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
Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution
Subject to FCC regulation
Received technological assistance from
NASA
Received diplomatic assistance from the
state department
Some US presidential oversight

Fin 203, Kihlstrom:

Notes on Comsat

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

Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution (continued)

Early operations in mid and late 60's were
successful
first operating profit in 4th quarter of 1967
(p.4)

Fin 203, Kihlstrom:

Notes on Comsat

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

Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution (continued)

Initially most of Comsats 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
this)
Even at this time investors knew that Comsat
was committed to using these funds to invest
in operations

Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution (continued)

Later more of Comsats 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
this)

Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution: Its Assets

EX 4
PPE
mktable secs
secs/Assets

1967
70.6
155.6
0.69

1968
103.1
134.1
0.57

1969
138.5
102.1
0.42

Fin 203, Kihlstrom:

1970
182.5
100.6
0.36

1971
208.6
104.7
0.33

Notes on Comsat

1972
210.3
95
0.31

1973
395.6
129.9
0.25

1974
430.2
49.7
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

Fin 203, Kihlstrom:

Notes on Comsat

Comsat's Evolution (continued)

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
1974

Fin 203, Kihlstrom:

Notes on Comsat

10

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
Fin 203, Kihlstrom: Notes on Comsat
11

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

Fin 203, Kihlstrom:

Notes on Comsat

12

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

Fin 203, Kihlstrom:

Notes on Comsat

13

What Rate of Return? (continued)

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.

Fin 203, Kihlstrom:

Notes on Comsat

14

What Rate of Return?: (continued)

A rate was needed for the early years 19641968
A perhaps different rate might be needed for
the later years
Why these rates might be different
Different risks faced by Comsats
investors in the early and late years
Different interest rate environments

Different rate levels

Fin 203, Kihlstrom:

Notes on Comsat

15

The Proposed Rates

Proposed Rates of Return
Comsat* FCC*
1964
1967
1970
1971
1964-71
1972
1973
1974
1975

12%
12%
12%
12%
15%

7%
8.33%
8.70%
9.15%
9.42%

10 Treas
Yield**
4.91%
5.07%
7.35%
6.16%
6.21%
6.85%
7.56%
7.99%

* Case Exhibit 1
** 2011 Economic Report of the President
Fin 203, Kihlstrom:

Notes on Comsat

16

What Risk Premium?

What risks do investors face?

CAPM: risks added to portfolio by the

investment
systematic risks
not diversifiable risks

Fin 203, Kihlstrom:

Notes on Comsat

17

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 910)
Fin 203, Kihlstrom:

Notes on Comsat

18

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 didnt have
Comsats experience to use
What beta do we use when Comsat's
isn't available?
Fin 203, Kihlstrom:

Notes on Comsat

19

CAPM
Ero rf o Erm rf
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

EMRP Erm rf
Fin 203, Kihlstrom:

Notes on Comsat

20

A risk premium for Comsat after

1970
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

beta
Because Comsat has no debt Comsat's equity
beta equal's its asset or its operations beta

Fin 203, Kihlstrom:

Notes on Comsat

21

Comsats Beta

Comsats beta as measured from 1964 to

1967 measures the systematic risks
Comsats 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

Fin 203, Kihlstrom:

Notes on Comsat

22

Comsats 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

Fin 203, Kihlstrom:

Notes on Comsat

23

Comsat's Evolution

EX 4
PPE
mktable secs
secs/Assets

1967
70.6
155.6
0.69

1968
103.1
134.1
0.57

1969
138.5
102.1
0.42

Fin 203, Kihlstrom:

1970
182.5
100.6
0.36

1971
208.6
104.7
0.33

Notes on Comsat

1972
210.3
95
0.31

1973
395.6
129.9
0.25

1974
430.2
49.7
0.10

24

Comsat's Portfolio of Investments

The portfolio changed over time (Ex 4)

Marketable securities were roughly 70% of
Comsats assets in 1967
Marketable securities were about 40% of
Comsat's assets in 1969-70

Fin 203, Kihlstrom:

Notes on Comsat

25

How the Risks of Comsat's Asset

Portfolio Evolved
Comsats estimated beta for 1964-67 was
1.4
Comsats estimated beta for 1967-70 was
1.8
If Comcasts operations have a higher beta
than its marketable securities this change in
the beta occurs because more of its assets
are invested in operations

Fin 203, Kihlstrom:

Notes on Comsat

26

Deriving the beta on Comsat's

operations

Assume that the beta on Comsat's portfolio

of marketable securities is one

f s fraction of assets invested

in marketable securities
Fin 203, Kihlstrom:

Notes on Comsat

27

1967: 30% of assets invested in

operations, beta 1.4

A f s s fo o
1.4 .7 1 .3 o
o 2.33
Fin 203, Kihlstrom:

Notes on Comsat

28

1970: 60% of assets invested in

operations, beta 1.8

A f s s fo o
1.8 .4 1 .6 o
o 2.33
Fin 203, Kihlstrom:

Notes on Comsat

29

CAPM
Ero rf o Erm rf
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

EMRP Erm rf
Fin 203, Kihlstrom:

Notes on Comsat

30

Using the CAPM to get the required

return on Comsat's operations: 1975

Ero rf o Erm rf

To start, well use the operations beta we obtained of

2.33
Well use the 1975 10 year T-bond rate of 7.99%

Comsats investments are long term investments

This is the longest term government bond outstanding in
1975
For EMRP use 7.5% (Historical average 1926-75)

Fin 203, Kihlstrom:

Notes on Comsat

31

Using the CAPM to get the required

return on Comsat's operations:1975
Ero rf o Erm rf
7.99% 2.33 * 7.5%
7.99% 17.48%
25.47%
Proposed Comsat rate 15%
Proposed Comsat rate 9.42%
Fin 203, Kihlstrom:

Notes on Comsat

32

Historical Market Risk Premia

S&P 500 over LT Govts

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

Fin 203, Kihlstrom:

Notes on Comsat

33

Using the CAPM to get the required

return on Comsat's assets: 1975

ErA rf A Erm rf

Well now use Myers estimate, 1.8, of Comsats beta

for 1970
Well use the 1975 10 year T-bond rate of 7.99%
For EMRP use 7.5% (Historical average 192675)

Fin 203, Kihlstrom:

Notes on Comsat

34

Using the CAPM to get the required

return on Comsat's assets:1975
ErA rf A Erm rf
7.99% 1.8 * 7.5%
7.99% 13.5%
21.49%
Proposed Comsat rate 15%
Proposed Comsat rate 9.42%
Fin 203, Kihlstrom:

Notes on Comsat

35

Using the CAPM to get the required

return on Comsat's operations: 1970

Ero rf o Erm rf

Well again use the operations beta we obtained of

2.33
Well use the 1970 10 year T-bond rate of 7.35%
For EMRP use 7.5% (Historical average 192675)

Fin 203, Kihlstrom:

Notes on Comsat

36

Using the CAPM to get the required

return on Comsat's operations:1970
Ero rf o Erm rf
7.35% 2.33 * 7.5%
7.35% 17.48%
24.83%
Proposed Comsat rate 12%
Proposed Comsat rate 7%
Fin 203, Kihlstrom:

Notes on Comsat

37

Using the CAPM to get the required

return on Comsat's assets: 1970

ErA rf A Erm rf

Well now use Myers estimate, 1.8, of Comsats beta

for 1970
Well use the 1970 10 year T-bond rate of 7.35%
For EMRP use 7.5% (Historical average 192675)

Fin 203, Kihlstrom:

Notes on Comsat

38

Using the CAPM to get the required

return on Comsat's assets:1970
ErA rf A Erm rf
7.35% 1.8 * 7.5%
7.35% 13.5%
20.85%
Proposed Comsat rate 12%
Proposed Comsat rate 7%
Fin 203, Kihlstrom:

Notes on Comsat

39

Using the CAPM to get the required

return on Comsat's operations: 1967

Ero rf o Erm rf

Well first use the operations beta we obtained of

2.33
Well use the 1967 10 year T-bond rate of 5.07%
For EMRP use 7.5% (Historical average 192675)

Fin 203, Kihlstrom:

Notes on Comsat

40

Using the CAPM to get the required

return on Comsat's operations:1967
Ero rf o Erm rf
5.07% 2.33 * 7.5%
5.07% 17.48%
22.55%
Proposed Comsat rate 12%
Proposed Comsat rate 7%
Fin 203, Kihlstrom:

Notes on Comsat

41

Using the CAPM to get the required

return on Comsat's assets: 1967

ErA rf A Erm rf

Well now use Myers estimate, 1.4, of Comsats beta

for 1967
Well use the 1967 10 year T-bond rate of 5.07%
For EMRP use 7.5% (Historical average 192675)

Fin 203, Kihlstrom:

Notes on Comsat

42

Using the CAPM to get the required

return on Comsat's operations:1967
ErA rf A Erm rf

5.07% 1.4 * 7.5%

5.07% 10.5%
15.57%
Proposed Comsat rate 12%
Proposed Comsat rate 7%
Fin 203, Kihlstrom:

Notes on Comsat

43

Using The Experience of Other Firms

To Estimate Comsats Risk and Risk
Premia

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?

Fin 203, Kihlstrom:

Notes on Comsat

44

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)

Fin 203, Kihlstrom:

Notes on Comsat

45

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)

Fin 203, Kihlstrom:

Notes on Comsat

46

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)

Fin 203, Kihlstrom:

Notes on Comsat

47

What Risks are Faced by Comsat?

(continued)
Political or international risks (p. 7)
Financial risk (pp. 6-7)

Fin 203, Kihlstrom:

Notes on Comsat

48

Types of Risks Faced by Comsat

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

Fin 203, Kihlstrom:

Notes on Comsat

49

Types of Risks Faced by Comsat

(continued)

Demand risk
Systematic
Similar to AT&T's
Maybe similar to other utilities

Fin 203, Kihlstrom:

Notes on Comsat

50

Types of Risks Faced by Comsat

(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)

Fin 203, Kihlstrom:

Notes on Comsat

51

Types of Risks Faced by Comsat

(continued)

Regulatory risk
probably not systematic
Similar to AT&T's and other utilities

Political or international risks

Systematic?
Similar to AT&T's

Fin 203, Kihlstrom:

Notes on Comsat

52

Types of Risks Faced by Comsat

(continued)

Financial Risks
Comsat has no debt and faces no financial
risks
Other firms in the suggested comparison
groups are levered
must be accounted for when comparing

Fin 203, Kihlstrom:

Notes on Comsat

53

Getting a risk premium for Comsat

Using AT&Ts Experience
AT&T risks are reasonably comparable to
Comsat
Well use AT&T beta to get a risk premium
for Comsat
Well have to adjust for the fact that AT&T is
levered and Comsat is not

Fin 203, Kihlstrom:

Notes on Comsat

54