Mr. Rothschild’s testimony includes current cost of equity data and an explanation of how this data should be used in the regulation of Bell Atlantic-New Jersey (BA-NJ); quantification of savings attributable to mergers with NYNEX and GTE; and recommended revisions to BA-NJ’s current Plan for Alternative Regulation (PAR).

SUMMARY OF FINDINGS AND RECOMMENDATIONS
The Plan for Alternative Regulation (PAR) under which BA-NJ is currently regulated is entirely designed to benefit investors without balancing the interests of ratepayers. BA-NJ does not acknowledge the need to lower the threshold for earnings sharing to pre-1992 levels. The PAR computes only BA-NJ earnings, whereas the FCC has found that omitting earnings from Bell Atlantic subsidiaries manipulates earnings to appear low. Bell Atlantic has shared none of its billions of dollars of merger savings with ratepayers. Mr. Rothschild’s analysis is conservative and based on incomplete data assessed within considerable time constraints. Therefore, if BA-NJ provides the detail to interrogatories that Mr. Rothschild has requested, this testimony can be expected to be supplemented with additional evidentiary support.

BA-NJ’s books show a higher percentage of common equity for BA-NJ than for its holding company, Bell Atlantic. The capital structure of BA-NJ can easily be manipulated to understate BA-NJ’s actual return on equity. This directly harms ratepayers because they are denied earnings sharing to which they are entitled under alternative regulation. Thus, regulatory analysis should focus on the consolidated Bell Atlantic capital structure.

Earnings sharing thresholds should be updated. If the cost of equity had gone up since 1992, BA-NJ would have been very vocal about the need to increase earnings sharings parameters. But the earnings sharing threshold should be reduced because the cost of capital has been reduced by about 1.6% since 1992, when the threshold levels were set. Considering how well Bell Atlantic stockholders have done, (18.9% average annual return since 1993), the absence of earnings sharing with ratepayers shows that the existing alternative ratemaking procedure is biased towards investors.

CAPITAL STRUCTURE

For decades, the erstwhile NJ Bell’s costs have been supported 100% by ratepayers. This support has made mergers and the accompanying savings possible. Ratepayers are entitled to share the benefits. Mr. Rothschild recommends 50% of the benefits go to ratepayers, through a one-time refund of $59 million and $205 million annually.

The BPU should use the consolidated capital structure because it is not subject to manipulation. It is an actual capital structure, with an accurate reflection of the relationship between public debt and investor equity. Data Mr. Rothschild obtained from the 1999 Moody’s Public Utility Manual indicates that the consolidated capital structure of Bell Atlantic contained 38.47% common equity, while BA-NJ carried 51.52%. But there is no reason to believe that regulated operations in NJ are more risky than other businesses owned by Bell Atlantic. Rather, Bell Atlantic has allocated most of its common equity to its regulated industries rather than its non-regulated subsidiaries. This makes a significant difference because it keeps its NJ regulated earnings below the level that triggers sharing with ratepayers.

Other jurisdictions have found fault in the subsidiary capital structure. The FCC has declared it "subject to manipulation by the holding companies." Although the Illinois Commerce Commission initially rejected the consolidated capital structure analysis, the Appellate Court of Illinois subsequently reversed and remanded after criticizing the ICC’s acceptance of Illinois Bell’s manipulated capital structure. PriceWaterhouse partner Elizabeth M. McCarthy testified to the Long Island Power Authority, "a holding company can capitalize its operating companies any way it wants."

COST OF EQUITY

The earnings sharing formula was passed eight years ago and should be revised. The cost of equity has declined in an absolute sense by about 1.6% since the BPU’s finding. Earnings sharing should begin at a level no higher than 10%. Common equity investment always entails risk, but public utilities are typically among the least risky investments; utility service is needed in both good times and bad times.

Mr. Rothschild used a combination of the DCF method and the risk premium/CAPM method to calculate BA-NJ’s current cost of equity as 10%. The constant growth version of the DCF method indicates that the cost of equity was 12.61% in 1992 and is 10.91% now. The risk premium/CAPM method more accurately shows the cost of equity as 10.52% in 1992 and currently 9.02%. Aggregating the two yields an estimate of 11.56% in 1992 and 9.96% today. The risk of Bell Atlantic stock has remained constant since 1992: some 15% below the risk experienced by the average company.

MERGER SAVINGS

Mr. Rothschild’s merger benefits testimony is incomplete and will be supplemented upon receipt of BA-NJ’s answers to interrogatories. Based on an average asset life of 7.5 years, and using figures from BA-NJ’s own witnesses, Mr. Rothschild calculates that the $300 million annual reduction in costs amounts to $72 million in the first year, $139 million the second year, and gradually increasing until it reaches $435 million by the eighth year.

Merger savings should be shared with ratepayers immediately, rather than in the future. This method is consistent with how ratepayers are charged for known increases. If the merger sharing is postponed until the future, competition may complicate the disbursement. And if merger savings were dispersed in rate reductions, BA-NJ would receive an unfair price advantage over competitors. A sharing formula based on book equity is too dependent upon actual book earnings, which are influenced by abnormal conditions and changes in accounting practices. Analyzing the price of common stock as the basis for creating a sharing formula also has limitations as it is impacted by regulated operations in NJ, and regulated and unregulated operations outside NJ. Therefore, weight must be given to both approaches.