Comsat 15 Part 1

Fin 203, Kihlstrom: Notes on Comsat 1

Comsat's Evolution

Incorporated in February 1963 as a private

company representing the US in a

“worldwide satellite company”

Goal specified in ‘62 Communications

Satellite Act: establish a commercial

satellite system as part of global network

Act specified other obligations of Comsat

Improved quality communications

Reduced charges

Comsat's Evolution

Subject to FCC regulation

Received technological assistance from

Received diplomatic assistance from the

state department

Some US presidential oversight

Comsat's Evolution

Issued $200 million in Equity in June 1964

Envisioned high start-up costs and low

initial operating revenues

First commercial satellite launched in April

1965 and established service in June, 2

years ahead of schedule

Early operations in mid and late 60's were

successful

first operating profit in 4th quarter of 1967

Comsat's Evolution (continued)

Early success of synchronous technology

resulted in cost savings (footnote 17, p. 9) no need to exploit alternative technology

resulted in less investment in operations than

initially envisioned

Initially most of Comsat’s assets were

Cash and Marketable securities its income came mostly from the return to

these investments (see slides to follow)

The risks it face were the risks associated

with these kinds of investments (come back to

Even at this time investors knew that Comsat

was committed to using these funds to invest

in operations

Later more of Comsat’s assets were

invested in operations Most of its income then came from its

operations (see the slides below)

The risks it then faced were the risks

associated with its operations (come back to

Comsat's Evolution: Its Assets

1967 1968 1969 1970 1971 1972 1973 1974

PPE 70.6 103.1 138.5 182.5 208.6 210.3 395.6 430.2

mktable secs 155.6 134.1 102.1 100.6 104.7 95 129.9 49.7

secs/Assets 0.69 0.57 0.42 0.36 0.33 0.31 0.25 0.10

Comsat's Evolution: Its Income

Exhibit 3 1968 1972 1973 1974

$million $million $million $million

Operating Income 2.2 43.4 59.5 73.7

% of total income 17.60% 91.18% 84.52% 85.50%

Interest income 8.6 4.5 8.8 7.4

% of total income 68.80% 9.45% 12.50% 8.58%

other income 1.7 -0.3 2.1 5.1

Total pretax income 12.5 47.6 70.4 86.2

Income from leases grew from 20% in 1965

to 90% in 1971

40% revenue growth from 1965 to 74 (p.4)

The fraction of assets held as marketable

securities fell from 96% in 1964 to 8.9% in

The 1975 Hearings Initiated in 1965

In response to a Comsat rate request

Goal: determine how Comsat should be

regulated

Formal hearings began in 1972

To determine whether the rates charged by

Comsat since its formation were too high

Refunds were admitted as possible

Also to determine how future rates should

be set

Comsat Issues

What rate of return For regulatory purposes

What rate base For regulatory purposes

Related to and should be consistent with the

decision on rates

What Rate of Return?

Same for regulatory and investment

purposes return sufficient to attract investors

risk free rate plus risk premium to compensate

investors for risks they take

Hope case decision "..the return to equity

should be commensurate with returns on

investments in other enterprises having

commensurate risks." (p.5)

Carleton (FCC Staff) testimony "Risk premium

(to shareholders) equals the additional return

investors require for bearing the business and

financial risks of the firm's equity.

What Rate of Return? (continued)

What Rate of Return?: (continued)

A rate was needed for the early years 1964-

A perhaps different rate might be needed for

the later years

Why these rates might be different

Different risks faced by Comsat’s

investors in the early and late years

Different interest rate environments Different rate levels

The Proposed Rates

Proposed Rates of Return

Comsat* FCC* 10 Treas

Yield**

1964 4.91%

1967 5.07%

1970 7.35%

1971 6.16%

1964-71 12% 7%

1972 12% 8.33% 6.21%

1973 12% 8.70% 6.85%

1974 12% 9.15% 7.56%

1975 15% 9.42% 7.99%

* Case Exhibit 1

** 2011 Economic Report of the President

What Risk Premium?

What risks do investors face? CAPM: risks added to portfolio by the

investment

systematic risks

not diversifiable risks

What Risk Premium? (continued)

How do we measure the risk premium

required by investors? Possibilities: Use historical returns for comparable firms

Carleton's dividend growth model applied

using AT&T's experience (p. 11)

Brigham's estimates based on returns

earned by industrial firms and utilities (pp 9-

What Risk Premium? (continued)

Use CAPM (Myers pp11-12)

Use beta to measure risks

In the later years

Use the betas Myers calculates for

Comsat

In the early years investors didn’t have

Comsat’s experience to use

What beta do we use when Comsat's

isn't available?

• Will need to get the risk free rate

– See the Economic Report of the President

• Will need to get beta

• Will also need to get the Equity Market Risk

Premium (EMRP)

– For information on possible EMRP see Exhibit 6

of the Midland case

fmofo rErrEr

fm rErEMRP

A risk premium for Comsat after

To get a risk premium for use say in 1975

we use the CAPM and the Comsat betas

computed by Myers for 1964-70.

Compute a beta for Comsat's Operations Use Myer's estimates for Comsat's equity

Because Comsat has no debt Comsat's equity

beta equal's its asset or it’s operations beta

Comsat’s Beta

Comsat’s beta as measured from 1964 to

1967 measures the systematic risks

Comsat’s investors had borne during those

years Use Myer's estimates For Comsat's equity

beta (Exhibit 9)

Because Comsat has no debt Comsat's equity

beta equal's its asset beta

We treat Comsat's assets as a portfolio which

includes

Marketable securities

Assets invested in operations (PP&E)

Comsat's asset beta is the beta of its portfolio of

investments in operations and marketable securities

Compute a beta for Comsat's Operations

Comsat’s Asset Beta

Comsat's Evolution

1967 1968 1969 1970 1971 1972 1973 1974

PPE 70.6 103.1 138.5 182.5 208.6 210.3 395.6 430.2

mktable secs 155.6 134.1 102.1 100.6 104.7 95 129.9 49.7

secs/Assets 0.69 0.57 0.42 0.36 0.33 0.31 0.25 0.10

Comsat's Portfolio of Investments

The portfolio changed over time (Ex 4) Marketable securities were roughly 70% of

Comsat’s assets in 1967

Marketable securities were about 40% of

Comsat's assets in 1969-70

Comsat’s estimated beta for 1964-67 was

Comsat’s estimated beta for 1967-70 was

If Comcast’s operations have a higher beta

than it’s marketable securities this change in

the beta occurs because more of its assets

are invested in operations

How the Risks of Comsat's Asset

Portfolio Evolved

Deriving the beta on Comsat's

operations

Assume that the beta on Comsat's portfolio

of marketable securities is one

securities marketablein

invested assets offraction sf

1967: 30% of assets invested in

operations, beta 1.4

3.17.4.1

oossA ff

1970: 60% of assets invested in

operations, beta 1.8

6.14.8.1

oossA ff

• Will need to get the risk free rate

– See the Economic Report of the President

• Will need to get beta

• Will also need to get the Equity Market Risk

Premium (EMRP)

– For information on possible EMRP see Exhibit 6

of the Midland case

fmofo rErrEr

fm rErEMRP

To start, we’ll use the operations beta we obtained of

We’ll use the 1975 10 year T-bond rate of 7.99% Comsat’s investments are long term investments

This is the longest term government bond outstanding in

For EMRP use 7.5% (Historical average 1926-75)

Using the CAPM to get the required

return on Comsat's operations: 1975

fmofo rErrEr

return on Comsat's operations:1975

.42%9 rateComsat Proposed

15% rateComsat Proposed

%47.25

%48.17%99.7

%5.7*33.2%99.7

fmofo rErrEr

Historical Market Risk Premia

S&P 500 over LT Gov’ts

1926-1929 1930s 1940s 1950s 1960s 1970s 1980s 1990s 1987-1996

17.6 2.3 8.0 1 7.9 4.2 0.3 7.9 7.9 8.3

Ibbotson Associates

We’ll now use Myer’s estimate, 1.8, of Comsat’s beta

for 1970

We’ll use the 1975 10 year T-bond rate of 7.99%

For EMRP use 7.5% (Historical average 1926-

return on Comsat's assets: 1975

fmAfA rErrEr

return on Comsat's assets:1975

%42.9 rateComsat Proposed

%15 rateComsat Proposed

%49.21

%5.13%99.7

%5.7*8.1%99.7

fmAfA rErrEr

We’ll again use the operations beta we obtained of

fmofo rErrEr

%83.24

%48.17%35.7

%5.7*33.2%35.7

fmofo rErrEr

for 1970

fmAfA rErrEr

return on Comsat's assets:1970

%85.20

%5.13%35.7

%5.7*8.1%35.7

fmAfA rErrEr

We’ll first use the operations beta we obtained of

fmofo rErrEr

%55.22

%48.17%07.5

%5.7*33.2%07.5

fmofo rErrEr

for 1967

fmAfA rErrEr

%57.15

%5.10%07.5

%5.7*4.1%07.5

fmAfA rErrEr

For the purpose of getting a rate for the

early years say, for example 1965, we use

firms that face comparable risks How do Comsat's risks compare to those faced

by other firms?

How does leverage affect the comparison?

Using The Experience of Other Firms

To Estimate Comsat’s Risk and Risk

Premia

What Firms Face Comparable Risks?

ATT Equity (Carleton and Myers)

The 602 Industrial firms and 56 utilities on

S&P's compustat files (Brigham)

The utilities involved in the 4 cases cited in

the 1964 Anderson study (Brigham)

What Firms Face Comparable Risks?

(continued)

The telephone and telegraph companies

involved in the 94 cases cited in the 1970

Anderson study (Brigham)

Major firms in other industries (Myers)

Electric utilities and natural gas pipelines

(Myers)

Major airlines (Myers)

What Risks are Faced by Comsat?

Technological risk (p. 6)

Business risk (p. 6) Startup risks

Government mandate effect?

Demand risk (p.6)

Competitive risks (p. 7) customers are competitors

Regulatory risk (p. 7)

What Risks are Faced by Comsat?

(continued)

Political or international risks (p. 7)

Financial risk (pp. 6-7)

Technological risk Probably not systematic

Different from those of ATT and other utilities

Business risk Startup risks

diversifiable?

effect of government mandate?

Some similar to those of ATT

Types of Risks Faced by Comsat

Demand risk Systematic

Similar to AT&T's

Maybe similar to other utilities

(continued)

Competitive risks Systematic? In bad times competition might

become more severe

Effect of having competitors as customers?

Monopoly in market for color TV transmission,

but not phone service (p. 4)

Superior service advantage (p.4)

(continued)

Regulatory risk probably not systematic

Similar to AT&T's and other utilities

Political or international risks Systematic?

Similar to AT&T's

(continued)

Financial Risks Comsat has no debt and faces no financial

Other firms in the suggested comparison

groups are levered

must be accounted for when comparing

Getting a risk premium for Comsat

Using AT&T’s Experience

AT&T risks are reasonably comparable to

Comsat

We’ll use AT&T beta to get a risk premium

for Comsat

We’ll have to adjust for the fact that AT&T is

levered and Comsat is not

Comsat 15 Part 1

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