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AGENDA #9

MEMORANDUM

TO: Mayor and Town Council

FROM: W. Calvin Horton, Town Manager

Ralph D. Karpinos, Town Attorney

SUBJECT: Report on Time Warner/America Online Merger

DATE: May 22, 2000

REVISED AND UPDATED: July 5, 2000

The purpose of this report is to outline the merger of Time Warner and American Online, AT&T’s acquisition of MediaOne’s 25% stake in Time Warner, and any effects of these transactions on the Town as franchising authority.

This report takes into account the June 22 decision by the Ninth U.S. Circuit Court of Appeals, which held that Portland, Oregon, could not require a cable operator to open its cable modem platform to all Internet service providers on a nondiscriminatory basis. The Ninth Circuit reached this decision by concluding that cable modem service to provide Internet access was a telecommunications service, not a cable service. Local governments cannot exercise regulatory authority over telecommunications services, such as telephones.

Based on this court decision and on the review of the attached materials, we conclude that the Time Warner-America Online merger issues will have little or no effect on the Town or local cable customers. However, as part of the process, we recommend that the Council tonight: (1) allow time for public comment on these issues; (2) approve the attached FCC-394 (Attachment 1); (3) adopt the attached report from Robert Sepe of Triangle J Council of Governments (Attachment 2); and (4) approve Resolution A, which grants Town consent to the merger.

Representatives of both Time Warner and Triangle J Council of Governments will be present tonight to answer Council Members’ questions.

BACKGROUND

On January 10, 2000, America Online announced its $166-billion acquisition of Time Warner, the world’s largest media and entertainment company. America Online (AOL) shareholders would own 55 % of the combined company, to be called AOL Time Warner Inc. Time Warner had previously announced AT&T’s acquisition of MediaOne’s 25% stake in Time Warner Entertainment.

On February 8, Brad Phillips, Time Warner Vice President of Government and Public Affairs, wrote the Town Manager to state that the Time Warner merger would have no adverse impact on Town cable subscribers (Attachment 3). Mr. Phillips stated that the cable franchise would be held by the same entity, and that Time Warner Cable would continue to be solely responsible for day-to-day management of the cable system. He requested that the Council approve a Federal Communications Commission (FCC) Form 394, which conveys the franchise authority’s approval of the merger (Attachment 1).

On April 7, Robert Sepe, consultant with Triangle J Council of Governments (TJCOG) who specializes in cable issues, submitted the attached staff report (Attachment 2), with recommendations for receiving public comment on the matter. His report is summarized below.

On May 1, Mr. Phillips sent the attached letter to the Town Attorney, stating that there would be no assignment or transfer of the cable franchise, or of the day-to-day management of the cable system (Attachment 6).

On May 8, TJCOG Attorney David Permar wrote a letter summarizing two draft resolutions for TJCOG member governments to consider (Attachment 7). One of these resolutions contained mandatory open access and nondiscrimination provisions, which were later ruled invalid in the June 22 U.S. Circuit Court case. Mr. Permar also recommended a provision that required Time Warner to reimburse the Town $10,000 for expenses related to the transfer.

On May 11, Brad Phillips sent the attached letter to the Town Manager, which, among other issues, objected to the $10,000 fee, explaining that the Town already recovers an annual franchise fee of 5 % of Time Warner’s local revenues (Attachment 8).

On May 16, Mr. Permar provided an additional summary letter and resolution, which still contained mandatory open Internet access provisions, deleted references to nondiscriminatory cable programming, and retained the $10,000 stipulation (Attachment 9).

On May 22, prior to the Council’s consideration of the Time Warner-AOL transfer, Time Warner agreed to an extension of 30 days for franchising authorities to consider the transfer, designating a new deadline of July 10 (Attachment 10).

Time Warner officials also provided information on a U.S. District Court case, MediaOne Group Inc., et al v. County of Henrico, Virginia, which found that a Henrico County ordinance requiring MediaOne to provide “indiscriminate access to its cable facilities” to all Internet Service Providers (ISPs) is “prohibited common carrier regulation.” No specific grants of regulatory power allow “a locality to require that the franchise holder give other ISPs the right to use its cable modem platform.” The court further ruled that there are no provisions in federal law that specifically allow “a locality to compel a cable company to make its facilities available to all ISPs” (Attachment 11). This finding preceded the conclusions of the AT&T Corp. et al v. City of Portland case on June 22.

On June 5, Mr. Permar responded with a recommendation that TJCOG members adopt the TJCOG resolution, explaining that the $10,000 reimbursement to local governments was still reasonable. (Attachment 12). Mr. Permar continued to advocate an “open access provision in any transfer resolution.”

Many local governments within the TJCOG followed suit, adopting the TJCOG draft. As of June 29, Knightdale, Holly Springs, Oxford, Smithfield, Hillsborough, and Carrboro have adopted Mr. Permar’s draft.

On June 21, Time Warner representatives met with the Town Attorney and the Assistant to the Manager to discuss language for a final draft resolution. Time Warner officials agreed to provide the attached letter of June 23, summarizing the points of FCC Form 394 and answering the Town Attorney’s questions (Attachment 13). We believe that these responses adequately answer questions raised by the Town Attorney.

On June 23, TJCOG reported that the U.S. Court of Appeals for the Ninth Circuit ruled that local franchising authorities could not impose open access requirements on cable operators in AT&T Corp. et al v. City of Portland. (Attachment 14).

On June 28, Mr. Permar reported that TJCOG negotiators met with Time Warner officials to discuss an updated transfer resolution (Attachment 15). The resulting resolution is shown as Resolution A, which we believe adequately reflects the decisions of the U.S. Court of Appeals in the Portland case.

ORDINANCES AND FRANCHISE PROVISIONS

Section 10-87(a) of the Town Code contains a provision whereby the Grantee (Time Warner) “shall not sell, transfer, lease, assign, sublet, or dispose of, in whole or in part...the Franchise…without the prior consent of the Council.” Section 10-87(b) explains that such a transfer would include: “(ii) the sale, assignment, or other transfer of capital stock or partnership….” Section 10-87(f) states that, for the purpose of the Town’s consent to the merger, the Town “may inquire into the qualifications of the prospective transferee or controlling party, and grantee shall assist grantor in such an inquiry.” Section 6.5(e) of the Town Franchise Ordinance states that Time Warner, “in seeking Grantor’s (Town’s) consent to any change of ownership or control…shall have the responsibility of ensuring that the transferee completes an application on the required FCC form” and “shall include the information required under State and federal law….” (Attachments 16-17).

DISCUSSION

The consultant and Town staff have reviewed the merger details, as described below:

A. Consultant

1. The Town contracts with TJCOG to review the Town cable franchise agreements to determine how the agreements relate to Cable Television Act requirements. The TJCOG consultant also assists franchising authorities by determining whether or not records required by the franchise agreements are being provided by the cable operator.

2. Robert Sepe, TJCOG consultant, reviewed the merger materials and provided the attached report. Sepe confirmed that the FCC-394 form must be completed by the cable operator and provided to the franchise authority for disclosure purposes. Time Warner must: (a) furnish a copy of the document providing for the transfer of control from Time Warner to AOL; (b) provide information on transfer of ownership from MediaOne to AT&T; (c) address whether the transferees are legally qualified to transact business in North Carolina; (d) address the character of qualifications of the transferees; (e) discuss the transferee’s financial qualifications; and (f) present evidence that the transferee is technically qualified to operate the cable system.

3. Sepe found no material misstatements with either the Time Warner-AOL merger issue or the AT&T acquisition of MediaOne’s 25% stake in Time Warner. He recommends that the Council approve the FCC-394 transfer request, adopt the staff report, allow time for public comment on the merger, and approve a transfer resolution.

B. Town Staff

Both the Manager and Town Attorney have reviewed the FCC-394 form and met with Time Warner representatives on February 21, March 24, and June 21. The Town Attorney raised a number of issues regarding the federal application form and asked for a response from Time-Warner. We believe that Time Warner’s response is adequate, as summarized below (Attachment 13).

C. Time Warner Response

According to the June 23 letter from Time Warner Attorney Mark Prak, the merger would not change the business entity that holds cable franchises in Chapel Hill (Attachment 13). Mr. Prak therefore concludes that Section 10-87 of the franchise agreement between the Town and Time Warner does not apply.

D. Time Limit for Town Council Response

1. Time Warner originally asked that the Council approve a transfer resolution by June 8. Time Warner extended the deadline to July 10, and has since agreed to an extension until September 8. The Manager and Attorney do not believe that such an extension is necessary for the Town of Chapel Hill, since the language in Resolution A takes the recent court decisions into account.

CONCLUSIONS

We believe that the merger of Time Warner and AOL and AT&T’s acquisition of MediaOne’s 25% stake in Time Warner would not negatively affect Chapel Hill cablevision subscribers.

Resolution A contains provisions where Time Warner would operate its cable systems in a manner that does not discriminate among Internet Service Providers based on their affiliation with Time Warner/America Online, thus satisfying nondiscriminatory access concerns.

Resolution A also contains provisions whereby Time Warner will pay the Town $2,500 for costs incurred during the transfer review process, in addition to the Town’s 5 percent franchise fee.

We recommend in Resolution A that the Council consent to the merger and transfer of ownership.

RECOMMENDATION

That the Council approve Resolution A, in whichthe Council: (1) adopts FCC Form 394; and (2) consents to the merger and transfer of ownership between Time Warner and AOL, with provisions for reimbursement of $2,500 to the Town.

Resolution B denies Council’s consent to transfer of control.

ATTACHMENTS

1. FCC-394 (without attachments) (p. 13).

2. April 7, 2000 Memorandum from Robert F. Sepe (p. 21)

3. February 8, 2000 letter from Brad Phillips to Town Manager (p. 36)

4. February 17, 2000 letter from the Town Manager to Randy Fraser (p 38).

5. February 28, 2000 report from the Town Manager to Mayor and Town Council (p.39).

6. May 1 letter from Brad Phillips to Ralph Karpinos (p. 40)

7. May 8 letter from David Permar (p. 41)

8. May 11 letter from Brad Phillips to Town Manager (p. 42).

9. May 16 Memorandum from David Permar to TJCOG Consortium Members (p. 45).

10. May 22 letter from Brad Phillips to David Permar (p.47).

11. United States District Court Case, MediaOne Group, Inc., et al v. County of Henrico, Virginia (p.48).

12. June 5 Memorandum from David Permar to TJCOG Cable Consortium Members (p.62).

13. June 23 letter from Mark Prak to Ralph Karpinos (p.63).

14. Article, “AT&T Cable Wins Round Two” (p.70).

15. June 28 Memorandum from David Permar to TJCOG Cable Consortium Members (p.74).

16. Section 10-87 through 10-93, Town of Chapel Hill Development Ordinance (p. 76)

17. Section 6.5, Town of Chapel Hill Cablevision Franchise Ordinance (p. ).

RESOLUTION A

A RESOLUTION ADOPTING FCC FORM 394 AND GRANTING THE CONSENT OF THE TOWN OF CHAPEL HILL TO THE TRANSFER OF CONTROL OF A CABLE TELEVISION FRANCHISE FROM TIME WARNER, INC., TO AOL TIME WARNER, INC., AND A TRANSFER OF CONTROL FROM MEDIA ONE GROUP, INC., TO AT&T CORPORATION (2000-07-05/R-10.1a)

WHEREAS, Time Warner Entertainment-Advance/Newhouse Partnership (“TWEAN”) holds a valid, non-exclusive franchise to operate a cable television system in Chapel Hill, North Carolina (the “Franchising Authority”); and

WHEREAS, TWEAN is a subsidiary of Time Warner, Inc. (TWI); and

WHEREAS, Media One Group, Inc., (“Media One”) holds a 25.51% interest in Time Warner Entertainment Company, L.P., (“TWE”) which in turn owns a 66.66% interest in TWEAN; and

WHEREAS, a wholly-owned subsidiary of AT&T Corporation (“AT&T”) is acquiring all of the shares of Media One pursuant to an Agreement and Plan of Merger dated May 6, 1999, (“Transaction No. 1”) so that following closing of the transaction, AT&T will control an approximate 17% interest in TWEAN; and

WHEREAS, TWI and America Online, Inc., (“AOL”) have entered into an Agreement and Plan of Merger dated January 10, 2000 (“Transaction No. 2”); and

WHEREAS, the merger agreement will result in a stock to stock merger (“Transaction No. 2”) in which TWI and AOL will merge with subsidiaries of a newly formed holding company; and

WHEREAS, as a result of Transaction No. 2, both TWI and AOL will become wholly owned subsidiaries of the new company, AOL-Time Warner, Inc (“AOL-TW”); and

WHEREAS, the franchisee, TWEAN, and TWI, AOL-TW, Media One, and AT&T, have requested the consent of the Franchising Authority, if it determines consent is necessary, to the aforementioned change of control and Transaction Nos. 1 and 2; and

WHEREAS, on or about February 10, 2000, TWI, as transferor, and AOL-TW, as transferee, filed an FCC Form 394 seeking the consent of the Franchising Authority to Transaction No. 2; and

WHEREAS, on or about February 18, 2000, Media One, transferor, and AT&T, transferee, filed a Form 394 with the Franchising Authority seeking consent to Transaction No. 1; and

WHEREAS, the Franchising Authority has conducted a thorough review of the legal, technical and financial qualifications of the applicants and the transferees to own and operate the cable system; and

WHEREAS, the Franchising Authority has received and reviewed the report of its cable television consultant concerning the legal, technical and financial qualifications of the transferees and provided an opportunity for public comments; and

WHEREAS, AT&T and TWI are the two largest cable television operators in the United States and AOL is the largest and most dominant provider of Internet services; and

WHEREAS, TWI and AOL have entered into a Memorandum of Understanding dated February 29, 2000 (the “MOU”), a copy of which is attached hereto as Attachment A, setting forth significant commitments that AOL/TW will undertake to enable cable modem subscribers to obtain service from affiliated Internet Service Providers (ISPs). Included among those commitments is the commitment of AOL/TW to operate its cable systems in a manner that does not discriminate among ISPs based on their affiliation with AOL/TW; and

WHEREAS, following further review and an investigation, the Franchising Authority has concluded that the transferees have established that they meet the technical, legal, and financial criteria to operate the cable system and have satisfied all criteria set forth in and/or under all applicable or required local government and federal documents, laws, rules and regulations, including FCC Form 394 and contingent upon applicants meeting all of the requirements set forth below;

NOW, THEREFORE, BE IT RESOLVED that in consideration of the foregoing and the promises set forth herein, the Franchising Authority and the transferees agree to the following:

1. The Franchising Authority consents to Transaction Nos. 1 and 2, effective immediately upon the closing of the transactions contemplated by the agreements, provided that said closings take place prior to July 1, 2001.

2. The Franchising Authority confirms that:

(a) the franchise held by the franchisee is valid and in full force and effect.

(b) the franchisee will be in material compliance with the franchise if the other conditions set forth in this Resolution are met.

3. TWEAN:

(a) agrees to be bound by the franchise and perform all duties and obligations thereunder;

(b) represents and warrants that it is able to provide and agrees to provide all services required under said franchise;

(c) acknowledges and agrees that TWEAN is subject to the regulatory authority of the grantor as provided by state and federal law;

(d) agrees to cooperate fully with the Franchising Authority and to obtain from any governmental agency having jurisdiction, all licenses, permits, and other authority necessary for lawful operation and maintenance of the cable system.

4. The past performance of TWEAN under the control of TWI pursuant to the franchise is not waived by the Franchising Authority consenting to this transfer and adopting this Resolution. TWEAN (under the control of its new parent, AOL-TW) agrees to be responsible for and bound by the breaches and non-performance, if any, of TWEAN (under the control of TWI) prior to this transfer. The Franchising Authority may, after consummation of the Transaction Nos. 1 and 2, consider in any ongoing renewal proceeding, the past performance of TWEAN (under the control of TWI) to the extent permitted under 47 U.S.C. §546, as if it were the past performance of TWEAN (under the control of AOL-TW).

5. TWEAN and AOL-TW agrees that the revaluation of the cable system assets, if any, resulting from Transaction Nos. 1 and 2 shall not be the basis for any future rate increases for any regulated cable service, including, but not limited to basic cable service, equipment rentals, and installation costs.

6. This Resolution shall become effective on the date of passage, but shall be automatically rescinded and the transfer of control denied (1) if not accepted in writing by TWEAN within thirty (30) days of passage; or (2) if any of the conditions of this consent resolution are determined to be invalid in a final judgment by a court of competent jurisdiction.

7. Within thirty (30) days following the adoption of this Resolution, TWEAN shall pay the sum of $2,500 to the Franchising Authority if it has 1,000 or more subscribers and the sum of $1,250 to the Franchising Authority if it has 999 or fewer subscribers, to reimburse the Franchising Authority for its expenses in connection with this transfer. None of the foregoing expenses described in this paragraph or TWEAN’s payment shall constitute an offset against franchise fees or any other amounts due the Franchising Authority from TWEAN pursuant to the terms of the Franchise or otherwise.

8. The Franchising Authority is granting its consent to the transfer of control of the Franchise in reliance on the commitment of TWI and AOL (as expressed in the MOU), and Franchisee (as an entity substantially owned by TWI, and proposed to be substantially owned by AOL/TW), to the principles expressed in and underlying the MOU.

PASSED, ADOPTED AND APPROVED this ______________ day of _____________________, 2000.

LOCAL GOVERNMENT

By:_____________________________

Title:____________________________

ATTEST:

By:___________________________________

Clerk

WE CONSENT TO AND ACCEPT THE TERMS AND CONDITIONS OF THIS RESOLUTION.

DATE OF ACCEPTANCE: TIME WARNER ENTERTAINMENT

ADVANCE NEWHOUSE PARTNERSHIP

_______________________________ By:_________________________________

RESOLUTION B

(DENIAL)

A RESOLUTION DENYING THE CONSENT OF THE TOWN OF CHAPEL HILL TO THE TRANSFER OF CONTROL OF A CABLE TELEVISION FRANCHISE FROM TIME WARNER, INC., TO AOL TIME WARNER, INC., AND A TRANSFER OF CONTROL FROM MEDIA ONE GROUP, INC., TO AT&T CORPORATION (2000-07-05/R-10.1b)

WHEREAS, TWEAN is a subsidiary of Time Warner, Inc. (“TWI”); and

WHEREAS, Media One Group, Inc., (“Media One”) holds a 25.51% interest in Time Warner Entertainment Company, L.P., (“TWE”) which in turn owns a 66.66% interest in TWEAN; and

WHEREAS, TWI and America Online, Inc., (“AOL”) have entered into an Agreement and Plan of Merger dated January 10, 2000 (“Transaction No. 2”); and

WHEREAS, the merger agreement will result in a stock to stock merger (“Transaction No. 2”) in which TWI and AOL will merge with subsidiaries of a newly formed holding company; and

WHEREAS, as a result of Transaction No. 2, both TWI and AOL will become wholly owned subsidiaries of the new company, AOL-Time Warner, Inc (“AOL-TW”); and

WHEREAS, on or about February 10, 2000, TWI, as transferor, and AOL-TW, as transferee, filed an FCC Form 394 seeking the consent of the Franchising Authority to Transaction No. 2; and

WHEREAS, on or about February 18, 2000, Media One, transferor, and AT&T, transferee, filed a Form 394 with the Franchising Authority seeking consent to Transaction No. 1; and

WHEREAS, the Franchising Authority has conducted a thorough review of the legal, technical and financial qualifications of the applicants and the transferees to own and operate the cable system; and

WHEREAS, AT&T and TWI are the two largest cable television operators in the United States and AOL is the largest and most dominant provider of internet services; and

WHEREAS, TWI is a major provider of news, entertainment, and sports programming for cable systems, and AOL is a major provider of programming and services on the Internet; and

WHEREAS, Roadrunner, a high speed internet service provider, is jointly owned by Media One and TWI, and AT&T has a majority interest in Excite At Home Corp., another high speed internet service provider; and

WHEREAS, cable television operators through the use of their broadband platforms offer a technically superior method of providing internet services to customers and is therefore and “essential facility” that competing internet service providers cannot practically duplicate; and

WHEREAS, there are many Internet service providers and cable programming providers who are not affiliated with any cable operator; and

WHEREAS, TWEAN, as a franchise holder under N.C.G.S. §160A-311 et seq., is a “public enterprise” obligated to provide service to all persons without discrimination; and

WHEREAS, in a recent settlement agreement with the Federal Trade Commission, TWI agreed to stop pressure tactics that have added millions of dollars to compact disc prices since 1997 and end anti-competitive policies and discontinue coercive agreements requiring record stores to charge specific minimum advertised prices for CDs; and

WHEREAS, Transaction Nos. 1 and 2 will eliminate or reduce competition in the provision of Internet services and cable programming to the public;.