Alameda’s Cable Conundrum

The pending disposition of the city's troubled cable TV system may go down as the largest financial disaster in city history

Kevin Kennedy doesn’t think of himself as a whistleblower. Nor is the financial planner prone to saying “I told you so.” It’s counterproductive, he says.

But following a joint Alameda City Council and Public Utilities Board meeting in February 2006 at which the elected city treasurer just happened to focus on an obscure footnote at the bottom of a PowerPoint slide during the meeting, he started asking questions about Alameda Power & Telecom’s nascent cable TV system and its financial health. When he didn’t get immediate answers to his questions and was delayed in getting copies of requested reports, he started asking the same questions publicly, sometimes in meetings with local newspapers.

As it turned out, he and City Auditor Kevin Kearney were the only public officials to speak out on what many believe will be the biggest finance debacle in Alameda’s 154-year incorporated history. Sometime before the end of this year, the city may write the final chapter in the history of the utility’s troubled cable and Internet division, likely by selling the system and in the process losing close to $80 million in ratepayer and taxpayer money.

“I can tell you sincerely that I wish I hadn’t been right,” Kennedy, 41, said during a recent interview. “What continues to concern me is that I wonder exactly how far does a person have to go before people start listening?”

Like other municipalities across the nation, Alameda became interested in the cable business following the 1996 deregulation of the telecom industry. Soon thereafter, the idea of Alameda owning and operating its own cable TV system began to circulate around city hall. That gave birth to a ballot proposition that city voters narrowly approved two years later.

People who voted for the 1998 proposition say they distinctly remember proponents swearing that an economic “firewall” would separate the fledgling cable start-up from the financially flush Bureau of Electricity, which traces its roots back to 1886. Voters were told that the telecom project would be financed with funds from bond sales and that the project would quickly pay for itself in just a few years.

While members of the city council, utilities board, and AP&T staff would later debate exactly what these assurances meant, it was clear from almost the beginning that any firewall between the electric utility and the cable system was more rhetorical than financial. After all, as early as 1996, the utility already had built a fiber-optic system — ostensibly to help manage its electrical power system but also as the backbone of what officials anticipated would eventually be a cable TV system.

The city and the Bureau of Electricity (the predecessor agency to AP&T) began construction on the system in 1999. By 2000, AP&T began “loaning” its cable start-up millions of dollars from the electric division — all in apparent contravention of what voters were promised.

The money initially was transferred in small amounts but then increasingly grew in scope. From 2003 to 2004 alone, $11.4 million was given to the cable project. The problem with these so-called “interfund advances” — which totaled $43.6 million as of last year according to records — is that they were never made a part of the public debate. In fact, until Kennedy and Kearney started talking about the loans, very few people knew anything about them.

Even in late 2000 and early 2001, as the telecom bubble was bursting, AP&T continued with its construction efforts. Across the bay in Palo Alto, which had been building its own fiber optic-based cable system, officials abruptly stopped work on their project, apparently seeing the financial handwriting on the wall.

In July 2001, construction on Alameda’s system reached the point where cable services could be offered to a few initial customers. A year later, the system had 5,000 subscribers. In June 2005, construction on the project was declared complete and the utility claimed it had 15,000 subscribers, some 5,000 of whom were getting Internet-only services.

And while the cable division continued to be propped up by the electric division’s loans, the initial construction bonds were coming due and had to be refinanced. As a result, the division’s total bonded debt grew to $33 million, with a balloon payment in June 2009.

While observers argue about why this series of events unfolded as it did, what has become clear is that a nearly blind faith in the cable division’s ultimate success pervaded the ranks of the utility board and city management. They were sure that the city’s foray into the cable business would be lauded as an example of forward-thinking municipal governance.

But in the summer of 2006, partially in response to the concerns expressed by Kennedy and Kearney and by the growing media coverage, the utilities board hired a consultant to get an outsider’s perspective on the situation. The board’s consultant recommended that AP&T do several things, including slashing its municipal workforce and adding telephone service to its lineup of programs and services.

The board eventually held two large, well-attended community meetings in January 2007, at which it got its first direct taste of the public’s displeasure with the situation. Following those meetings, the board ditched the telephone proposal but did implement many of the consultant’s other recommendations. This allowed the utility to begin seeing operating revenues slowly match expenses on a year-over-year basis.

And while the whole issue slowly drifted back under the public’s radar for the bulk of 2007, it began to sink in to utility board members and city hall management that the long-term bonded debt was acting like an ever-tightening noose around their necks. Realizing that they had far more questions than answers, in late 2007 the utilities board hired a cadre of outside experts to help them study the crisis.

When this second group of experts returned to the board in February with its initial findings, its report was downright bleak. Led by San Rafael-based Northcross, Hill & Ach, Inc. and New York-based Waller Capital Partners, the group presented the Public Utilities Board with three options:

1) Keep the system and try to refinance the wilting $33 million bond balloon payment before it comes due in June 2009;

2) Keep the system and refinance the bond but also add telephone services to increase revenues, or

3) Sell the system.

The problem with options one and two — and the reason they won’t likely be pursued by the utilities board — is that the cable system is just not bringing in enough revenue to enable the city to refinance.

But selling the system won’t be easy, either. The consultants noted that the bond holders must first consent to the sale. Otherwise, they could take control of the cable system themselves or force AP&T to run the system under their direction for up to ten years, extracting any net revenue along the way. Meanwhile, selling the system may not generate enough cash to retire the $33 million balloon payment.

Industry consultants say that when healthy cable systems are sold they can generate roughly $1,500 to $2,000 per cable customer. AP&T now has about 10,000 cable customers and 5,000 Internet customers, which suggests that any sale under those terms would leave the agency roughly $13 million short. And some sources close to the situation say that the actual worth of the Alameda cable system has been judged to be worth far less than what the $1,500 to $2,000 per customer ratio would yield.

Because many municipal bond lawyers and traders operate in a cloistered environment where a partner one day could become a competitor the next, no such expert contacted for this article would agree to allow their names be used on the record. Still, two people in the bond business offered interesting views of AP&T’s situation.

One said that assuming the city does raise something close to $20 million from the sale of the system, it also would have to float another long-term bond to pay off the balance of the note. “That’s probably the most expeditious way the city could get out from under this mess,” she said.

But a colleague said that wasn’t the city’s only option. “Default is a real possibility,” he said. “It might not be politically palatable, but the fallout in terms of damage to the agency’s credit rating or its ability to float a bond in the future would be minimal — and those costs would be nothing in comparison to the cost of floating another bond just to pay off the [$33 million] note.”

In many ways, the damage to AP&T’s credit rating may have already been done, the analyst said. “The $44 million in interfund transfers are up in smoke,” he said. “That much seems quite clear. This materially weakens AP&T’s balance sheet. There’s a good chance they face a credit rating downgrade but that likely just means incrementally higher rates, not a cutoff of credit.”

Politically, the fallout from the debacle remains to be seen.

The city charter allows the appointed Public Utilities Board to operate semi-autonomously from the city council thanks in part to a 1933 city hall corruption scandal which sent at least one city official to jail. However the city council is ultimately responsible for approving AP&T’s annual budgets. That is where council members could have acted to avert or at least soften the financial hit caused by the cable system’s derailment.

With the possible exception of Councilwoman Lena Tam, who was elected in November 2006, the remaining four city council members — Mayor Beverly Johnson and council members Doug deHaan, Marie Gilmore, and Frank Matarrese — all have been on the panel for years now. DeHaan and Gilmore are just completing their first four-year terms and are expected to seek reelection to office this fall.

But it remains to be seen whether the debacle actually has any political “legs” amongst the city’s voters. Both Matarrese and Johnson were handily reelected to their respective offices despite numerous stories appearing on the issue in the Alameda Journal, the East Bay Express, and other papers.

While Johnson, who has been on the council since 1998, declined to answer questions for this article, Matarrese said he remains deeply troubled by the whole matter. Although not defending AP&T’s actions, he said that the city’s foray into the cable business was done originally with the best of intentions.

“The original idea was that we — the citizens of Alameda — would have local control on the system’s content and on its prices,” Matarrese said. “Clearly, that didn’t happen. With hindsight being 20-20, do I think the effort was worth it? Obviously not.”

Neither Matarrese, utilities board president Ann McCormick, nor AP&T general manager Girish Balachandran would disclose how they were leaning on the final disposition of the system. DeHaan noted that the unsavory experience has provided him and his council colleagues with some important lessons. “We know the $44 million is gone and that’s a bitter pill to swallow,” he said. “Going forward, it’s clear that we have to change the city charter and regain full control over this utility.”

Balachandran said he hopes to have a “decision-ready” report from the consultants to place in front of the five-member utilities board soon, perhaps within the next three to four months.

Meanwhile, Kennedy, the city’s treasurer, says that if he takes comfort in anything related to AP&T, it is that his and city Auditor Kearney’s outcry served to at least slow the cable division’s financial free fall. “Yes, I’m an elected treasurer, but I’m not a real politician — I’ve never claimed to be. My main goal all along was to get the bleeding stopped on this thing,” Kennedy said. “We’re very close to that. We’re close to stabilizing this situation and for that I’m glad.”

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