CR 2000-54 Approve Resolution 2000-12 Approving Transfer of Control of the Cable Television System
March 27,2000
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Council Report 2000-54
Approve Resolution 2000-12 Approving
Transfer of Control of the Cable Television System
Proposed Action
Staff recommends adoption of the following motion: Approve Resolution 2000-12 approving the
transfer of control ofKBL Cable Systems of the Southwest to AOL Time Warner.
This result ofthis motion will be to consent to transfer of control of the cable system currently serving
Hopkins to the company formed by the merger of Time Warner and AOL.
Overview
In January, America Online, Inc. (AOL) and Time Warner, Inc. (TW) announced a merger in which
both TW and AOL will become wholly-owned subsidiaries of a new holding company call AOL Time
Warner, Inc. Because Hopkins is served by KBL Cable Systems of the Southwest, Inc., a subsidiary of
TW, the proposed merger and resulting transfer of control requires approval under our franchise and
Minnesota Law.
The City Council ordered a public hearing at the March 6 Council meeting.
. Primary Issues to Consider
. Is there any reason to withhold approval of the transfer?
Supporting Information
· Report prepared by Brian Grogan re: Time Warner Transfer of Control
. Resolution 2000-12, Approving the Transfer of Control ofKBL Cable Systems
Ja es Genellie
ssistant City Manager
Financial Impact: $ None Budgeted: Y IN
Related Documents (CIP, ERP, etc.):
Notes:
Source:
Council Report 2000-54
Page 2
. Is there any reason to withhold approval of the transfer?
As indicated in the attached report from Brian Grogan (Transfer Report), the new entity, AOL Time
Warner, meets the legal, technical, and financial standards necessary to operate the cable system.
Legal standard: The Franchisee is registered and authorized to conduct business in the State of
Minnesota. (Transfer Report, Page 9)
Technical standard: The same staffthat is currently operating the system will continue to operate the
system. (Transfer Report, Page 10)
Financial standard: It does not appear that Time Warner assets will have to be used to fund AOL
operations. Therefore, the new entity should be capable of continuing to fund the cable system
operations. (Transfer Report, Page 12)
One other issue that has arisen during the discussions regarding mergers and transfers is open access.
Open access concerns allowing cable subscribers to have a choice ofInternet service providers (ISP)
when the sign up for Internet access through the cable system. As indicated in Mr. Grogan's report.
(page 15), AOL Time Warner has gone on record promising to provide open access.
However, there are outstanding questions concerning how open this access would be. Mr. Grogan is
recommending that the City reserve the right to impose open access conditions at a later date.
Language, to that effect, is included in Resolution 2000-12.
Alternatives
.
1. Approve Resolution 2000-12. This will approve the Transfer of Control.
2. Do not approve Resolution 2000-12 because there are some additional issues that need to be
resolved.
3. Take no action, which would also result in consenting to the change of control
Staff recommends Alternative #1.
.
.
.
.
Report to the City of Hopkins, Minnesota
Regarding the Proposed Transfer of Control
of the City's Cable Television Franchisee
to AOL Time Warner, Inc.
March 22, 2000
Prepared by:
Brian T. Grogan, Esq.
Timothy L. Gustin, Esq.
Michael R. Nixt, Esq.
MOSS & BARNETT
A Professional Association
4800 Norwest Center
90 South Seventh Street
Minneapolis, MN 55402-4129
(612) 347-0340 phone
(612) 339.6686 facsimile
GroganB@moss-barnett.com
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Report to the City of Hopkins, Minnesota
Regarding the Proposed Transfer of Control
of the City's Cable Television Franchisee
to AOL Time Warner, Inc.
March 22, 2000
Table of Contents
I ntroducti on.................................................................................................................... 1
Applicable Law........,...... .......... ............................. .............. ................. .................. ........ 2
Description of Transfer of Control............................................................................... 7
Chart Demonstrating Proposed Merger.................... .................... ........................ ....... 8
Legal Qualifications .... ..... .................................... .................. ..................................,....9
Technical Qualifications ................... ..... ......... ..................... ........................ ............... 10
Financial Qualifications....... ....... ..................... ................................... ......... .......... ..... 12
Open Access Considerations.................... ............ .................... ...... ..... ...................... 15
Recommendations..................................... ............................ .......... ....... .................... 18
Exhibit
A. Resolution - Approving Transfer
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Introduction
The City of Hopkins, Minnesota ("City") has before it a request from its cable
television franchisee, KBL Cablesystems of the Southwest, Inc. ("Franchisee"), to
approve a proposed transfer of control of the Franchisee resulting from the merger of to-
be-formed subsidiaries of the existing parent corporation of Franchisee, Time Warner
Inc. ("TWI"), and America Online, Inc. ("AOL") into a new company and ultimate parent
of Franchisee called AOL Time Warner, Inc. ("AOL Time Warner").
The merger does not involve the sale or transfer of the cable system operated by
Franchisee or of the Franchisee itself. Therefore, the request before the City does not
involve a transfer or assignment of the franchise operated by Franchisee ("Franchise"),
but instead a transfer of control of the Franchisee. Pursuant to Minnesota Statutes
Section 238.083 and the Franchise at Section 25, the proposed transfer of control is
prohibited without the written consent of the City.
In light of the request by the Franchisee and the procedural requirements of
Minn. Stat. Section 238.083 and Section 25 of the Franchise, Moss & Barnett, A
Professional Association, has been retained by the City and was asked to provide this
Report. This Report will provide the City with an analysis of the transfer of control and
will provide recommendations to the City.
In preparing this Report, Moss & Barnett has relied upon information submitted
by TWI and AOL including:
1. FCC Form 394 - Application for Franchise Authority Consent to
Assignment or Transfer of Control of Cable Television Franchise dated February ii,
2000, received by the City on or about February 18, 2000, including all attachments
thereto.
2. The financial information referenced in the Financial Qualifications section
of this Report.
3. Agreement and Plan of Merger between AOL and TWI dated as of
January 10, 2000, with certain exhibits and schedules redacted for reasons of
confidentiality.
The Report has been prepared with Brian 1. Grogan serving as project manager,
Timothy L. Gustin assisting with due diligence and document preparation, and Michael
R. Nixt, who is a former CPA with Coopers & Lybrand, performing the financial review of
AOL, TWI, and AOL Time Warner.
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Applicable Law
The following provisions of federal law, state law, and the Franchise govern the
actions of the City in acting on the request af 1W1 and AOL for approval of the transfer
of control.
FEDERAL LAW
The Cable Communications Policy Act of 1984, as amended by the Cable
Consumer Protection and Competition Act of 1992 and the Telecommunications Act of
1996 ("Cable Act"), provides at Section 617 (47 U.S.C. S 537):
Sales of Cable Systems
A franchising authority shall, if the franchise requires franchising authority
approval of a sale or transfer, have 120 days to act upon any request far approval of
such sale or transfer that contains or is accompanied by such information as is
required in accordance with Commission regulations and by the franchising authority.
If the franchising authority fails to render a final decision on the request within 120
days, such request shall be deemed granted unless the requesting party and the
franchising authority agree to an extension of time.
The Cable Act also provides at Section 613d (47 U.S.C. S 533d) as follows:
(d) ReQulation of ownership bv States or franchisinQauthorities
Any State or franchising authority may not prohibit the ownership or control of a
cable system by any person because of such person's ownership or control of any
other media of mass communications or other media interests. Nothing in this section
shall be construed to prevent any State or franchising authority from prohibiting the
ownership or control of a cable system in a jurisdiction by any person (1) because of
such person's ownership or control of any other cable system in such jurisdiction, or
(2) in circumstances in which the State or franchising authority determines that the
acquisition of such a cable system may eliminate or reduce competition in the delivery
of cable seNice in such jurisdiction.
Further, the Federal Communications Commission ("FCC") has promulgated
regulations governing the sale of cable systems. Section 76.502 of the FCC's
regulations (47 C.F.R. S 76.502) provides:
.
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47 C.F.R. ~ 76.502 Time Limits Applicable to Franchise Authoritv
Consideration of Transfer Applications
(a) A franchise authority shall have 120 days from the date of submission of
a completed FCC Form 394, together with all exhibits, and any additional
information required by the terms of the franchise agreement or
applicable state or local law to act upon an application to sell, assign, or
otherwise transfer controlling ownership of a cable system.
(b) A franchise authority that questions the accuracy of the information
provided under paragraph (a) must notify the cable operator within 30
days of the filing of such information, or such information shall be
deemed accepted, unless the cable operator has failed to provide any
additional information reasonably requested by the franchise authority
within 10 days of such request.
(c) If the franchise authority fails to act upon such transfer request within
120 days, such request shall be deemed granted unless the franchise
authority and the requesting party otherwise agree to an extension of
time.
tt. STATE LAW
Minnesota Statutes Section 238.083 Sale or Transfer of Franchise
provides:
Subd. 1. Fundamental corporate change defined. For purposes of this
section, "fundamental corporate change" means the sale or transfer of a majority of a
corporation's assets; merger, including a parent and its subsidiary corporation;
consolidation or creation of a subsidiary corporation.
Subd. 2. Written approval of franchising authority. A sale or transfer of a
franchise, including a sale or transfer by means of a fundamental corporate change,
requires the written approval of the franchising authority. The parties to the sale or
transfer of a franchise shall make a written request to the franchising authority for its
approval of the sale or transfer. The franchising authority shall reply, in writing, within
30 days of the request and shall indicate its approval of the request or its
determination that a public hearing is necessary if it determines that a sale or transfer
of a franchise may adversely affect the company's subscribers. The franchising
authority shall conduct a public hearing on the request within 30 days of that
determination.
.
Subd. 3. Notice of hearing. Unless otherwise already provided for by local
law, notice of the hearing must be given 14 days before the hearing by publishing
notice of it once in a newspaper of general circulation in the area being served by the
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franchise. The notice must contain the date, time, and place of the hearing and must
briefly state the substance of the action to be considered by the franchising authority.
Subd. 4. Approval or denial of sale or transfer request. Within 30 days
after the public hearing, the franchisIng authority shall approve or deny, in writing, the
sale or transfer request. The approval must not be unreasonably withheld.
Subd. 5. Sale or transfer of franchise without system. The parties to the
sale or transfer of a franchise only, without the inclusion of a cable communications
system in which at least substantial construction has commenced, shall establish that
the sale or transfer of only the franchise will be in the public interest.
Subd. 6. Sale or transfer of stock. Sale or transfer of stock in a corporation
so as to create a new controlling interest in a cable communications system is subject
to the requirements of this section.
The term "controlling interest, " as used herein, is not limited to majority stock
ownership, but includes actual working control in whatever manner exercised.
.
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LOCAL LAW
The Franchise at Section 25. Transfer of Ownership provides:
A.
A Franchise shall not be assigned or transferred, either in whole or in part,
or leased, sublet or mortgaged in any manner, nor shall title thereto, either
legal or equitable or any right, interest or property therein, pass to or vest
in any person other than an Affiliate of Grantee without the prior written
consent of City! which consent shall not be unreasonably withheld.
Further, Grantee shall not sell or transfer any stock or ownership interest
so as to create a new controlling interest except with the consent of City,
which consent shall not be unreasonably withheld.
B.
Any sale or transfer of Franchise, including a sale or transfer by means of
a fundamental corporate change, requires the written approval of City.
The parties to the sale or transfer of Franchise shall make a written
request to City for its consent. City shall reply in writing within 30 days of
actual receipt of the request and shall indicate its approval of the request
or its determination that a public hearing is necessary. City shall conduct
a public hearing on the request within 30 days of such determination if it
determines that a sale or transfer of Franchise may adversely affect the
Grantee's subscribers.
C.
Unless otherwise already provided for by local law, notice of any such
hearing shall be given 14 days prior to the hearing by publishing notice
thereof once in a newspaper of general circulation in the City. The notice
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.
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shall contain the date, time and place of the hearing and shall briefly state
the substance of the action to be considered by City. Within 30 days after
the public hearing, City shall approve or deny in writing the sale or transfer
request.
D.
In a sale or transfer of only a Franchise, without the inclusion of the
System in which at least substantial initial construction has commenced, a
Grantee shall be required to establish to a sole satisfaction of City that the
sale or transfer of a Franchise is in the public interest.
E.
For purposes of this section, fundamental corporate change means the
sale or transfer of a controlling interest in the stock of a corporation or the
sale or transfer of all or a majority of a corporation's assets, merger
(including a parent and its subsidiary corporation), consolidation or
creation of a subsidiary corporation. For the purposes of this Section,
fundamental partnership change means the sale or transfer of all or a
majority of a partnership's assets, change of a general partner in a limited
partnership, change from a limited to a general partnership, incorporation
of a partnership, or change in the control of partnership.
F.
The word "contro/': as used herein, shall apply to the sale or transfer of all
or a majority of Grantee's assets or shares of stock, merger (including any
parent and its subsidiary corporation), consolidation, creation of a
subsidiary corporation of the parent company, or sale or transfer of stock
in Grantee so as to create a new controlling interest. The term "controlling
interest" as used herein is not limited to majority stock ownership, but
includes actual working control in whatever manner exercised, including
the creation or transfer of decision-making authority to a new or different
board of directors. Every ch.ange, transfer or acquisition of control of a
Grantee shall make the Franchise subject to cancellation unless and until
City shall have consented in writing thereto, which consent shall not be
unreasonably withheld. For the purpose of determining whether it shall
consent to such change, transfer or acquisition of control, City may inquire
into the qualifications of the prospective controlling party. The City
reserves the right to seek reimbursement of its costs for conducting an
inquiry to the extent permitted by applicable state and federal law. The
preceding statement does not constitute an agreement by any party to
reimburse the City.
G.
In no event shall a transfer or assignment of ownership or control be
approved without transferee becoming a signatory to a Franchise.
Any transferee of a Franchise shall be subordinate to any right, title or
interest of City.
5
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I. For information on the right of the City to purchase the cable system
during a transfer of ownership, see Section 26.
J. Notwithstanding anything to the contrary, no such consent or approval
shall be required for a 'transfer or assignment to any Person controlling,
controlled by or under the same common control as the Grantee.
6
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Description of Transfer of Control
On January 10, 2000, an Agreement of Plan and Merger ("Merger Agreement")
was entered into between America Online, Inc., a Delaware corporation ("AOL"), and
Time Warner Inc., a Delaware corporation ("TWI"). The Merger Agreement
contemplates the two existing parent corporations, AOL and 1W1 to merge and become
wholly-owned subsidiaries of a to-be-formed and ultimate parent called AOL Time
Warner, Inc. ("AOL Time Warner").
To that end, AOL Time Warner will first form two new subsidiaries, referred to in
the Merger Agreement as "AOL Merger Sub" and "Time Warner Merger Sub". The
Merger Subs are to be formed solely for the purpose of effectuating the merger. AOL
will merge into the AOL Merger Sub, with the AOL Merger Sub ceasing to exist as an
operation of law. 1W1 will merge into the Time Warner Merger Sub, with the Time
Warner Merger Sub ceasing to exist as an operation of law. AOL and 1WI, as merged
with the Merger Subs, will become wholly-owned subsidiaries of the new parent and
holding company, AOL Time Warner. The Merger Subs will be corporations organized
under the laws of Delaware and will presumably be renamed upon incorporation.
Pursuant to the Merger Agreement, all of the issued and outstanding capital
stock of AOL and 1W1 will be exchanged and converted into shares of capital stock of
AOL Time Warner with virtually identical rights and preferences. This includes all series
and classes of both AOL and TWI. The Merger Agreement establishes the conversion
ratio for each of the series and specific classes of capital stock.
The Franchisee is the operating subsidiary currently holding the Franchise and
operating the cable television system within the City. Upon consummation of the
merger, the Franchisee will remain unchanged. It will continue to hold the Franchise
and operate the cable system. There will be no sale or assignment of the Franchisee or
the system it operates. There will, however, be a change in the parent corporation that
controls the Franchisee. As such, the request of 1W1 is to authorize the change of
control of the Franchisee, not a change of ownership of the cable television system.
To better understand the proposed merger, a corporate chart has been provided
on the following page.
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---
Chart Demonstrating Proposed Merger
Before the merger, Time Warner Inc. and America Online, Inc. are separate and unrelated
corporate utilities.
Time Warner Inc.
America Online, Inc.
Time Warner Inc. merges into Time Warner Merger Sub with Time Warner Inc. surviving the
merger (to be renamed at a later date) and Time Warner Merger Sub ceasing to exist.
Time Warner
Inc.
Time Warner
Merger Sub
Time Warner
~ Inc.
America Online, Inc. merges into AOL Merger Sub with America Online, Inc. surviving the
merger (to be renamed at a later date) and AOL Merger Sub ceasing to exist.
America Online,
Inc.
+
I AOL Merger Sub I
America Online,
~ Inc.
A new holding company, AOL Time Warner, Inc., serves as parent of the two wholly-owned
subsidiaries, Time Warner Inc. and America Online, Inc.
AOL Time
Warner, Inc.
~
Time
Warner Inc.
America
Online, Inc.
Time Warner cable remains the cable management arm for the new parent, AOL Time
Warner, Inc., and the City's Franchisee, will remain unchanged.
AOL Time
Warner, Inc.
Time
Warner, Inc.
America
Online, Inc.
Time Warner
Cable
I
Franchisee
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Legal Qualifications
The legal qualifications standard relates primarily to an analysis of whether the
Franchisee, as controlled by AOL Time Warner, will remain duly organized and
authorized to operate the cable television system under the terms of the Franchise. The
applicable standard of review is that the City's consent shall not be unreasonably
withheld.1
The proposed transferee, AOL Time Warner, is a corporation that was
incorporated under the laws of Delaware on February 7,2000. It will not commence
business operations until consummation of the proposed transaction. As such, it has
not had an application for a cable television franchise transfer or renewal dismissed or
denied by any franchise authority. As the parent of the Franchisee, AOL Time Warner
need not be qualified to do business in the state where the City and the system used by
the Franchisee are located.
.
TWI has stipulated that it is aware of no instance in which Time Warner Cable,
the management arm of TWI, or any of its affiliates has been denied renewal of a cable
television franchise. In only two instances were applications for a consent to transfer a
franchise denied, both involving a transfer from Time Warner Entertainment Company,
L. P. ("TWE") to an affiliated entity, Time Warner Entertainment - Advance/Newhouse
Partnership. Certain issues of dispute remain unresolved. In both situations, TWE
continues to hold the franchise and operate the system pending authorization of the
proposed transfers.
Under the Merger Agreement, the Franchisee will remain the holder of the
Franchise and will continue to operate the cable television system in the City. We
therefore focus our analysis on the Franchisee and its pertinent legal qualifications.
The Franchisee is currently registered and authorized to conduct business in the
State of Minnesota. TWI has stipulated that the Franchisee, as the legal entity that
operates the City's cable system, will not change and that the Franchisee will continue
to be duly qualified to transact business in said State. To confirm this is the case, a
certificate of good standing was obtained from the Secretary of State, and according to
the certificate, the Franchisee currently is in good standing to conduct business and
operate the system in the City.
Based on the foregoing, we conclude it would be unreasonable for the City to find
that upon closing of the transaction contemplated under the Merger Agreement, the
Franchisee, as controlled by AOL Time Warner, will not be legally qualified.
1 See Minn. Stat. Section 238.083.
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.
Technical Qualifications
The technical qualifications standard relates to the technical expertise and
experience of the Franchisee, as controlled by TWI America Online, to operate and
maintain a cable television system under the Franchise. In such a review, the standard
is once again that the City's consent shall not be unreasonably withheld. 2
As stated, the Franchisee will remain unchanged, and with that, TWI has
stipulated that the local management and staff will remain the same. The local
management and staff will continue to report to the same executives of Time Warner
Cable, which is the cable management arm of the existing and ultimate parent of the
Franchisee, TWI. Assuming this is true, the City should be unaffected by the merger
and resulting transfer of control. For example, customer service issues will be directed
to the same personnel as before the transfer, and the same level of service at the local
level should be provided.
.
What begs the question, however, is the reason why AOL and TWI would merge
and create a new parent if subscribers would experience no change. True, decisions
may happen at the upper management level, making it appear that the City and its
subscribers will go unaffected, but such decisions will have to be implemented at the
local level. With such a monumental merger of media and information companies, there
is reason to believe that the City may see some changes at the local level, whether AOL
andTWI anticipate them at this point or not.
Currently, Time Warner Cable or its affiliates manage cable systems serving a
total of approximately 12.6 million cable subscribers, geographically concentrated in 35
groupings of more than 100,000 subscribers each. It boasts being "one of the largest
and most experienced multiple system cable operators in the United States." Now, with
the proposed merger with AOL, Time Warner Cable will undoubtedly manage many
more subscribers with new issues, many of which may relate to Internet service over the
cable system. This is likely, considering the incredible presence AOL has over the
Internet and the future offering of its Internet service over existing TWI cable systems.
Although the possible benefits of the merger abound, so do the possible strains on
management, namely Time Warner Cable.
TWI states that it is committed to giving its customers not only an array of
entertainment and information choices, but also high quality service. In its efforts to
provide the former, the latter may suffer. Local personnel may have every good
intention to continue to provide quality service to the City and its subscribers, but strain
on upper level management may filter down to the local level, creating confusion and
inefficiency.
We remain optimistic, however, that the merger, by combining the strengths of
the cable and Internet industry, will provide subscribers with countless benefits.
2 See Minn. Stat. Section 238.083.
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Particularly, Internet service over cable systems which is many times faster than
traditional service over telephone lines, even telephones lines with digital subscriber line
("DSL") service. Despite such optimism and as previously stated, we remain concerned
that management will be strained as a result of this mega-merger, such strain
particularly felt by Time Warner Cable.
Based on the foregoing, we conclude it would be unreasonable for the City to find
that upon closing of the transaction contemplated under the Merger Agreement, the
Franchisee, as controlled by AOL Time Warner, will not be technically qualified.
.
.
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Financial Qualifications
OVERVIEW AND SCOPE OF ANALYSIS
The following is a summary of our analysis of selected financial information
provided by Time Warner, Inc., a Delaware corporation ("Time Warner") in conjunction
with Time Warner's request for consent to the change in control of a television cable
system ("System") serving the City which will occur as the result of the merger of Time
Warner and America Online, Inc., a Delaware corporation ("AOL") (the "Merger")..
The selected financial information to which our review has been limited, consists solely
of the following (collective, the "Financial Statements"):
1. Time Warner Form 1 O-K for the fiscal year ended December 31, 1998;
2. Time Warner Form 10-Q for the quarterly period ended September 30,
1999;
3. AOL Form 1 O-K for the fiscal year ended December 31, 1998; and
4. AOL Form 10Q for the quarterly period ended September 30, 1999
.
Our procedure is limited to providing a summary of our analysis of the Financial
Statements and other relevant information to facilitate the City's assessment of the
financial capabilities of AOL Time Warner, Inc., a Delaware corporation to be formed to
consummate the Merger, to become the ultimate parent and successor operator of the
System serving the City.
SUMMARY OF TRANSACTION
Time Warner and AOL entered into an Agreement and Plan of Merger dated
January 10, 2000 (the "Merger Agreement") pursuant to which AOL and Time Warner
established the terms and conditions whereby both AOL and Time Warner would
become wholly-owned subsidiaries of AOL Time Warner, Inc., a Delaware corporation
to be formed ("AOL Time Warner"). The Merger is to be accomplished by AOL and
Time Warner causing AOL Time Warner to form two wholly-owned subsidiaries, "AOL
Merger Sub" and "Time Warner Merger Sub." AOL would merge AOL Merger Sub into
itself and Time Warner would merge Time Warner Merger Sub into itself. Immediately
following the mergers of the foregoing described Constituent Corporations, AOL and
Time Warner would become wholly-owned subsidiaries of AOL Time Warner. In
accordance with the provisions of the Merger Agreement, all of the issued and
outstanding capital stock of all series and classes of each of AOL and Time Warner
would be exchanged and converted into shares of capital stock of AOL Time Warner
with virtually identical rights and preferences. The Merger Agreement establishes the
. conversion ratio for each of the specific classes and series of capital stock.
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As a result of the Merger, the Time Warner operating subsidiary that currently
holds the franchise to operate the System in the City will continue to hold the cable
franchise notwithstanding the Merger. As such, the request of Time Warner is to
authorize the change of control, not change of ownership of the System.
COMPARATIVE ANALYSIS OF PRO FORMA FINANCIAL STATEMENTS
Neither federal law nor FCC regulations provide franchising authorities with any
guidance concerning evaluation of the financial qualifications of an applicant for a cable
franchise. In certain circumstances, it is appropriate to consider the performance of an
applicant based on the applicant's historical performance in relation to recognized
industry standards. Given the fact that Time Warner, through its operating entities, has
a history of cable system operations, such statistical analysis is relevant with respect to
the Time Warner's historical operations. We have based our analysis, in part, on
industry standards which are generally recognized in making such a determination.
These industry standards are more precisely described below.3
Based on the selected pro forma financial information which we analyzed, the
following is a summary of the various financial factors, as compared to the applicable
Industry Standards, for the 9-month period ended September 30, 1999 and the 12-
month periods ended December 31, 1998 and 1997.
.....:.::...:.::::.:. '\):/::?::::::::::::::!{::i::::::::::::i::::!::::::::::'::::::::::::.':::::::::::::':":':'" J~8.~~+~Y::::::::::::1:i::r:::i:::::" Jt::::::;:/
::[HiSeRIProtON:::::,:::::::.::.:::.:.':.:.::.::::}::::: ::,$TANQARO.::::'::::.:: 1999...
Operating Ratio 60% or less 59.0%
(op-expense/revenue)
Operating Margin
I (op-profit/revenue)
Pretax profit Margin
I (pretax income/revenue)
DebUEquity Ratio
(long-term debUtotal equity)
Current Ratio
(current assets/current
liabilities)
Operating Cash Flow
EBITDA
EBITDA Margin
(operating cash flow/revenue)
:....:.. .,::'
.. .
1 g9~)(.:)/::.::..:::/:::}
56.3%
40% or more
41.0%
43.7%
+10% or more
3.0%
4.2%
2.2:1
2.03:1
1.23:1
1.0:1
1.00:1
1.18:1
N/A
$4.9 Billion $2.2 Billion
24.0%
25.2%
15.3%
AOL FINANCIAL OVERVIEW
.
Based on information contained in the AOL 1999 annual report, for the 12
months ending June 30, 1999, AOL had total revenues of $4.8 billion, operating income
3 Industry data based on information compiled by Paul Kagan and Associates.
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of $578.0 million and net income of $396.0 million, resulting in earnings per share of
$.34. During fiscal 1999, AOL's membership grew from 12.5 million to 17.6 million or
approximately 41 %.
As of September 30, 1999, AOL had total current assets of $2.4 billion, total
assets of $6.5 billion, total current liabilities of $2.0 billion, total liabilities of $2.7 billion
and total stockholders equity of $3.8 billion. For the three months ended September 30,
1999, AOL EBITDA increased from $153 million to $386 million or 152% over the three
months ended September 30, 1998. EBITDA margin increased from 15.3% for the
three month ending September 30, 1998 to 26.3% for the three months ended
September 30, 1999, with an incremental EBITDA margin of approximately 50.0%.
AOL's net worth and historical results from operations, although not necessarily
indicative of future performance, do support the position that AOL, as a subsidiary of
AOL Time Warner, will not have a materially adverse impact on the overall operating
results from a financial standpoint due to the shifting of resources from Time Warner to
AOL for the sole purpose of funding AOL's ongoing operations and working capital
needs. In addition, based on AOL's historical results, it is also not unreasonable to
conclude that the historical financial results of operations of AOL may, under certain
circumstances, be available to fund the ongoing operations of Time Warner, including
providing working capital.
SUMMARY
.
Based on the foregoing and limited strictly the Financial Statements, we do not
believe that Time Warner's request for transfer of control of the franchise to operate the
System can reasonably be denied based solely on lack of financial capabilities. This
statement should not be construed in any way to constitute an opinion as to the financial
capability of Time Warner, AOL or AOL Time Warner either individually or jointly to
operate the existing System serving the City or to successfully consummate the
transaction contemplated by the Merger and to successfully incorporate the operation of
the existing System and Time Warner's existing business operations with the business
operations of AOL, upon which we express no opinion. The sufficiency of the
procedures used in making an assessment of AOL Time Warner's financial capability is
solely the responsibility of the City. Consequently, we make no representation regard
sufficiency of the procedures used either for the purpose for which this analysis of
financial capabilities was requested or for any other purpose.
e
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Open Access Considerations
Cable television operators nationwide are beginning to provide access to the
Internet over their cable wires. Subscribers lease or buy "cable modems" that connect
to the computer and allow access to the Internet via cable, as opposed to local phone
lines. Cable modem service is often much faster than connections via phone lines and
is a very attractive service offering. Typically, the cable operator has an affiliation with
an Internet service provider ("ISP"), such as Road Runner or @Home, which
subscribers use to obtain access to the Internet. With the merger of TWI and AOL, AOL
Time Warner would gain its own ISP affiliate in which to provide TWI subscribers high-
speed Internet access, that being AOL. This benefit is likely a primary reason for the
proposed merger.
There has been considerable debate over whether cable television operators
must allow unaffiliated ISPs "open access" to their cable modem platforms. The
proposed transfer of control poses the question of whether AOL Time Warner will allow
open access to its cable modems for use of its system. Intending to provide more
competition and choice for subscribers, some local franchising authorities have taken an
aggressive approach by conditioning franchise renewals or transfers on open access
requirements. All who have done so have thus'far found themselves in court.
.
One case that has gained national attention on this issue is AT&T Corp. v. Citvof
Portland, 43 F. Supp. 2d 1146 (D. Org. 1999). In this case the City of Portland and
Multnomah County, Oregon, in reviewing the proposed transfer of control of TCI to
AT&T, passed a resolution requiring AT&T to allow unaffiliated ISPs to connect their
equipment directly to AT&T's cable modem platform, bypassing @Home, its proprietary
cable ISP. AT&T refused the open access requirement, which essentially led to a
denial of the proposed transfer. AT&T and TCI sued the City and County in federal
district court, where the City and County received a favorable decision. AT&T has since
appealed, and a decision from the Ninth Circuit Court of Appeals is expected sometime
in 2000.
Faced with ongoing criticism, AT&T not long ago announced its commitment to
provide open access to its cable and fixed wireless systems and afford subscribers a
choice of ISPs. The decision becomes effective this year for subscribers served by
AT&T's fixed wireless systems and in mid-2002 for subscribers of AT&T's broadband
cable systems, after AT&T's exclusivity contract with cable ISP, @Home, expires.
Many cable operators argue that it is bad policy to mandate access to new
technologies and infrastructures that are privately owned and financed. The Federal
Communications Commission has so far maintained a hands-off approach, intending to
have competition control. Some public utilities commissions, such as Minnesota's for
example, have also avoided the issue, letting market forces drive the issue. Local
governments continue to point out that without regulation, cable providers may be able
to monopolize the Internet, and subscribers will not be able to select their ISP of choice.
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With the level of scrutiny the open access issue has undergone on the federal,
state, and local level, TWI and AOL have responded by entering into Memorandum of
Understanding Regarding Open Access Business Practices dated February 29, 2000
("Memorandum"). According to TWI and AOL, they intend to enter into as quickly as
possible an agreement to provided broadband AOL Internet service on TWl's cable
systems. The agreement is to be used as a model for the commercial agreements that
will be available to other ISPs.
Specifically, the Memorandum commits to offer:
1. Consumer Choice: AOL and TWI stipulate that AOL Time Warner is
committed to offer consumers a choice among ISPs. Consumers will not
be required to purchase service from an ISP that is affiliated with AOL
Time Warner in order to enjoy broadband Internet service over AOL Time
Warner cable systems.
2. Diversity of ISPs: AOL and TWI stipulate that AOL Time Warner will not
place any fixed limit on the number of ISPs with which it will enter into
commercial arrangements, and it will offer these ISPs the choice to
partner on a national (on all AOL Time Warner cable systems), regional,
or local basis, in order to facilitate the ability of consumers to choose
among ISPs of difference size and scope.
3. Direct Relationship with the Customer for ISPs: AOL and TWI
stipulate that AOL Time Warner is also committed to allow both the cable
operator and the ISP to have the opportunity to have a direct relationship
with the consumer. Accordingly, both the cable operator and the ISP will
be allowed to market and sell broadband service directly to customers.
When an ISP sells broadband Internet service directly to a customer, it
may, if it so chooses, bill and collect from the customer directly.
4. Video Streaming: AOL andTWI stipulate that AOL Time Warner will
allow ISPs to provide video streaming, which is essentially video
conferencing over the Internet. AOL Time Warner states that it recognizes
that some consumers desire video streaming, and AOL Time Warner will
not block or limit it.
5. Fast Action: The Memorandum is subject to existing TWI obligations,
such as its contracts with other cable modem ISPs like Road Runner.
TWI stipulates that it is committed to provide consumer choice as quickly
as possible, and to that end, will work to achieve that goal before its
current obligations expire.
Despite such statements, TWI may struggle to achieve its goals of providing
consumer choice among ISPs in light of existing contract obligations with Road Runner
and other ISPs. AT&T, for example, has been forced to wait until mid-2002 to offer its
broadband subscribers such choice, when its contract with @Home expires.
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.
The Memorandum states that AOL Time Warner will offer ISPs the choice to
partner with it to offer broadband Internet service on a national, regional, or local basis
to facilitate choice among ISPs of different size and scope. However, it seems that only
those ISPs with the financial resources to provide Internet service on a large scale will
be given such opportunity. The Memorandum states that AOL is committed to bring the
benefits of the Internet to all Americans, but it "will not allow ISPs to offer 'redlined'
service to only a portion of anAOL Time Warner cable system. . ." .
The Memorandum seems to encourage open access, which is a positive step
from the City's perspective. However, there are many terms, conditions, and
parameters that still need to be articulated and likely will be in the forthcoming
agreement between AOL and TWI. There is no doubt that the Memorandum is timely
as the City and many others like it are now considering the proposed transfer of control.
The Memorandum commits to open access, but under undisclosed terms and
conditions.
In light of the pending Portland decision, the City should be wary to condition
approval on open access issues. As stated before, those cities who have are in court.
We will keep the City abreast of any developments in the case and with the open
access issue in general. In the meantime, if the City chooses to approve the transfer,
the proposed resolution, found at Exhibit A to this Report, reserves the City's right to
impose open access conditions at a later date.
.
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.
.
.
Recommendations
Based strictly on the information made available to us at the time of this review,
we believe that the Franchisee, as controlled by AOL Time Warner, will possess the
necessary legal, technical, and financial qualifications based on the standards of review
identified in applicable law, and the Franchise as described within this Report.
Based on these findings, we recommend that:
1. The City Council review this Report, listen to public comment, as
necessary or appropriate, and undertake all necessary action to pass and adopt a
resolution similar in form and content to the document following these
recommendations.
2. The City follow-up to ensure that the Franchisee submit the Acceptance of
the Resolution Approving the Transfer of Control, which must be delivered following
closing of the transaction.
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.
Exhibit A
Resolution - Approving Transfer
.
.
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.
RESOLUTION NO. 2000-12
APPROVING THE TRANSFER OF CONTROL OF
KBL CABLESYSTEMS OF THE SOUTHWEST, INC.,
THE CABLE 'TELEVISION FRANCHISEE,
RESULTING FROM THE MERGERS OF SUBSIDIARIES OF
TIME WARNER, INC. AND AMERICA ONLINE, INC.
INTO AOL TIME WARNER, INC.
WHEREAS, on or about January 1, 1987, the City of Hopkins, Minnesota
("City") passed and adopted Ordinance No. 96-792, granting a Cable Television
Franchise ("Franchise") currently held by KBL Cablesystems of the Southwest,
Inc. ("Franchisee"), a subsidiary of Time Warner, Inc., doing business as Time
Warner Cable (collectively, "TWI"); and
WHEREAS, on January 1 0, 2000, a certain Agreement and Plan of
Merger ("Merger Agreement") was made and entered into by and among TWI
and America Online, Inc. ("AOL"); and
WHEREAS, the Merger Agreement contemplates the merging of a to-be-
formed TWI subsidiary and a to-be-formed AOL subsidiary with a parent holding
company known as AOL Time Warner, Inc. ("AOL Time Warner"); and
WHEREAS, TWI and AOL have requested consent by the City to these
mergers and the resulting transfer of control of the Franchisee to AOL Time
Warner; and
WHEREAS, under the Franchise and applicable state and federal law, the
proposed mergers and resulting transfer of control of the Franchisee require
consent from the City; and
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.
WHEREAS, the City has reviewed the proposed mergers, transfer of
control, .and the legal, technical, and financial qualifications of AOL Time Warner;
and
WHEREAS, based on information obtained and on the reports and
information received by the City from TWI and AOL, the City has found no reason
to disapprove of the proposed transfer of control of the Franchisee to AOL Time
Warner.
NOW, THEREFORE, the City Council for the City resolves as follows:
1. The Franchise is in full force and effect, and the Franchisee is the
lawful holder of the Franchise.
2.
The Franchisee will remain the lawful holder of the Franchise after
.
consummation of the mergers contemplated under the Merger
Agreement.
3. The City hereby consents to and approves of the proposed transfer
of control of the Franchisee subject to:
a. Closing of the transaction contemplated within the Merger
Agreement pursuant to the terms and conditions described
in information provided to the City by TWI and AOL.
b. AOL Time Warner or the Franchisee notifying the City in
writing of the completion of the mergers and the transfer of
control within thirty (30) days of the date of closing.
c. The Franchisee, within thirty (30) days of the date of closing,
providing the City with a signed acceptance of this
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.
.
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4.
Resolution in the form attached hereto and incorporated
herein by reference.
d. AOL Time Warner, TWI, or the Franchisee, within thirty (30)
days of the date of adoption of this Resolution, reimbursing
the City for all reasonable costs, expenses, and professional
fees related to the City's review and action on the proposed
mergers and the transfer of control.
The City hereby waives any right of first refusal which the City may
have to purchase the Franchise, or the cable television system
serving the City, but only as such right of first refusal applies to the
request for approval of the mergers and the transfer of control now
before the City.
In the event the mergers of the TWI and AOL subsidiaries into AOL
Time Warner contemplated by the foregoing resolutions is not
completed, for any reason, the City's consent shall not be effective.
The City's approval of the transfer of control does not waive or
diminish any lawful authority of the City to require the provision of
non-discriminatory access to the cable system for providers of
Internet access service, subject to applicable law. The City and the
Franchisee have not waived any rights, obligations, claims,
defenses, or remedies regarding the authority of the City to impose
such conditions. Prior to the enactment of any such requirement,
the Franchisee shall be provided with reasonable notice and an
5.
6.
3
.
opportunity to be heard, including the right to present evidence on
any findings to be made by the City with respect to the need for
such a requirement.
7. To the maximum extent permitted by all applicable local, state, and
federal laws, this Resolution shall not be construed to in any way
relieve the Franchisee nor limit the Franchisee from any liability
under the Franchise.
This Resolution shall take effect and continue and remain in effect from
and after the date of its passage, approval, and adoption.
A motion to approve the foregoing Resolution No.
was made
by Council Member
and duly seconded by Council Member
.
The following Council Members voted in the affirmative:
The following Council Members voted in the negative:
Passed and adopted by the City Council for the City this _ day of
,2000.
ATTEST:
CITY OF HOPKINS, MINNESOTA
By:
By:
Its:
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.
ACCEPTANCE OF THE RESOLUTION
APPROVING THE TRANSFER OF CONTROL
KBL Cablesystems of the Southwest, Inc. hereby agrees to comply with
the terms and conditions of this Resolution No. and the Franchise
referenced herein.
KBL CABLESYSTEMS OF THE
SOUTHWEST, INC.
By
Its
Subscribed and sworn to me this
to me this _ day of
,2000
Notary Public
.
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