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Telecom Public Notice
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Ottawa, 23 February 1990
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Telecom Public Notice CRTC 1990-21
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TELEGLOBE CANADA INC. - ADVANCES TO MEMOTEC DATA INC.
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I BACKGROUND
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After Memotec Data Inc. (Memotec) acquired Teleglobe Canada Inc. (Teleglobe) in 1987, Teleglobe was included in the parent company's centralized cash management system. Under this system, all of the funds in Teleglobe's bank accounts, except imprest and payroll accounts, are transferred to a Memotec corporate account at the end of each day. Teleglobe imputes an interest income on the outstanding balance on deposit with the parent company. This imputed interest income is based on 91-day treasury bill rates. It is treated by Teleglobe as a net income item for regulatory purposes and is added to the equity rate base. However, Teleglobe has never actually received any interest payments from Memotec.
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Teleglobe has had a large amount of cash on deposit with Memotec, mainly as a result of the international telephone revenue settlement process. Under this process, Teleglobe receives collections from Telecom Canada for overseas telephone calls some six to eight months before the accounts are finally settled with foreign administrations. Since Canadians make many more telephone calls to foreign destinations than they receive, Teleglobe's accounts payable to its foreign correspondents are larger than its accounts receivable. These and other factors combine to give Teleglobe a monetary float that fluctuates around $80 million, which is on deposit with Memotec.
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The Commission has had and continues to have a number of concerns with respect to Teleglobe's cash management arrangements with Memotec. The Commission has particular concerns with respect to the adequacy of the return earned by Teleglobe on its advances to Memotec, the size of the advances and their security, and the difference between financial indicators (including rate of return on average common equity (ROE) and interest coverage) based on the company's books of account and those derived for regulatory purposes. The latter take into account imputed interest income on the advances, while the former do not.
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Teleglobe's position with respect to these issues was explored in the proceeding leading to Reduction in International Telephone Service Rates, Advances to Memotec Data Inc., Telecom Letter Decision CRTC 89-23, 9 November 1989 (Letter Decision 89-23). In Letter Decision 89-23, the Commission found that the cash management arrangements between Teleglobe and Memotec were inconsistent with Teleglobe's best interests and with its obligation to ensure that its customers' interests are protected. The Commission was concerned, among other things, that the company's financial ratios would, in time, be distorted to such a degree that it would impair the Commission's ability to determine Teleglobe's costs of debt and equity and, consequently, to set just and reasonable rates.
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In Letter Decision 89-23, the Commission also expressed the view that, since Teleglobe would continue to have access to a monetary float of at least $60 million for the foreseeable future, it would be more cost effective for Teleglobe to use the funds to lower its long-term liabilities and its shareholder's equity (invested capital), subject to the removal of a restrictive covenant contained in its loan agreement with the National Bank of Canada. That covenant requires Teleglobe to maintain a ratio of current assets to current liabilities of at least 1:1.
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In that Letter Decision, the Commission indicated that there were at least three acceptable alternatives to Teleglobe's present arrangements with Memotec, namely: (1) that Teleglobe maintain its own bank accounts and manage its own short-term investment program; (2) that Teleglobe enter into a written agreement with Memotec to formalize the current arrangements and ensure that Memotec actually pays it a market interest rate on the outstanding cash balance; or (3) that Teleglobe contract out its cash management and short-term investment program to an unrelated company. Teleglobe was directed to file proposals to organize its cash management and short-term investment functions in a manner that, in the company's judgment, would appropriately address the concerns expressed by the Commission. In addition, Teleglobe was directed to file comments as to why some $60 million of its advances to Memotec should not be used to reduce its invested capital. Finally, Teleglobe was also directed to explain why it should not negotiate to remove the restrictive covenant in its loan agreement with the National Bank of Canada.
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In its submission of 8 December 1989, Teleglobe undertook to enter into a written agreement with Memotec that would include provisions to impute interest at 91-day treasury bill rates. Under the proposed agreement, Teleglobe would have the right to repayment on 7 days notice of an amount slightly higher than Teleglobe's budgeted net cash requirement for the quarter in which the repayment occurred. The balance of Teleglobe's cash advances would be repayable on 90 days notice. The National Bank of Canada would provide Memotec with a comfort letter indicating that funds would be available to enable Memotec to meet its repayment obligation. Teleglobe also proposed to impute a monthly deemed dividend equal to the after-tax value of the imputed interest. In addition, Teleglobe proposed to make a one-time deemed dividend adjustment equal to the after-tax value of the imputed interest for the years 1988 and 1989.
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Teleglobe also stated that no part of its advances to Memotec should be used to reduce its long-term capital and that it would be financially unwise to negotiate with the National Bank of Canada to remove the covenant restricting its current ratio to at least 1:1.
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Having reviewed the proposals contained in Teleglobe's submission of 8 December 1989, the Commission is of the view that those proposals do not adequately address the concerns expressed in Letter Decision 89-23. The Commission therefore invites comments on the issues set out below.
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II ISSUES
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A. What arrangements for managing Teleglobe's cash flow would be acceptable?
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Under Teleglobe's proposal, the company would continue to impute interest income on its advances to Memotec, but would not actually receive any interest payments. To the extent that the imputed income represents a fair return on the funds on deposit with Memotec, the Commission would take it into account in determining Teleglobe's revenue requirement and in setting the company's rates. As a result, Teleglobe's book earnings would still be lower than its regulated income by the amount of the imputed interest income. As an example, based on Teleglobe's proposals described in its 8 December 1989 letter, the company's net income for book purposes would be some $7.3 million less than its regulated net income, since no actual interest payment was received from Memotec. In 1989 the imputed interest income (on an after-tax basis) represents approximately 22% of Teleglobe's net income for book purposes. Should the Commission determine that the imputed interest income calculated under Teleglobe's proposals does not represent a fair return on the funds on deposit with Memotec, the difference between net income for regulated purposes and book purposes would be increased further.
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As is evident from the above, the fact that Teleglobe does not actually receive the interest imputed on the amounts advanced to Memotec results in an earnings stream that is smaller than would otherwise be the case. This, in and of itself, lowers the value of the company and is therefore not in Teleglobe's best interests. In addition, the Commission is concerned that, over time, the company's financial integrity will be jeopardized.
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Furthermore, the company's key financial ratios, including ROE and interest coverage, are adversely affected. Based on Teleglobe's proposals, the company's 1989 book ROE would be about 2.9 percentage points lower than its regulated ROE, which is a significant difference. As long as the nature of Teleglobe's international telephone business remains essentially unchanged, substantial differences between book and regulated financial ratios will persist. This situation, in which Teleglobe does not receive a fair and real return on its funds, will likely lead to a deterioration in its credit rating. As a result, Teleglobe's borrowing costs and its required ROE will likely increase.
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It could be argued that it is theoretically possible for the Commission to isolate the increase in capital costs arising from the interest imputation and to let the company's shareholder bear this cost. However, as a practical matter, it may be impossible for the Commission to make such an adjustment. Therefore, the proposed imputation approach would entail a risk that customers would bear the burden of the company's increased cost of capital, in the form of higher rates. Accordingly, the Commission considers that, like Teleglobe's present arrangements with Memotec, the company's proposals are not in the best interests of its customers.
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In addition, even under Teleglobe's proposed agreement with Memotec, the Commission remains concerned with the security of Teleglobe's advances on deposit with Memotec which, over the period January 1988 to September 1989, have reached as high as $121.8 million. The Commission considers it imperative that Teleglobe's customers be provided adequate protection in this regard.
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Teleglobe has available to it a variety of cash management practices that are consistent with its own interests and with those of its customers. As mentioned above, the Commission identified three such approaches in Letter Decision 89-23.
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B. Is a significant portion of Teleglobe's advances to Memotec an asset of a long-term nature? If so, what alternatives are available to the company to use that asset more effectively and to earn a return commensurate with that required from such an asset?
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As mentioned above, the level of funds on deposit with Memotec is primarily the result of the international revenue settlement process involving Teleglobe, Telecom Canada and foreign administrations, and of the pattern of calls originating and terminating in Canada. As Teleglobe's international telephone business grows, the potential value of the monetary float will increase.
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If a significant portion of the monetary float advanced to Memotec is, in effect, on deposit with the parent company on a long-term basis, it would be more appropriate for Teleglobe to employ those funds in a way that gives Teleglobe the opportunity to earn a return commensurate with that required from a long-term asset. In Letter Decision 89-23, the Commission indicated that, should that required return be the same as the company's cost of invested capital, that portion of the float that can be considered a long-term asset could be used to pay down Teleglobe's invested capital.
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C. Are there limitations on the Commission's jurisdiction in this matter?
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In Teleglobe's 8 December 1989 response to the Commission's directions, Teleglobe stated that any Commission action with respect to the advances that was intended to alter Teleglobe's invested capital would not serve any legitimate regulatory purpose and would be an unwarranted interference in the management of the company. In addition, Teleglobe stated that it considered its banking arrangements, particularly the fact that it maintains current assets (a significant portion of which are advances to Memotec) at a slightly higher level than current liabilities, are not a matter for Commission intervention.
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The Commission hereby invites comments as to what type of corrective action it should take when, as a result of non-arm's length arrangements, Teleglobe employs certain assets (such as its advances to Memotec) arising from its regulated telecommunications activities, in such a manner that those assets may not have an opportunity to earn a fair and real return and, as a result, customers may have to pay higher rates than they otherwise would.
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III PROCEDURE
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1. The mailing addresses for the Commission and for Teleglobe are as follows:
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Mr. Fernand Bélisle
Secretary General
CRTC
Ottawa, Ontario
K1A 0N2
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and
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Mr. Jules Lemay
Director
Regulatory and Corporate Analysis
Corporate Affairs Group
Teleglobe Canada Inc.
680 Sherbrooke Street West
Montréal, Quebec
H3A 2S4
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2. Interested persons wishing to participate in this proceeding (interveners) must notify the Commission of their intention to do so by writing to the Commission at the address noted above by 16 March 1990. A copy of that notice should be sent to Teleglobe.
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3. The Commission has addressed interrogatories to Teleglobe today. The company is directed to file its responses to these interrogatories, and any comments it may have in response to the issues raised in this public notice, by 26 March 1990. Copies are to be served on all interveners by the same date.
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4. Interveners may address interrogatories to Teleglobe. Any such interrogatories must be filed with the Commission and served on Teleglobe by 9 April 1990.
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5. Teleglobe's responses to interrogatories must be filed with the Commission and served on interveners by 30 April 1990.
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6. Interveners may file comments with the Commission, serving a copy on Teleglobe, by 25 May 1990.
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7. Teleglobe may file a reply to any comments, serving a copy on interveners, by 4 June 1990.
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8. Where a document is to be filed or served by a specific date, the document must be actually received, not merely mailed, by that date.
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Related documents may be examined at Teleglobe's business office or at the offices of the CRTC, Room 201, Central Building, Les Terrasses de la Chaudière, 1 Promenade du Portage, Hull, Quebec, or Complexe Guy Favreau, East Tower, 200 René-Lévesque Blvd. West, 6th Floor, Montréal, Quebec. Copies may be obtained by any interested person upon request directed to Teleglobe at the address shown in paragraph 1 above.
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Fernand Bélisle
Secretary General
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