KPU TELECOMMUNICATIONS – WHY SELL

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KPU TELECOMMUNICATIONS 3 WHY SELL? This document explores the history of KPU Telecommunications and discusses questions surrounding the proposed sale of the KPU Telecommunications Division. KPU Telecommunications 3 The Past Why does the City of Ketchikan own the local telephone company ?

KPU Telecommunications has been owned and operated by the City of Ketchikan for over 70 years. At the time of its founding, KPU Telecommunications perfectly fit the bill of a cmunicipally owned utility. d Telephone service, much like electric and water, was a vital public service in Ketchikan that only the City could afford to own and operate. In the early part of the last century, it was not uncommon for local municipalities to own local telephone companies.

In fact, the City initially invested in providing telephone service in Ketchikan because no private business was interested in doing so. For over 7 decades two constants ensured the City of Ketchikan profited from owning KPU Telecommunications: " State, Federal and other unique subsidies guaranteed KPU Telecommunications would earn a reasonable profit . Unique to the telecommunications industry at that time, various government formulas ensured that the more money KPU Telecom invested in buildings, labor and infrastructure, the more money it received ... more. less.

in subsidies. In turn, the federal and state subsidies enabled KPU Telecom to maintain very low rates for local telephone service. The formulas ensured great service, low rates and many local employment opportunities. " Until mid-2007 KPU Telecommunications was effectively the local monopoly provider of telephone service . Simply put, prior to 2007, other companies did not compete with KPU Telecom to provide dial tone service. In summary, for approximately 70 years KPU Telecommunications operated as a non- competitive monopoly and enjoyed virtually guaranteed annual profit through a series of government regulated subsidies. This enabled the City to invest millions of dollars in switching and cabling networks required to provide the community with basic plain old telephone service (POTS). During this same period of time, the City of Ketchikan consolidated the Telecommunications Division with the Water and Electric Divisions into a combined cUtility d. This ensured that the Telecommunications Division 9s annual profits could be utilized to partially offset the cost of operating the Electric and Water Divisions. In short, profits from KPU Telecommunications subsidized the Electric and Water Divisions, thereby maintaining very affordable rates for water and electric customers. KPU Telecommunications 3 The Present What 9s changed? Why do we keep investing millions of dollars in KPU Telecommunications if we might sell? KPU Telecommunications has been doing a great job. Why should we sell ? As previously noted, for many decades it was common for local municipalities to own local telephone companies. For example, in Alaska several cities owned their own local telephone companies, including Anchorage and Fairbanks (both of which were sold to private enterprise about ten years ago ). However, today, in the entire United States, only Ketchikan and two other cities continue to own local telephone companies. Several compelling and intertwined developments have driven this change: Competition 3 Technology 3 Subsidies Competition : In the early 1980 9s, telephone companies lost their monopoly status. The introduction of competition ensured an explosion of new technology (can you imagine life without the Internet and cell phones?). You may have noticed that many of today 9s telecom companies are in the TV, telephone, Internet, cellular and many other related communications businesses. In part, they do this because offering different technologies is the only way they can survive. KPU Telecom for example, expended approximately $3.2 million to provide high-speed Internet and digital television services in anticipation of GCI entering the Ketchikan marketplace. Technology : If you are reading this article and are under 30 years old you may have never subscribed to the primary service for which KPU Telecom originally invested millions of dollars to provide: dial tone from a local landline. Instead, you probably have a wireless phone. As a practical matter, wireless technology ensures a continued erosion of KPU Telecom landline dial tone business. Ironically, today 9s state and federal subsidies (upon which KPU so heavily depends) are still very clandline d based. Every time KPU Telecom loses a landline customer it not only loses the revenue from local service charges, it also loses a portion of its subsidy income. Adding fuel to the competitive fire, wireless and local telecom companies basically compete for the same subsidies. Subsidies: Behind the scenes there is intense debate about and fierce competition for telecommunications-related subsidies. At the state and federal levels, wireless, long distance, and local telephone companies argue, posture and lobby over complex subsidy formulas. Everyone wants a share of the subsidy pot, while also debating whether the pot should exist in the first place for the other guy. In the meantime, it seems certain that KPU Telecom 9s share can only decline in the mid-term. And, in the short-term, the size of subsidy varies annually with increasing uncertainty over how long the rules will remain in place, with virtually no control or input as to what will happen with the next iteration of the subsidy formulas. Despite intense competition for local customers and state and federal subsidies, and despite competitive pressures and market risk, one thing is certain: KPU Telecom must continue to invest millions of dollars into telecommunications switching and cabling networks if it is to : " Remain a viable competitor. " Ensure some share of ongoing subsidies. " Remain an asset worthy of either keeping or selling. To continue investing millions of dollars into KPU Telecom 9s network in the face of increasing competitive pressure and ever uncertain subsidies begs the question: cWhat is the future of KPU Telecommunications? d KPU Telecommunications 3 The Future There are several key factors that, when combined, guarantee that KPU Telecommunications will potentially confront a challenging and precarious future : " Competition " City Ownership " Telecommunications as Part of the KPU Enterprise Fund " Future Infrastructure Investment Requirements Competition: As a practical matter, the issue of competition permeates and drives every aspect of KPU Telecom 9s future. Competitive telecommunications promises to become more intense, complex and difficult in the years ahead. Competition is already fierce for local Ketchikan telephone, long distance, wireless, Internet and television customers. Since GCI entered the local marketplace in 2007, KPU Telecom has lost approximately 1,600 of its residential lines and 400 of its business lines. Line loss, as well as the need to lower KPU Telecom 9 rates to compete with GCI, has had a negative impact on the profits of the Telecommunications Division: KPU Telecommunications Schedule of Operating Results Estimated 200920082007200620052004 Revenues$13,962,808$13,413,024$13,957,902$14,463,766$12,591,849$12,284,408 Expenses(13,479,848)(12,556,588)(12,703,059)(12,037,268)(11,073,995)(10,841,557) Net Income (Loss)482,960856,4361,254,8432,426,4981,517,8541,442,851 Actual Loss of revenues and rising costs have not only made it difficult to invest in critically needed telecommunications infrastructure for the community, but it has taken financial resources away from the Electric and Water Divisions as well. City Ownership: The very public nature of City ownership hinders KPU Telecom 9s ability to compete in an effective manner. In the private sector, success is dependent upon simplicity, speed, privacy and knowing that cone thing d that no one else knows. By contrast, City ownership often subjects KPU Telecom to very deliberative decision- making processes that are slow, public, complex and, in some cases, subject to political influences. One might reasonably ask, cHow can KPU Telecommunications compete when its business, financial, and competitive decisions are made in a public forums subject to delay and direct scrutiny by its competitors ? d Telecommunications as Part of the KPU Enterprise Fund: To succeed, KPU Telecom must invest millions in future fiber and wireless projects. Since 2004, the Telecommunications Division 9s annual capital budget has averaged approximately $3.4 million. To date, KPU Telecom has provided such improvements through the use of funds that the Utility has accrued over the years (Appropriated Reserves of the KPU Enterprise Fund). As indicated below, these funds are rapidly being depleted to fund critically important Telecommunications projects, as well as urgently needed improvements to the Electric and Water systems. Ketchikan Public Utilities Schedule of Appropriated Reserves ProjectedEstimated 2010200920082007200620052004 $4,282,399$9,134,176$14,161,046$14,249,105$14,464,290$12,804,840$13,119,893 Actual The Telecommunications Division should have the ability to fund these projects from its own profits. As noted above, however, profits are down due to competition. To make matters worse, by City Charter the Telecommunications Division is funded out of the KPU Enterprise Fund, which also provides the financial resources to operate the Electric and Water Divisions. Since the Water Division has operated historically at an annual deficit of $1,000,000, this means the profits of KPU Telecommunications have been used to fund the Water Division. The situation is only expected to get worse in the future as the Electric and Water Divisions have to invest significant dollars for infrastructure upgrades such as the Whitman Lake Hydroelectric Project, the replacement of the Bethe Substation and the replacement of deteriorated water mains in Tongass Avenue, Jackson Street and Alaska Avenue. On June 22, 2010, voters will be asked to authorize $28,700,000 in KPU revenue bonds to fund these projects. If approved, future electric and water rate increases will likely be required to pay the annual debt service on these bonds. Since KPU Telecom cannot raise its rates if it is to remain competitive with other local providers such as GCI, it is unable to issue bonds to fund additional strategic infrastructure improvements that are needed to maintain its viability in the market place. Consequently, the $3.5 million that will be required to complete the deployment of Fiber to the Home and to roll out KPU Telecom cellular service can only be funded through the combined rate structure of the three utilities, which could require even higher water and electric rate increases. In summary, to succeed in the future KPU Teleco must invest today 9s profits in building tomorrow 9s infrastructure. However, today 9s profits have been eroded by competition. Under private ownership, the presently debt-free Telecommunications Division could simply borrow money to invest in infrastructure. Under City ownership, KPU Telecom must follow a complex process requiring voter approval before it can borrow money to invest in advanced technologies. Under private ownership, the Telecommunications Division will be well positioned to enjoy a bright future. Under continued City ownership, the Telecommunications Division is not well positioned and faces a difficult future. The great irony is, of course, if the community must sell KPU Telecom, the best time to sell it is when it 9s in great shape and worth something. And right now KPU Telecom is definitely worth something. KPU Telecom has one of the best local telecom networks in the United States. It has great employees and provides a great quality of service, fantastic local TV programming and many aspects of its business have been growing. Unfortunately, the reality is that given pricing pressures, strong competition and the problems associated with public ownership of a competitive business, the time has come to sell KPU Telecom to private enterprise. Simply put, it 9s time to sell KPU Telecom because competition and required investment in technology can no longer be accommodated under City ownership. Private ownership is the only alternative to maintain what the community has come to expect from its local Telecommunications Provider. KPU Telecommunications - What Happens If We Sell? The question of selling KPU Telecommunications comes down to several key questions . " What Happens to Water and Electric Rates? Doesn 9t Telecommunications Division Revenues 8Subsidize 9 Them? " What Happens to the KPU Telecommunications Division Employees? " What Happens to KPU Telecommunications 9 Service Rates Under New Ownership? " What Happens to KPU Telecommunications 9 Quality of Service? What Happens to Water and Electric Rates? Whatever happens to water and electric rates in the future will to a certain extent occur regardless of the sale of the Telecommunications Division. As the cost of operating the electric and water utilities increases, the rates should reflect that reality. Additionally, since the net revenues of the Telecommunications Division have decreased due to competition, they are no longer available to offset future electric and water rate increases. What profits KPU Telecommunications generates will need to be reinvested into future telecommunications infrastructure if the sale of the Telecommunications Division is not approved. What is gained by the sale of the Telecommunications Division is the placement of the purchase proceeds into a Rate Stabilization Fund. This fund will be available to offset future electric and water rate increases that may be required as the result of additional debt that will be incurred to fund projects such as the Whitman Lake Hydroelectric Project, the replacement of the Bethe Substation and the replacement of deteriorated water mains in Tongass Avenue, Jackson Street and Alaska Avenue. Simply stated, should the sale of the Telecommunication Division and the placement of the proceeds from the purchase in the Rate Stabilization Fund not be approved, future electric and water rate increases could be that much higher. What Happens to KPU Telecommunications Division Employees? The ordinance adopted by the City Council authorizing the sale of the Telecommunications Division binds the new owner to employment and benefit guarantees for all Telecommunications and Customer Service employees for a period of three years. This provision ensures employees and the new owner sufficient time to grow the enterprise and take advantage of future opportunities. As evidenced by this year 9s deliberations on the 2010 Ketchikan Public Utilities Annual Budget, this guarantee is far superior to existing circumstances, which include the potential of future employee layoffs. Today KPU Telecom employees are subject to immediate fluctuations in the City 9s overall financial situation, which is challenging at best. Simply stated, if a sale is approved Telecommunications Division employees will have a three-year employment guarantee. Without a sale, there is no employment guarantee of any kind for the future. What Happens to KPU Telecommunications 9 Service Rates? There 9s no guarantee that rates will either go up or down. Regardless of public versus private ownership, what is virtually certain is that competition will continue to be intense. And intense competition tends to ensure reasonable and competitive rates. To date, it is not City ownership that has ensured competitive rates. Rather, it has been competition that has resulted in competitive rates . Unfortunately, these same competitive pressures have reduced KPU Telecom 9s profits. And, it is the City ownership that has hindered KPU Telecom 9s ability to effectively compete. The City 9s limited bonding capacity will preclude KPU Telecom from adequately investing in a competitive future, which will be detrimental to the Telecommunications Division remaining viable in the Ketchikan marketplace. In summary, selling KPU Telecom should not affect competitive telecommunications rates currently enjoyed by the community. What Happens to KPU Telecommunications 9 Quality of Service? Private enterprise will purchase KPU Telecommunications for the purpose of profit. That profit will only materialize to the extent that the new owner focuses upon beating the competition through superior products, pricing and service. Under private ownership, KPU Telecommunications is well positioned (in fact better positioned than the vast majority of telecom companies in Alaska and throughout the United States) to continue doing just that. Unfortunately, under continued City ownership it will not have the necessary financial resources to maintain such superior products, pricing and service into the future. A 8yes 9 vote on selling KPU Telecommunications places the best possible bet on a bright future for KPU Telecommunications 9 employees, rates, products, services and customers. cKPU Telecommunications 3 How Do We Sell It? And What is it Worth? d The City Council has authorized a two-step sales process, which is similar to that which was followed by the City of Anchorage when it sold its municipal phone company in 1998 : " First, the question of whether to explore a sale will be put to City residents at a special election to be held on April 6 th of this year. " Should the voters authorize a potential sale of the Telecommunications Division, the City will work with Falkenberg Capital Corporation, its professional brokerage consultant, to identify potential buyers. A preferred buyer will be selected and a formal Asset Purchase Agreement will be negotiated for a sale at a price that equals or exceeds the Fair Market Value of the division. Following the negotiation of an Asset Purchase Agreement, Falkenberg Capital Corporation will issue its opinion to the City that states whether it believes the price is fair to the City as the seller. It is important to note that the City Council will not be obligated to accept the value determined to be fair by Falkenberg Capital Corporation and that the City Council has the right to refuse the sale of the Telecommunications Division at any price . Many residents have asked the question, cWhy can 9t the buyer and purchase price be identified prior to placing the sale of the Telecommunications Division to a public vote? d The last time residents of the City considered the possible sale of the Telecommunications Division was in 1996. At that time, voters failed to authorize the sale of the division to PTI Communications, Inc. for $30,200,000. The margin of defeat was 67 votes. Since that time local telephone companies across the country have seen the value of their businesses decrease and it is unlikely that the City will receive an offer to purchase KPU Telecommunications for a price that will be comparable to that which was negotiated in 1996. If the voters authorize a possible sale of the Telecommunications Division, it is expected that there will be fewer potential buyers than there were in 1996. Those buyers that are potentially interested in acquiring KPU Telecommunications will not be willing to invest the time and resources necessary to undertake due diligence and to negotiate a purchase agreement without assurances that the City can complete a sales transaction. This is why voters are being asked to authorize a potential sale in advance of an actual offer being considered by the City Council. Again, it is important to stress that the City Council has the right to refuse the sale of the Telecommunications Division at any price. Ultimately, the creal d value of KPU Telecommunications will be determined by a valid offer from a willing buyer. The offer or value will be determined by a buyer through a process of due diligence wherein prospective buyers perform a thorough and detailed analysis of KPU Telecommunications 9 assets, future investment requirements, competitive landscape and other factors. Assuming the voters authorize the sale of KPU Telecommunications, and assuming a fair offer is received, it is believed that a new owner will assume control of the Telecommunications Division by end of 2010 or the first part of 2011. --------------------------------------------------------------------------------------------

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