the Discounted Cash Flow (DCF) Model to the S&P Industrials, a composite of large competitive companies in the U.S. economy.6 As shown on Vander Weide Schedule 1, the market-weighted average DCF cost of equity for the S&P Industrials is 14.9 percent.


Q. How did you arrive at a capital structure comprised of 23.8 percent debt and 76.2 percent equity?

A. The average market-based percentages of debt and equity in the capital structures of the S&P Industrials is a good proxy for the capital structures of competitive firms on a forward-looking economic basis. It would be inconsistent to use forward-looking competitive assumptions in the investment and expense components of a forward-looking study, but historical accounting-based capital structures in the cost of capital component. As shown in Vander Weide Schedule 2, the average market-based capital structure of the S&P Industrials contains 23.8 percent debt and 76.2 percent equity.



Q. How does the average market-based capital structure of the S&P Industrials compare to the average market-based capital structure of the Regional Bell Holding Companies (RHCs)?

A. As shown in Schedule 3, the average market-based capital structure of the RHCs contains 22.4 percent debt and 77.6 percent equity. Thus, the average market-based capital structure of the RHCs is approximately equal to the average market-based capital structure of the S&P Industrials.


Q. What is your conclusion as to the appropriate cost of capital for use in BA-MD's long-run incremental cost studies?

A. I conclude that the appropriate overall cost of capital for use in BA-MD's long-run incremental cost studies is 13.2 percent. This estimate is based on a 7.6 percent cost of debt, a 14.9 percent cost of equity, and a capital structure containing 23.8 percent debt and 76.2 percent equity.


Q. Does this conclude your testimony?

A. Yes, it does.



ABBOTT LABORATORIES

ABT

41.63

787.31

32,771.65

1,485.06

95.66%

4.34%

AIR PRODUCTS & CHEMICALS INC

APD

52.75

111.68

5,891.28

1,681.00

77.80%

22.20%

ALBERTO-CULVER CO -CL B

ACV

34.38

27.73

953.18

184.48

83.78%

16.22%

ALBERTSONS INC

ABS

32.88

251.92

8,281.84

817.81

91.01%

8.99%

ALCAN ALUMINIUM LTD

AL

31.13

225.91

7,031.54

1,951.00

78.28%

21.72%

ALCO STANDARD CORP

ASN

45.63

112.06

5,112.92

1,450.05

77.91%

22.09%

ALLERGAN INC

AGN

32.50

64.53

2,097.32

325.20

86.58%

13.42%

ALLIEDSIGNAL INC

ALD

47.50

282.77

13,431.57

2,010.00

86.98%

13.02%

ALLTEL CORP

AT

29.50

189.27

5,583.41

1,798.50

75.64%

24.36%

ALUMINUM CO OF AMERICA

AA

52.88

176.31

9,322.60

1,908.70

83.01%

16.99%

AMERADA HESS CORP

AHC

53.00

93.01

4,929.58

2,797.92

63.79%

36.21%

AMERICAN BRANDS INC/DE

AMB

44.50

178.13

7,926.79

1,865.40

80.95%

19.05%

AMERICAN GREETINGS -CL A

AGREA

27.63

74.71

2,063.81

350.25

85.49%

14.51%

AMERICAN HOME PRODUCTS CORP

AHP

48.50

627.40

30,428.90

7,880.97

79.43%

20.57%

AMERICAN STORES CO

ASC

26.75

146.45

3,917.48

2,240.17

63.62%

36.38%

AMERITECH CORP

AIT

58.88

553.84

32,607.27

6,651.10

83.06%

16.94%

AMOCO CORP

AN

71.50

496.40

35,492.82

5,038.00

87.57%

12.43%

AMP INC

AMP

38.25

217.69

8,326.76

530.65

94.01%

5.99%

ANHEUSER-BUSCH COS INC

BUD

33.44

507.95

16,984.39

3,270.10

83.85%

16.15%

ARCHER-DANIELS-MIDLAND CO

ADM

17.14

559.15

9,585.50

2,085.71

82.13%

17.87%

ARMSTRONG WORLD INDS INC

ACK

62.00

36.87

2,285.63

485.10

82.49%

17.51%

ASARCO INC

AR

32.00

42.57

1,362.27

1,121.87

54.84%

45.16%

ASHLAND INC

ASH

35.13

64.00

2,248.00

2,100.00

51.70%

48.30%

AT&T CORP

T

64.75

1,596.01

103,341.32

28,224.00

78.55%

21.45%

ATLANTIC RICHFIELD CO

ARC

110.75

160.83

17,812.03

8,066.00

68.83%

31.17%

AUTODESK INC

ADSK

34.25

46.35

1,587.52

0.00

100.00%

0.00%

AUTOMATIC DATA PROCESSING

AUD

37.13

288.17

10,698.24

399.73

96.40%

3.60%

AVERY DENNISON CORP

AVY

50.13

53.06

2,659.58

449.40

85.55%

14.45%

AVON PRODUCTS

AVP

37.69

135.23

5,096.56

161.50

96.93%

3.07%

BAKER-HUGHES INC

BHI

24.38

142.24

3,467.03

801.25

81.23%

18.77%

BALL CORP

BLL

27.75

30.11

835.69

475.40

63.74%

36.26%

BARD (C.R.) INC

BCR

32.25

57.10

1,841.51

265.30

87.41%

12.59%

BARRICK GOLD CORPORATION

ABX

26.38

357.20

9,421.15

133.40

98.60%

1.40%

BATTLE MTN GOLD CO

BMG

8.50

81.13

689.64

185.17

78.83%

21.17%

BAUSCH & LOMB INC

BOL

39.63

56.94

2,256.29

574.47

79.71%

20.29%

BAXTER INTERNATIONAL INC

BAX

41.88

271.90

11,385.81

2,591.00

81.46%

18.54%

BECTON DICKINSON & CO

BDX

37.50

130.15

4,880.62

763.39

86.47%

13.53%

BELL ATLANTIC CORP

BEL

66.88

437.70

29,271.32

8,337.40

77.83%

22.17%

BELLSOUTH CORP

BLS

43.50

994.00

43,239.00

10,875.00

79.90%

20.10%

BEMIS CO

BMS

25.63

52.57

1,347.03

170.92

88.74%

11.26%

BLACK & DECKER CORP

BDK

35.25

86.45

3,047.29

2,351.70

56.44%

43.56%

BLOCK H & R INC

HRB

40.50

103.42

4,188.39

72.65

98.29%

1.71%

BOEING CO

BA

78.38

343.95

26,957.32

2,615.00

91.16%

8.84%

BOISE CASCADE CORP

BCC

34.50

47.76

1,647.72

1,616.55

50.48%

49.52%

BRIGGS & STRATTON

BGG

43.38

28.93

1,254.71

94.92

92.97%

7.03%

BRISTOL MYERS SQUIBB

BMY

85.88

505.23

43,386.88

1,210.00

97.29%

2.71%

BROWN-FORMAN -CL B

BF.B

36.50

69.00

2,518.35

267.00

90.41%

9.59%

BROWNING-FERRIS INDS

BFI

29.38

212.44

6,240.40

2,473.21

71.62%

28.38%

BRUNSWICK CORP

BC

24.00

97.90

2,349.72

318.90

88.05%

11.95%

BURLINGTON RESOURCES INC

BR

39.25

126.57

4,968.03

1,350.32

78.63%

21.37%

CAMPBELL SOUP CO

CPB

60.00

249.00

14,940.00

1,722.00

89.67%

10.33%

CASE CORP

CSE

45.75

71.44

3,268.20

1,941.00

62.74%

37.26%

CATERPILLAR INC

CAT

58.75

194.01

11,398.38

6,400.00

64.04%

35.96%

CENTEX CORP

CTX

34.75

28.43

987.80

983.27

50.12%

49.88%

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