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Court de-cap-itates FCC; Elimination of cable cap raises questions for AT & T, FCC - Government Activity

The elimination of the cap, even on a temporary basis, opens up new strategic possibilities to AT & T.

Handing a victory to AT & T, a federal appeals court recently ruled the FCC's cap prohibiting cable operators from serving more than 30% of U.S. cable subscribers is too low but affirmed the agency's right to establish the cap. The commission's calculations have AT & T controlling about 42%.

The FCC established the cap, in part, by theorizing that two large, multiple systems operators (MSOs) - each controlling cable systems and programming assets - could collude in their programming decisions, thereby preventing the success of independent programming entities and, consequently, harming consumers.

It was this line of reasoning the appeals court rejected.

"The only justification that the FCC offers in support of its collusion hypothesis is the economic commonplace that, all other things being equal, collusion is less likely when there are more firms," the court's ruling read. "This observation will always be true, although marginally less so for each additional firm; but by itself it lends no insight into the question of what the appropriate horizontal limit is."

At a speech before the U.S. Telecom Association, FCC Chairman Michael Powell said the commission was still digesting the ruling and had yet to decide whether it would appeal the decision or modify conditions to the AT & T/MediaOne merger, which caused AT & T to exceed the 30% cap.

Given Powell's free-market approach, however, there is a good chance that the commission will not seek to have the 30% cap reinstated by the courts.

The subscriber cap was established last year when the commission was under the stewardship of William Kennard, who had a more activist approach to regulation than Powell. In the past, Powell has indicted broad use of abstractions in making regulatory decisions, as evidenced by his comments concerning the instant messaging conditions placed on the AOL/Time Warner merger.

"The majority... accepts a competitive analysis that I believe is flawed and undermined by the known evidence," Powell said. "Yet according to the evolving analysis as it exists now, the FCC is undeterred, and wherever the competitive analysis is obviously ailing, the holes are plugged by resorting to the venerable and amorphous public-interest standard."

Even if the FCC chooses to accept the ruling, it will be challenged, said Keith Kennebeck, cable analyst with The Strategis Group.

"It sounds very controversial, and opposing organizations or other regulatory bodies will strike it down or try to strike it down," he said.

Regardless of the FCC's decision on an appeal, it likely will create some sort of cap, said Mike Paxton, senior analyst for multimedia at Cahners In-Stat Group.

"They may establish a cap at a much higher level, such as 40% or 45%," he said.

Justices on the appeals courts suggested a 60% cap might be appropriate, unless the FCC provides evidence to the contrary. However, the court did not say what the cap should be in its ruling.

The elimination of the cap, even on a temporary basis, opens up new strategic possibilities to AT & T.

As a condition to its acquisition of MediaOne, the FCC ordered AT & T to sell its 25.5% stake in Time Warner Entertainment by May 2001. The court ruling, however, seems to nullify that condition, giving AT & T flexibility during this period of transition.

"Internally, they are in a very fluid strategic situation where, on any given day, one option might look better than another," said Cynthia Brumfield, president of Broadband Intelligence.

But AT & T has a large debt load and still may unload its TWE stake to help even out its balance sheet, Paxton said. If the company chooses to divest its TWE holdings, it still benefits by having extra leverage in negotiations.

So far, the only potential buyer of AT & T's TWE stake is AOL Time Warner. Negotiations have stalled, however, causing some to speculate that AOL Time Warner is trying to force AT & T to sell on the cheap.

But this ruling may remove AT & T's deadline, giving the carrier a valuable chip at the bargaining table.

While the court's ruling may have the greatest immediate effect on AT & T, it has implications for the entire cable industry. The removal of the cap creates the possibility of an M & A revival down the road with probable acquisition targets being all but the largest MSOs.

The appeals court also overturned two other cable regulations, the first being the 40% limit to the amount of programming a cable operator may supply itself.

The appeals court ruled that the FCC offered no justification for setting the threshold at 40% and, therefore, found it in violation of the First Amendment. This ruling has the greatest potential impact on AOL Time Warner, which holds significant assets in cable systems and programming.

The court also made a decision regarding subscriber attribution. The FCC stipulated that a company owning a minimum 5% of a cable operator is attributed all of the operator's subscribers in regulatory matters. The appeals court ruled that, if a cable operator has one majority shareholder, subscribers may not be attributed to minority shareholders.