Re: I/M/O Application of Verizon New Jersey For Approval of Alternative Form of Regulation and to Reclassify Multi-line Business Services as Competitive

James A. Rothschild presents testimony on behalf of the Ratepayer Advocate on the current cost of equity data that should be used by Verizon New Jersey ("Verizon") in its Plan for Alternative Regulation II ("PAR-2") currently before the Board of Public Utilities ("Board"). Mr. Rothschild has over 28 years of experience as a financial consultant specializing in utility regulation. In this proceeding, Mr. Rothschild analyzes Verizon’s capital structure which is crucial to fully understand the economic effects and added revenue to the company resulting from the NYNEX and GTE mergers, as well as the sharing of overearnings with ratepayers.

Summary of Findings and Recommendations

Verizon has benefitted significantly in New Jersey’s regulatory environment. Verizon Communications, Inc., the parent company of Verizon New Jersey, has also strongly benefited from the cash flow and existing customer base provided from their regulated telephone subsidiaries. This inherent strength has become obvious during the severe downturn recently experienced by the rest of the telecommunications industry.

Competitive local exchange providers ("CLECs") who seek to enter the telecommunications market are faced with great barriers stemming chiefly from the Incumbent Local Exchange Carriers’ ("ILECs’") stronghold of their respective service areas. These entry barriers are documented in the business media, such as the article that the April 23, 2001 article in Business Week magazine entitled "TELECOM MELTDOWN". The article noted on page 106, that:

Verizon thinks the communications business is promising enough that it’s boosting its capital spending to $18 billion this year from $17.6 billion in 2000. "We’re going through a period where the fittest and the best-financed will do well," says co-CEO Ivan Seidenberg.

The above quote is typical of other opinions that have been expressed in the financial press regarding the telecommunications industry and are confirmed by stock price movements. The evidence is now more obvious than ever that the regulated telephone operations of Verizon have provided it with a huge advantage over CLECs. Verizon has, in effect, been able to ride the checkbooks and advantages of its customer base of the regulated companies onto establishing positions of extreme power within the telecommunications marketplace. In order for PAR-2 to properly balance the interests of investors and ratepayers, it needs to recognize what has been happening. Instead of going even further away from recognizing the important contribution of New Jersey ratepayers , PAR-2 should fix the problems inherent under Verizon’s existing Plan for Alternative Regulation ("PAR-1"). Instead of eliminating the profit sharing feature of PAR I, this ratepayer protection feature should be strengthened in PAR-2. This strengthening should include:

• An immediate consumer benefit of $175,249,046, or 12.3% of intrastate regulated services. This figure is conservative and does not include any of the high profits from the yellow page business. This consists of a $56,189,053 to reflect the current return on equity in excess of the cost of equity and another $119,059,993 to reflect one-half of the intrastate share of the ongoing savings from both the Bell Atlantic-Nynex merger and the Bell Atlantic-GTE merger to be realized after 2000.
  

• An additional $53 million return to consumers to reflect a 50% share of the cumulative merger savings allocated to New Jersey intrastate regulated operations for the period 1997 to 2000.
  

• The new formula should be based upon the current cost of equity rather than frozen at the old, much higher cost of equity level that existed back in 1992. The earnings sharing threshold should be reduced from 13.7% under PAR I to 10% because the cost of equity has declined 2.3% from the cost of equity set in 1992
  .

• Recognition that the capital structure to use to compute the return on equity should contain no higher percentage of common equity than is utilized by Verizon, Inc. Verizon’s interrogatory responses show that the reported capital structure of Verizon New Jersey in no way reflects either the actual capital structure financing New Jersey regulated operations or the capital structure management would choose if it were designing a capital structure that it believed to be most appropriate for the regulated telephone operations in New Jersey.

The complete text of Mr. Rothschild’s testimony is available on the Ratepayer Advocate’s website.

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