PACIFICORP, Plаintiff, v. DEPARTMENT OF REVENUE, State of Oregon, Defendant.
TC 5411
IN THE OREGON TAX COURT REGULAR DIVISION
July 17, 2023
25 OTR 227
ROBERT T. MANICKE, Judge.
No. 19. Decision rendered May 24, 2023; upon parties’ motions for reconsideration, the court issued an Amended Opinion on July 17, 2023.
Trial was held November 15 through 19, 2021, in the courtroom of the Oregon Tax Court, Salem.
David J. Crapo, Crapo Deeds LLC, Bountiful, UT argued the cause for Plaintiff.
Marilyn J. Harbur, Senior Assistant Attorney General, Department of Justice, Salem, argued the cause for Defendant Department of Revenue.
Decision rendered May 24, 2023; upon parties’ motions for reconsideration, the court issued an Amended Opinion on July 17, 2023.
This Amended Opinion reflects changes to the opinion issued May 24, 2023, as determined in the court‘s Order on Cross-Motions for Reconsideration which the court issues separately today.
I. INTRODUCTION
This case concerns the real market value of Plaintiff‘s Oregon property as of January 1, 2020. Plaintiff is a rate-regulated electric utility with operating property in Oregon, as well as California, Idaho, Utah, Washington, and Wyoming.1 Because Plaintiff is in the electricity business, its property is subject to central assessment by Defendant. See
On May 22, 2020, Defendant issued a Notice of Proposed Assessment asserting that the real market value of Plaintiff‘s Oregon centrally assessed property was $3,180,000,000 on the January 1, 2020, assessment date.
Plaintiff timely appealed to the Magistrate Division from the O&O under
At trial, both parties presented expert reports and testimony complying with the requirement to “consider[] three different approaches to valuation: the cost approach, the comparable sales approach, and the income approach.” Powell Street I v. Multnomah County Assessor, 365 Or 245, 249, 445 P3d 297 (2019) (“The appraiser is not required to use all three approaches, but the appraiser must consider them.“) (Emphasis in original).
II. LEGAL ISSUES
Before determining the real market value of Plaintiff‘s property, the court must resolve two issues of law. First, the parties have different views about the extent to which the court must defer to two of Defendant‘s administrative rules relating to the determination of value. Second,
A. Court‘s Deference to Defendant‘s Administrative Rules
The parties disagree over the level of deference the court should afford to
1. OAR 150-308-0690: WSATA Handbook as Authority for Valuation Under ORS 308.205
“The 2009 Western States Association of Tax Administrators Appraisal Handbook: Unit Valuation of Centrally Assessed Properties is adopted as the official valuation guide for property assessed by the Oregon Department of Revenue under
ORS 308.505 to308.665 for ad valorem tax purposes.”
The “WSATA Handbook” consists of approximately 350 pages of guidance, in varying degrees of depth, about methods and tools for unit valuation and value allocation with respect to utility property and other centrally assessed property. It “serves as the primary textbook *** to train state government appraisers of centrally assessed properties.” WSATA Handbook at vi. As such it “incorporates WSATA‘s opinion of the current state of academic and appraisal theory” as applicable to centrally assessed property. Id. at I-1. As will be seen, the authors of the WSATA Handbook identify strengths and weaknesses in various valuation methods and theories; they rarely mandate or entirely condemn the use of a particular method, but they express reasons to prefer some techniques and to reject others. Cf., e.g.,
a. Analysis under published sources of statutory authority for OAR 150-308-0690: ORS 305.100 and ORS 308.655
Any analysis of the level of deference to afford an administrative rule must begin by identifying the statute or statutes that are the source of the agency‘s authority to adopt the rule. See Trebesch v. Employment Division, 300 Or 264, 267, 710 P2d 136 (1985) (“We seek to derive the legislature‘s intent from an analysis of the statutes by which a particular agency operates.“). The Administrative Procedures Act generally requires agencies to specify that source when adopting or amending a rule. See
The first statute referred to in the published rule states in relevant part: “The Department of Revenue shall: (1) Make such rules and regulations it deems proper to regulate its own procedure and to effectually carry out the purposes for which it is constituted.”
(1) ORS 305.100 does not require court to defer to OAR 150-308-0690.
As to the first statute, the Oregon Supreme Court repeatedly has characterized
As to the second statute, this court has found no reported decisions analyzing the degree of deferеnce or weight that applies to rules adopted under
“(1) whether the court has concluded that the term, or one like it, is delegative in another context; (2) whether the term is defined by statute or, on the other hand, susceptible to many different interpretations; (3) whether the term is one that invites a value or policy judgment; and (4) whether other, related provisions suggest a legislative intent that the term be considered a delegation.”
Penn v. Board of Parole, 365 Or 607, 628, 451 P3d 589 (2019) (summarizing OR-OSHA discussion).
Following the Penn considerations, and applying the Gaines framework, the court starts by examining the single sentence comprising the text of
The statutory context, including other central assessment statutes, provides numerous examples of “requirements” as to which guidance from Defendant is obviously helpful. Most requirements are imposed on Defendant itself, such as the procedures for apportioning Oregon value among the counties, and preparing, finalizing, and correcting the annual roll. See
Finally, the court looks to the report commissioned by the Oregon legislature in 1905 and delivered in 1906 (1906 Oregon Report), which examined Oregon‘s property tax system and proposed constitutional amendments and a statutory scheme. See Frederick W. Mulkey, E.B. Seabrook, Wm. J. Lachner, Report of the Board of Commissioners Appointed Under the Provisions of Chapter 90, Law of 1905, for the Purpose of Examining and Reporting on Matters of Assessment and Taxation, Etc. (June 30, 1906) discussed in Jarvill v. City of Eugene, 289 Or 157, 175-78, 613 P2d 1 (1980); Level 3 Communications LLC III v. Dept. of Rev., 23 OTR 440, 469-71 (2019); aff‘d 368 Or 303, 490 P3d 149 (2021). The 1906 Oregon Report includes a proposed statutory provision that reads:
“The board is hereby given the power to prescribe such directions, rules, and regulations to be followed in answering any of the requirements of this section, or as herein authorized, as in its judgment shall be best calculated to insure accuracy and uniformity in reporting the facts.”
1906 Report at 121. The writers included this sentence in an unnumbered portion at the end of section 8 of their proposed statute, which contains provisions materially similar to the tax return requirements now found in
b. Analysis under ORS 308.205
Rather than look to the published sources of statutory authority, both parties frame their arguments on the assumption that the statutory authority for
“(1) Real market value of all property, real and personal, means the amount in cash that could reasonably be expected to be paid by an informed buyer to an informed seller, each acting without compulsion in an arm‘s-length transaction occurring as of the assessment date for the tax year.”
“(2) Real market value in all cases shall be determined by methods and procedures in accordance with rules adopted by the Department of Revenue and in accordance with the following:
“(a) The amount a typical seller would accept or the amount a typical buyer would offer that could reasonably be expected by a seller of property.
“(b) An amount in cash shall be considered the equivalent of a financing method that is typical for a property.
“(c) If the property has no immediate market value, its real market value is the amount of money that would justly compensate the owner for loss of the property.
“(d) If the property is subject to governmental restriction as to use on the assessment date under applicable law or regulation, real market value shall not be based upon sales that reflect for the property a value that the property would have if the use of the property were not subject to the restriction unless adjustments in value are made reflecting the effect of the restrictions.”
(Emphasis added.) The court assumes, without deciding, that Defendant may rely on the emphasized portion of
Subsection (1) of
Subsection (2) of
- The introductory flush language, relating to rulemaking by the Department of Revenue, dates substantially to 1953 and 1955. See Or Laws 1953, ch 701, § 1 (“True cash value of all property, whether real or personal, shall be held and taken to mean the amount such property would sell for at a voluntary sale made in the ordinary course of business, under normal conditions, in accordance with rules and regulations promulgated by the State Tax Commission.“) (Emphasis added.); Or Laws 1955, ch 691, § 1 (“True cash value of all property, real and personal, means market value as of the assessment date. True cash value in all cases shall be determined by methods and procedures in accordance with rules and regulations promulgated by the State Tax Commission.“), § 2 (prescribing effective date of January 1, 1961) (emphasis added).7
- Paragraph (a) relates to a “typical” buyer and seller, and paragraph (b) refers to a “financing method.” This text was first added by the 1991 act but does not appear to correspond to or implement a specific provision in Measure 5. Paragraph (c) consists substantially of text first added to
ORS 308.205 in 1955. See Or Laws, 1955, ch 691, § 1 (adding: “With respect to property which has no immediate market value, its true cash value shall be the amount of money that would justly compensate the owner for loss of the property.“). Paragraph (d) consists substantially of text first added toORS 308.205 in 1977. See Or Laws, 1977, ch 423, § 2 (adding: “With respect to property that is subject to
governmental restriction as to use on the assessment date under applicable law or regulation, true cash value shall not be based upon sales that reflect for the property a market value that the property would have if the use of the property were not subject to the restriction unless adjustments in value are made reflecting the effect of the restrictions.“).
(1) Portland Canning and Other Cases Addressing Rulemaking Under ORS 308.205
In 1965, four years after the text now substantially found in subsection (2) had become effective, the court construed the statutory reference to rulemaking as follows:
“Clearly the dominant note of the legislation is that, if possible, value is to be ascertained in accordance with market value. While the commission has been given power to make regulations setting forth procedures as to how this may be done, it cannot vary the mandate of the law under this guise.”
Portland Canning Co. v. Tax Com., 241 Or 109, 113, 404 P2d 236 (1965) (emphasis added). Defendant‘s rule in effect for the tax year at issue in Portland Canning allowed market value to be determined by using “[a]ny one of” the three standard methods (the cost approach, the income approach, or the market approach). Id. at 113 (quoting former Reg Art 8205.1). The court found that a market existed for the majority of the component parts of the taxpayer‘s food canning plants. See id. at 113-14. Without expressly invalidating the rule‘s allowance of a single valuation approach, the court concluded that defendant erred by ignoring the existence of a market for the canning equipment in favor of relying solely on the cost approach. See id. at 113 (“The commission has no power to permit the evaluation of the property by the exclusive means of the cost approach to determine the value to the owner when a market in fact exists.“).8
Some 20 years later, the Oregon Supreme Court reached a similar conclusion in Alsea Veneer, Inc. v. Dept. of Rev., 297 Or 512, 516, 687 P2d 137 (1984). At that time, the rule provided in part:
“‘A “unit of property” is the item, structure, plant or integrated complex as it physically exists on the assessment date as real or personal property. The market value of a unit of property is not ascertained from the market price of its component materials, such as wood, glass, concrete, pipe, wire, furnaces, elevators, etc., each priced separately as an item of personal property, without regard to its being integrated into the total unit. Similarly, in the appraisal of industrial properties the fixed machinery and equipment comprise an integral part of a manufacturing plant and as such is usually real property. The market value test of such a plant is predicated upon the sales of comparable plants. No market test of unit property exists when there are no sales of comparable property at times and places which are reasonably relevant to the appraisal date and subject property under the existing circumstances.‘”
Former OAR 150-308.205-(A) (emphases added). In Alsea Veneer, Defendant argued that the “unit of property” provision in its rule precluded consideration of the market value of component parts of the taxpayer‘s veneer plant. The court rejected that argument, pointing out that Defendant had “used the component parts method” in its own valuation of the plant. Id. at 517. The court implicitly criticized Defendant for incorrectly relying on the “unit of property” provision in its rule to limit the field of comparable sales, concluding that the point of the rule provision was instead to “assist in the determination of whether property is personal or real ***.” Id. As to the portion of the rule that required sales of “comparable plants” as a predicate for using the market test, the court stated: “We cannot agree with the Department that this rule prevents the Tax Court from considering plaintiff‘s method of evaluating the machinery and equipment *** based on an appraisal of the component parts,” which included auction sales of comparable equipment. Id. However, as in Portland Canning, the court stopped short of expressly declaring
In 1999, the Oregon Supreme Court relied heavily on Defendant‘s administrative rules under
(2) Applicаtion of Springfield and Portland Canning assuming authority under ORS 308.205
In summary, none of the decisions the court has found under
“Clearly the dominant note of the legislation is that, if possible, value is to be ascertained in accordance with market value. While [Defendant] has been given power to make
regulations setting forth procedures as to how this may be done, it cannot vary the mandate of the law under this guise.”
241 Or at 113. No subsequent Supreme Court opinion overturns the holding in Portland Canning.
The court concludes that, whatever discretion might be delegated to Defendant to prescribe valuation methods and procedures for centrally assessed property, under Portland Canning that discretion does not include the authority to compel the use of methods and procedures that fail to result in real market value in a particular case. Stated positively, a taxpayer remains free to argue that a value determined in accordance with Defendant‘s rules is inconsistent with the definition of real market value in subsection (1) of
2. OAR 150-308-0590: Defendant‘s Allocation Formula for Electricity Companies
The parties also dispute the degree of deference the court should afford to Defendant‘s separate administrative
B. Burden of Proof
Each party argued at trial for an Oregon real market value different from the value shown on the central assessment roll prepared under
“In all proceedings before the judge or a magistrate of the tax court and upon appeal therefrom, a preponderance of
the evidence shall suffice to sustain the burden of proof. The burden of proof shall fall upon the party seeking affirmative relief and the burden of going forward with the evidence shall shift as in other civil litigation.”
Plaintiff acknowledges that it “seek[s] affirmative relief” in the form of a reduction of the real market value shown on the roll, and that it bears the burden of proving any such reduction. Defendant agrees with that point but disagrees with Plaintiff‘s next assertion, that Defendant bears the burden of proving any “‘increase compared to the roll RMVs.‘” Level 3 Communications LLC III, 23 OTR at 443 (2019). Defendant relies on the following passage from a 1989 central assessment opinion by the Oregon Supreme Court:
“Pacific next argues that the Tax Court erred in not requiring the Department to carry the burden of proving that its appraisal, which suggested a value significantly greater than that found by the Director of the Department of Revenue at an earlier, administrative step in this case, should be adopted. Pacific cites no binding authority for this proposition, which contradicts the basic idea that the burden in an appeal by a taxpayer to the Tax Court is on the taxpayer.
ORS 305.427 .”
PP&L v. Dept. of Rev., 308 Or 49, 54-55, 775 P2d 303 (1989). In quoting this passage, Defendant omitted the remaining sentences in the paragraph:
“The Tax Court did not err. To the extent that Pacific is also asking that this court impose such a burden on the Department in this court, the request is denied. The burden is the same ‘upon appeal’ from the Tax Court.
ORS 305.427 .”
PP&L, 308 Or at 55. On the other hand, Plaintiff cites the following passage from another central assessment opinion decided three years later:
“With respect to the case as it is presented in this court, we note only that, as to the claims that UP makes that would require a modification of the decision of the Tax Court, UP has the burden of proof by a preponderance of the evidence. We have required UP to meet that burden throughout our review of its evidence. As to the matters concerning which the Department asks this court to change the decision of the Tax Court or as to which it cross-assigns error, it is the
Union Pacific Railroad v. Dept. of Rev., 315 Or 11, 17, 843 P2d 864 (1992) (referring also to the same passage quoted above in PP&L).
This court seeks to reconcile the above statements in PP&L and Union Pacific. Under PP&L, the Supreme Court concluded that Defendant did not bear the burden of proof before this court as to an increase above the value Defendant‘s own director had set and from which the taxpayer appealed. But under Union Pacific, Defendant did bear the burden of proof, on appeal to the Supreme Court, as to any value higher than the value determined by this court.13 Yet, as the omitted sentence in PP&L declares, the same law assigning the burden applied in both courts, as it does today. See
Because both PP&L and Union Pacific predate the Supreme Court‘s announcement of the current statutory interpretation framework in State v. Gaines, the court now applies that framework to
“Relief, benefit, or compensation which may be due and granted to defendant. Garner v. Hannah, 6 Duer (N. Y.) 262. Relief for which defendant might maintain an action independently of plaintiff‘s claim and on which he might proceed to recovery, although plaintiff abandoned his cause of action or failed to establish it. Southwestern Surety Ins. Co. v. Walser, 77 Okl 240, 188 P 335, 336.”14
Black‘s Law Dictionary 75 (4th ed 1951). Comcast Corp. v. Dept. of Rev., 356 Or 282, 296, 337 P3d 768 (2014) (“[W]hen a term is a legal one, we look to its ‘established legal meaning’ as revealed by * * * legal dictionaries.“). This definition indicates that a party proceeding as a defendant could be in a position of seeking affirmative relief, at least if that party made a counterclaim.
The court proceeds to consider statutory context, starting with other procedural statutes in place in 1965. The only contemporaneous use of the full phrase “affirmative relief” in the Oregon Revised Statutes provided:
“If a counterclaim established at the trial exceeds the plaintiff‘s demand so established, judgment for the defendant shall be given for the excess; or if it appears that the defendant is entitled to any other affirmative relief, judgment shall be given accordingly.”
Former
Indeed, case law at the time indicated that, depending on the circumstances, plaintiffs and defendants could seek affirmative relief, and whichever party did so had the burden of proof. See, e.g., Chance v. Carter, 81 Or 229, 240, 158 P 947 (1916) (concluding that statute enabled “the Defendant, upon proving his claim, not only to defeat the action of the plaintiff, but also to secure affirmative relief“) (emphasis added); Hanna v. Hope, 86 Or 303, 310, 168 P 618 (1917) (“The counterclaim upon which a defendant may have affirmative relief in an equity suit must contain matters of equitable cognizance.“); Comegys v. Hendricks, 55 Or 533, 535, 106 P 1016 (1910) (“The plaintiff did not offer any evidence in support of the controverted question, and thereby failed to substantiate her right to any affirmative relief.“).
A statute perhaps more closely on point was
“The party having the affirmative of the issue shall produce the evidence to prove it. Therefore, the burden of proof lies on the party who would be defeated if no evidence were given on either side.”
Some three months before
With this context in mind, the court returns to the text of
The court has found nothing in the legislative history of SB 4 thаt sheds light on the burden of proof under
Against this backdrop of the text and context of
III. REAL MARKET VALUE ANALYSIS
The court now seeks to apply the foregoing understanding of applicable law to determine the real market value of Plaintiff‘s property, based on the evidence presented at trial. As discussed above, the court first determines the real market value of the “system” comprising all of Plaintiff‘s property used in its electricity business, without regard to location, before determining the percentage of that value to allocate to Oregon. To a great extent, the issue is fact intensive and involves “competing testimony of appraisal experts, including the credibility and persuasiveness of those experts.” Hewlett-Packard, 357 Or at 609.
A. Cost Approach
Each party‘s appraiser gave approximately 20 percent weight to his value indicator derived from a cost approach. Plaintiff‘s appraiser, Thomas K. Tegarden, determined a cost indicator of $15,838,880,747. Defendant‘s appraiser, Brent Eyre, determined a cost indicator of $20,735,886,213. Tegarden and Eyre each started with the “net book value” Plaintiff reported on its annual “FERC 1,” a form Plaintiff filed with the Federal Energy Regulatory Commission (FERC). Net book value for FERC purposes is not identical with the locally determined “rate base” on which Plaintiff is allowed to earn a reasonable return, but local regulators
1. Plaintiff‘s Method: Additional Deduction for Economic Obsolescence
Nearly all of the difference between the parties’ cost method indicators arises because Tegarden took an additional deduction for “obsolescence” in the amount of $4,428,401,079, while Eyre did not. Plaintiff argues that an approach that starts with historical cost is valid only if it allows deduction of all three of the widely recognized forms of depreciation: physical depreciation, functional obsolescence, and economic obsolescence. Tegarden testified that the deduction for depreciation on Plaintiff‘s FERC filings is too low because it does not adequately account for a type of economic obsolescence peculiar to regulated utilities, namely, the utility‘s inability to earn a return on property acquired or paid for with the following:19
(1) Deferred Income Taxes (DIT).
Broаdly speaking, DIT is the difference between (1) the amount that ratemaking authorities consider Plaintiff to
(2) Income Tax Credits (ITC).
As with DIT, property attributable to certain income tax credits is excluded from the rate base but contributes to real market value for property tax purposes to the extent used in Plaintiff‘s electricity business.
(3) Contributions in Aid of Construction (CIAC).
Money or property contributed by particular utility customers (such as large industrial plants) to fund extensions of electricity infrastructure that primarily benefit those customers is likewise outside the rate base. However, the value of the property contributes to the real market value of Plaintiff‘s system to the extent that Plaintiff uses the property.
See generally PP&L v. Dept. of Rev., 308 Or 49, 52-53, 775 P2d 303 (1989) (describing above categories of property). Tegarden‘s sources included an email exchange with an economist employed by FERC, who stated that “accounting depreciation is a cost allocation process, not a valuation
2. Does Plaintiff‘s method fail as a matter of law?
Defendant acknowledges the general point that net book value equals real market value “‘only by coincidence.‘” However, Defendant argues that an additional deduction is unavailable both as a matter of law and as a factual matter. As to the first point, Defendant argues that a deduction for economic obsolescence would “violat[e] the WSATA Handbook guidelines * * *.”20 However, based on the court‘s reasoning above, violation of the WSATA Handbook guidelines is not a basis to reject an additional deduction under the cost approach if the taxpayer can persuade the court that a value determined pursuant to the WSATA Handbook is not the real market value of the property. Plaintiff‘s proffered method does not fail as a matter of law.
3. Does Plaintiff‘s “income shortfall” method have adequate factual support?
The court thus turns to the parties’ factual arguments. Notwithstanding Defendant‘s arguments that regulatory depreciation adequately accounts for all obsolescence, the court finds it clear that the historical cost of property included on the FERC 1 form, less the FERC subtraction for accounting depreciation, may not accurately reflect the real market value used in a centrally assessed business.21 The
By Tegarden‘s own description, an income shortfall computation requires (1) proof of the existence of a “negative influence” and (2) proof of a causal relationship between that influence and diminution of Plaintiff‘s income. In this case, Defendant does not contest that Plaintiff had some amount of DIT, ITC, and CIAC, and some of Plaintiff‘s financial documents admitted into evidence refer to various items of DIT, ITC, or CIAC. However, none of Plaintiff‘s witnesses attempted to identify or quantify the relevant amount of any of those items as of a relevant time; nor did the computation establish the amount of DIT, ITC, or CIAC of the comparator companies. It is true, as the Oregon Supreme Court has found, that a mere statement of these amounts, without more, would not likely suffice to support an adjustment to net book value.24 On the other hand, without an understand-
4. Defendant‘s Cost Analysis
The court turns to Defendant‘s analysis applying a cost approach. Eyre essentially applied the HCLD method described in the WSATA Handbook, which applies depreciation and other data from the FERC 1 form and resulted in a value indicator very close to Plaintiff‘s FERC net book value. See WSATA Handbook at II-8. He was satisfied that the result was not too low because, under a “market-to-book ratio” study summarized in his appraisal report, the historical sales prices of other regulated companies always exceeded the company‘s net book value. The court finds Defendant‘s HCLD analysis unhelpful in determining real market value. The WSATA Handbook describes the HCLD method in equivocal terms, on the one hand characterizing
As for DIT specifically, the WSATA Handbook states that “[a] utility‘s inability to earn an accounting ‘return on’ investment acquired with DIT is offset by its ability to collect revenue for a tax it does not yet owe.” Id. at II-11. While a conceptual “offset” may justify the regulatory policy of including DIT, ITC, and CIAC in net book value, the WSATA handbook does not state that the included amount accurately corresponds to the value of property a utility may acquire with the extra cash from its tax savings, or from CIAC. Just as Plaintiff has been unable to show that its income shortfall calculation accurately matches the effect of DIT, ITC, or CIAC on net book value, Defendant‘s ignoring of those items is a flaw that renders Defendant‘s HCLD approach unreliable as an indicator of real market value.
Defendant‘s market-to-book ratio studies do not persuade the court that a willing buyer and seller would be likely to give any particular weight to the result of an HCLD analysis as of any particular date, nor do they overcome the loose and tenuous connection that the WSATA Handbook declares between an HCLD result and fair market value. First, in post-trial briefing Plaintiff raised evidentiary issues regarding the comparability of the historical transactions, which Defendant dismissed as “attempts to pick nits.” But assuming that the parties were to engage in an exhaustive analysis of the historical transactions that would allow
5. Conclusion Under Cost Approach
The WSATA Handbook‘s solution to the tenuous connection between net book value and real market value is to assign less weight to the HCLD cost indicator than to other indicators in the reconciliation process. See, e.g., WSATA Handbook at II-12 (“The degree to which regulatory depreciation reflects an accurate estimate of market depreciation for a particular property is taken into account when reconciling the value indicators.“). In this case, however, the court finds no factual basis to assign any weight to either party‘s cost indicator of value.27
B. Income Approach
The parties agree that the income approach to valuation (1) determines the future expected cash flow from the property, and (2) divides that cash flow by a rate. The result is the present value of the future expected cash flow, which is an indicator of the value of the property. WSATA
Value = Cash Flow / Rate
The two main methods under the income approach are direct capitalization (which uses a single year‘s projected cash flow) and yield capitalization (which uses a projection of cash flow over future years). See WSATA Handbook at III-8; Appraisal Institute, Appraisal of Real Estate at 36 (15th ed 2020). The court begins by examining the parties’ analysis under the yield capitalization method.28
1. Yield Capitalization: Constant Growth Model
Both parties applied a variation of yield capitalization known as the constant growth yield capitalization model. The constant growth model assumes that the company‘s future cash flows will grow at a constant rate into perpetuity and determines value by applying the following formula:
Value = Next year‘s cash flow ÷ (weighted average cost of capital – growth rate)
The court now determines each component of the formula based on the parties’ evidence.
2. Yield Capitalization: Cash Flow and Growth Rate for Constant Growth Model
Each party determined an estimated cash flow amount for purposes of its yield capitalization method, with markedly different results. Tegarden determined an estimated cash flow of $1.1 billion, Eyre $800 million. Consistent with the WSATA Handbook, each appraiser used as his starting point the net operating income that Plaintiff reported on its FERC 1 form for 2019 ($1,038,196,981). See WSATA Handbook at III-3 (“accounting income, such as net operating income * ** should be transformed into cash flow prior to its use“). The parties agree that, to determine cash flow, depreciation must be added back to net operating income because the amount that was deducted for depreciation is an
Tegarden‘s estimated cash flow of $1,100,000,000 is only slightly greater than Plaintiff‘s actual 2019 net operating income, reflecting his “assum[ption] that the amount of capital reinvestment is equal to the depreciation expense.” Tegarden took into account net operating income in the prior three to five years and various statistical measures of those amounts, including a comparison against net plant investment. As for assumptions about the future relevant to growth, Tegarden considered the effect of anticipated positive and negative rate changes in different service territories, which he estimated would result in a modest net reduction ($1,957,538), as well as construction work in progress expected to be placed in service, which he estimated would cause a slight immediate increase.
Eyre determined an estimated cash flow of $800 million. Eyre first increased 2019 net operating income slightly, from $1,038,196,981 to $1,059,000,000 by applying a two percent growth factor. He created a substantial net decrease ($270,000,000) when he added back estimated depreciation and amortization of $1,030,000,000 while subtracting estimated capital expenditures of $1,300,000,000. Eyre also subtracted $43,000,000 to account for estimated changes in regulatory assets and liabilities, and made other, smaller adjustments, resulting in his rounded amount of $800,000,000.29
The $300 million difference separating the parties derives almost entirely from Eyre‘s large net subtraction ($270 million) that resulted when Eyre added $1,030,000,000 for depreciation and amortization while deducting $1,300,000,000 for capital expenditures, as opposed to Tegarden‘s assumption that capital expenditures will equal depreciation expense. The $300 million difference does not cut the way one might expect. Counterintuitively, under the simple formula for value shown above, if one assumes the same rate, Eyre‘s lower cash flow amount in the numerator
In arguing for their respective cash flow estimates, the parties refer frequently to their differing expectations of future growth. For that reason, the court will consider the issues of cash flow and the growth factor together.
3. Plaintiff‘s Method
Tegarden‘s method generаlly fits within what the WSATA Handbook describes, in critical terms, as a “No Growth Model.” See WSATA Handbook at III-15 to III-16. According to the WSATA Handbook, this model “assume[s] that the company has no ‘effective’ future growth potential which would contribute to value.” WSATA Handbook at III-15. At this point, the court pauses to consider the meaning of “growth” as the parties (and the WSATA Handbook) use that term. Both parties distinguish between “real growth, i.e., earning more than the cost of capital” and “nominal growth, meaning that the overall size of the plant increased, and the nominal cash flows increased due to the new size, but the company was still earning its cost of capital.” See WSATA Handbook at III-16 (stating that an assumption of no future growth in cash flow means that “future capital expenditures are only expected to earn their cost of capital.“).30
Tegarden‘s approach to cash flow ignores any additional capital expenditures in excess of depreciation, while Defendant points to such excess expenditures in 2018 and 2019, as well as future projections, as a source of “real” growth in the value of Plaintiff‘s property. Plaintiff presented evidence that, while its investment in its plant has grown over time, its growth in net operating income has not kept pace. Plaintiff points to a graph showing that, at least since 2001, the rate of annual increases (or losses) in net operating income corresponds closely to the rate of annual increases in net plant. A more detailed table shows that,
Plaintiff also presented officer testimony and an exhibit showing that, for the assessment year ended December 31, 2019, Plaintiff earned a regulatory rate of return of 7.373 percent, which was less than the allowed regulatory rate of return (7.60%). In addition, Plaintiff‘s managing director of revenue requirement, Steven McDougal, testified that Plaintiff earned less than its allowed return on equity for each of the approximately ten years preceding 2020. The WSATA Handbook recognizes this evidence as a potential predictor of future increases in net operating income. See WSATA Handbook at III-5 (“Another technique for predicting net operating income is to evaluate a utility‘s historical performance as compared to the regulatory body‘s allowed rate of return. An analysis of performance ratios can be used to predict where current earnings on net plant will fall in relationship to allowed earnings. For example, if it can be shown statistically that a centrally assessed company‘s historical earnings have been, for example, 95 percent of its allowed rate of return on rate base, it may be reasonable to assume a similar relationship in the future.“). The court finds that this evidence further supports Plaintiff‘s “no growth” position and enhances the reliability of net operating income as a proxy for cash flow for yield capitalization purposes.
4. Defendant‘s Method
Rather than use a proxy, Eyre attempted to build an actual cash flow estimate based on prior-year and projected
As to prior-year data, Eyre testified that he “normalized” depreciation and capital expenditure data from 2016 through 2019 in arriving at his projections for 2020. Eyre‘s normalization seems to have consisted mainly of simple arithmetic processes applied without investigation, as opposed to adjustments designed to account for identified anomalies, transactions, or other events. Eyre treated the four-year increase in Plaintiff‘s depreciation in 2016 through 2018 as a “trend” and determined his 2020 depreciation amount of $1,030,000,000 by multiplying the 2019 amount by the four-year average percentage increase. On cross-examination, however, he acknowledged that some of the increase in the two latter years may have been caused by changes in federal tax law, rather than by the addition of new property, and that he did not know whether those law changes had an effect beyond 2020.32 Also during 2018 and 2019, capital expenditures increased dramatically, jumping more than 60 percent in 2018 and more than 70 percent in 2019.33 There is no evidence that Eyre investigated the business reasons for these increases or the likelihood that they would continue to affect future cash flow. The court finds this troubling, particularly since capital expenditures declined approximately 14 percent from 2016 to 2017. Eyre simply averaged the amounts for all four years without explanation.
As to other prior-year data, for the item “net changes in regulatory assets and liabilities,” Eyre selected $43 million as his estimate for 2020, even though the amount for 2019 was below zero (negative $55,014,000), the amount declined for the two prior years, and there was an overall
Turning to Eyre‘s data of future projections, Eyre relied heavily on a “2020 Plan” generated by Plaintiff. The 2020 Plan is a 19-page document, consisting of tables and narrative, that bears the heading “Version 2 – 11/08/2019.” The tables are labeled “2020 Plan Summary,” “Income Statement,” “Balance Sheet,” and “Cash Flow“; each table contains columns for the years 2020 through 2029, and some tables also show one or two prior years. Eyre determined that the 2020 Plan forecasts a compound annual growth rate in net income of 8.6 percent for the first three years and 5.6 percent over the entire ten-year period. Eyre compared these rates to a forecasted compound annual growth rate in property, plant and equipment of only 2.63 percent and concluded that Plaintiff was itself predicting “real growth.” Based on this information, and on his observation that inflation for 2009 through 2019 had an annual average rate of 1.61 percent, Eyre selected a rate of growth of two percent, which affected two components of the constant growth model formula set forth above: increasing the 2019 cash flow by two percent and, separately, setting the growth rate to subtract from WACC.
The court finds little basis to rely on the 2020 Plan. Eyre understood the 2020 Plan to be Plaintiff‘s “business plan closest to the end of the year.” Eyre did not speak to anyone who had prepared it; he surmised, without evidence, that Plaintiff has “a large group of people that do this on an annual basis.” He did not ask the purpose for which the 2020 Plan was prepared. He acknowledged that the forecasted amounts become “more speculative * * * the farther you get out from the present days.” Eyre was unaware whether the 2020 Plan contained any mathematical errors
Eyre concluded that the 2020 Plan was a forecast of “real growth” because the plan predicts net income to grow at a compound annual growth rate of 5.6 percent (averaged over the ten years), while the plan predicts that property, plant, and equipment (PP&E) will grow at a compound annual growth rate of only 2.63 percent over the same period. However, Ross testified that Eyre’s computations contain a mismatch that overstates the difference between the two rates. In determining the compound annual growth rate in PP&E, Eyre included assets in each year that constituted “construction work in progress” (CWIP). Although Ross agreed that PP&E together with CWIP grew at 2.63 percent, Ross determined that PP&E without CWIP grew at 4.8 percent. Ross concluded that CWIP must be subtracted from PP&E because Plaintiff’s regulators do not allow Plaintiff to earn a return on CWIP, so CWIP does not contribute to net income. The court finds no argument from Defendant in response to this point. The court agrees with Plaintiff: Where the goal is to test for “real
The narrative in the 2020 Plan does not, by itself, support or refute Eyre’s conclusion of real growth. Like Plaintiff’s public filings on Forms FERC-1 and 10-K, the narrative in the 2020 Plan mentions many future projects and prospects, including new renewable energy and storage projects as well as coal plant retirements. However, the 2020 Plan does not appear to have the purpose of distinguishing between real growth and nominal growth, and its data are not organized in a way that informs the court on that point. The court finds no basis in the 2020 Plan to conclude that Plaintiff expected real growth.
The court finds no other evidence of future real growth. In post-trial briefing, Defendant argues that “PacifiCorp’s customer base has been increasing and is expected to continue to increase.” Defendant cites no evidence for this assertion. Eyre testified, without reference to any documentary or other evidence: “A growing company like PacifiCorp, they’re growing. They’re adding new customers every day. So they’re required to add new plant as they—as they continue to grow, they’ll probably on a normalized basis have more capital expenditure and depreciation because they’re growing.” Even if these circular assertions had a basis in evidence, they do not help the court because they fail to distinguish between real growth and nominal growth.
The court is compelled to choose between two imperfect measures of cash flow. Plaintiff offers net operating income as a proxy based on its firmly held view that the fact that it is a regulated utility means, per se, that it will never experience real growth because regulators will prevent it from earning more than its cost of capital. To some extent, Plaintiff relies on this theoretical position instead of addressing Defendant’s points, notably the fact that capital expenditures grew substantially in excess of depreciation and DIT in 2018 and 2019. On the other hand, Defendant insists just as strongly that all regulated utilities experience real growth that is not reflected in net operating income, building up a store of property value ignored by regulators, with the result that utilities always sell for more than their net book value. The court need not, and does not, resolve the parties’ competing theories to determine cash flow in this case. The court finds too many logical leaps and unsupported assumptions in Defendant’s build-up determination of cash flow. Plaintiff’s use of net operating income as a proxy, despite flaws, is superior because it is better supported by historical data. On balance, the court finds that the preponderance of the evidence supports Plaintiff’s estimated cash flow of $1,100,000,000.38 For the same reasons, the court finds that the growth rate in the yield capitalization formula is zero.39 In adopting this cash flow and the growth rate of zero in this case, the court neither validates nor rejects a generalized theory that the net operating income of a regulated utility is necessarily an appropriate
6. Yield Capitalization: Rate (Weighted Average Cost of Capital)
In a yield capitalization method, the rate by which cash flow is divided often is referred to as the “weighted average cost of capital” (WACC). See, e.g., WSATA Handbook at III-19 to III-20. The rate is composed of two components: the cost of debt, and the cost of equity. The WACC is the average of the two, weighted according to the cоmpany’s capital structure, i.e., its relative proportions of equity and debt. See id. at III-26 to III-30. The court reviews each party’s proffered capital structure, cost of debt, and cost of equity.
7. Capital Structure
In this case, the parties’ determinations of Plaintiff’s capital structure are very similar, and each is supported by substantial evidence. Tegarden determined a capital structure of 35 percent debt and 65 percent equity. Eyre determined a capital structure of 37 percent debt and 63 percent equity. The court determines a capital structure of 36 percent debt and 64 percent equity.
8. Capitalization Rate: Cost of Debt
Tegarden determined a cost of debt of 4.25 percent; Eyre determined a cost of debt of 3.73 percent. Both Tegarden and Eyre based their cost of debt on the actual yield to maturity of bonds issued by utilities they considered comparable. They agreed on one point: they each looked to bonds that were assigned the bond rating of BBB+.40 As discussed below, the parties disagree about whether to use effective rates for newly issued debt, as opposed to the yield to maturity for existing debt. They also disagree about the selection of comparator companies. Finally, Defendant argues that Plaintiff failed to select yields as of the relevant date.
Eyre reviewed one of the data sources Tegarden considered, namely, the Mergent data for all utility bonds. Eyre described this source as “the Mergent Bond Record for January 2020,” showing “the average yield to maturity for a public utility bond of [the BBB+] rating issued on 1/1/20 * * *.” Eyre selected that percentage as his cost of debt: 3.73 percent.
a. Use of Effective Rates for Newly Issued Debt vs. Yield to Maturity For Existing Debt
Defendant criticizes Tegarden’s approach on the grounds that it does not rely on the yield to maturity for debt issued on or around the assessment date, January 1, 2020. Defendant asserts: “Mr. Eyre’s 3.73% cost of debt was as of year-end 2019 but Mr. Tegarden’s 4.25% debt rate was not.” Defendant then qualifies this statement somewhat, stating that “certain of” Tegarden’s yields “are not year-end rates.” Eyre distinguished between (1) the effective rates for bonds actually issued on or about the assessment date, and (2) the effective rates for bonds issued months or years before the assessment date but traded on or about the assessment date.41 At trial, he criticized Tegarden because “Mr. Tegarden went and used the yields of bonds that have
The WSATA Handbook’s discussion of debt rates includes the following statement:
“An excellent source of debt money costs is the effective rate at which new debt issues are sold. The effective rate may vary from the coupon rate depending upon the market at the time. Wide publicity is given to the sale of new debt issues and these issues are very frequently put out to competitive bidding.”
WSATA Handbook at III-28. Thus, the WSATA Handbook implies that there is an evidentiary reason to prefer rates for newly issued debt, i.e., that those rates are more likely to be reliable because they are more likely to be based on bids from a larger number of potential buyers. The court questions whether this rationale, first stated more than thirty years ago, has a basis in fact in today’s bond market.43 Even if it does, the court finds Defendant’s reliance on the quoted passage misplaced because the WSATA Handbook elsewhere emphasizes that debt rates are “relatively easy to determine” and are “usually obtainable from current loan rates and current ratios of yield to price of bonds.” WSATA
Defendant’s second significant criticism is that, even though the Tegarden BBB+ List may have relied on yields to maturity for all rated electric utility bonds “traded at year-end 2019,” those data nevertheless were inaccurate because they were not yields to maturity “as of” December 31, 2019. Defendant’s expert Dr. Bradford Cornell testified that Tegarden may well have assembled a list of bonds that were traded at the end of 2019, but rather than use the yields attributable to trades of those bonds occurring at the end of 2019, he instead selected yields attributable to trades occurring throughout the year. Defendant presented evidence that yields on corporate and utility bonds generally declined significantly during 2019, such that relying on average rates during 2019 would be inaccurate. In a rebuttal exhibit, Cornell reprinted the entire Tegarden Master List, then selected five of the bonds shown on that list—bonds that had been issued by Plaintiff itself. Cornell presented a series of five screen shots from Bloomberg, which he described as “the traders’ internet site that produces actual market results.” For each of the five bonds, the screen shot showed seven to 12 dates in December 2019 or January 2020 on which the bond was traded, the volume and number of trades on each date, and a last yield on each date. On each screen shot the last yield reported was between approximately one percent and two percent lower than the yield shown on the Tegarden Master List. Cornell testified: “I can’t square anything like Mr. Tegarden’s number with the actual trading data for PacifiCorp’s bonds.” Defendant argues that this sample of
The court finds that the comparison of the Tegarden Lists with Bloomberg screen shots showing yields of actual trades near the assessment date raises questions but falls short as a reason to reject Tegarden’s debt rate. The trades on Cornell’s screen shots are of five bonds that Tegarden did not use because they had a rating different from the rating on which both appraisers agree. The list Tegarden actually used—his BBB+ List—includes only 37 bonds, but Cornell made no effort to provide comparable screen shots showing trades for those bonds. Cornell also made no effort to show that Tegarden used the wrong set of published data and that Tegarden should have used a more accurate set of published data. Rather, Cornell relied on unpublished data, apparently obtaining the screen shots by contacting “a trader [who] was nice enough to give [the screen shots] to me from Bloomberg * * *.” Cornell’s evidence implies that an appraiser seeking data on actual trades of seasoned bonds during a particular window of time must resort to a favor from a friend in the industry because the data are unavailable from publishing services such as Mergent. The court finds this implication implausible. The court finds the Department’s criticism of Tegarden’s debt rate inadequately substantiated by the evidence.
c. Use of Electric-Only Utilities as Guideline Issuers vs. Inclusion of Other Kinds of Utilities
Plaintiff criticizes Eyre’s cost of debt analysis because Eyre relied exclusively on a data point that includes
d. Conclusion as to Cost of Debt
The court finds that the preponderance of the evidence supports Plaintiff’s determination that the cost of debt was 4.25 percent.
9. Capitalization Rate: Cost of Equity
Tegarden determined a cost of equity of nine percent, excluding “flotation costs,” which are discussed below.47 Eyre determined a cost of equity of 6.7 percent. Each expert used three methods. Both Tegarden and Eyre used the Dividend Growth Model (DGM), which the court will discuss first.48 Both also used the historical Capital Asset Pricing Model (CAPM), as well as variations; the court will discuss the CAPM second. Finally, Tegarden used the Build-Up (Risk Premium) Method, which the court discusses third.
a. Cost of equity: DGM
Using the DGM, Tegarden determined a cost of equity of 8.35 percent. Plaintiff’s expert, Dr. Roger A. Morin, determined a cost of equity of 8.8 percent to 9.4 percent. Eyre
Cost of equity = (Dividend in Year 1 ÷ Stock Price in Year 0) + (Growth Rate)
The relatively uncontroversial fraction in clause (1) of the foregoing sentence sometimes is referred to as the current yield, or the dividend yield. For publicly traded companies, analyst firms regularly publish the current stock price, as well as estimated dividends and estimated growth rates. Because Plaintiff’s stock as a wholly-owned subsidiary is not publicly traded, the parties’ experts used published data for a group of investment-grade, dividend-paying electric utilities they selected. Morin concluded a dividend yield of 3.15 percent, and Eyre concluded a dividend yield of 3.10 percent. Tegarden’s appraisal report does not specify his conclusion as to a dividend yield, but it lists companies with average or mean dividend yield percentages ranging from 2.82 percent to 3.24 percent, and Plaintiff states in briefing: “The only material difference between Mr. Tegarden’s and Mr. Eyre’s DGM estimates is their growth estimates.” Accordingly, the court finds the dividend yield of 3.10 percent, consistent with Eyre’s conclusion and Plaintiff’s position.
Turning to the growth rate, because the DGM formula adds the growth rate to the dividend yield, the higher the growth rate, the higher the cost of equity. The parties’ experts differed over which companies’ growth rate estimates they selected and whether they modified those growth rate estimates. Tegarden and Morin used average estimated growth rates of selected companies, as published by Value Line, Standard & Poor’s, and Zacks, without modification,
“Another way of explaining this is as follows. If growth is going to decrease, less [of] the earnings will be required to finance the capital required by growth. So these liberated earnings, these freed up earnings, they have to go somewhere. Where do they go? Dividends. They can’t go anywhere else. And the big problem here with * * * Mr. Eyre’s multistage model is that he failed to take into account that if you lowered the growth you’ve got to beef up the dividend.”
Plaintiff’s tax director, Norman Ross, testified similarly:
“Mr. Eyre has used a three-stage version of the dividend growth model and that can, in fact, be a valid model, but it * * * can only be a valid model when the inputs are correctly applied, and Mr. Eyre has not correctly applied those. He’s left the dividend yield, and thus, the payout ratio constant over time while he’s shrunk the growth rate and that seriously understates the cost of equity estimate.”
The court finds that each party states valid criticisms about the other’s DGM, but neither party offers a DGM that incorporates corrections of the flaws identified by the other party. As to Plaintiff’s use of analyst-published growth rates to make a long-term forecast, the court finds Defendant’s criticism warranted. Neither party has submitted evidence
Defendant, meanwhile, proffers a multi-stage DGM that reduces the rate of growth over time. Brealey at 90-91. The court finds warranted Plaintiff’s criticism that Eyre failed to increase the expected dividend amount (the numerator in clause (1) of the formula). That some increase is likely, is supported by the testimony quoted above, as well as by a comment from a nationally recognized expert whose work is cited by both parties. (Dr. Aswath Damodoran, New York University: “A model that just changes growth and leaves discount rates and payout ratios unchanged is fundamentally flawed and that is one reason I would reject models that have 3 stages of growth and hold all else constant or the H-model, another over used and rigid model, when it comes to payout ratios.”) Cornell seemed to intend to address this point in rebuttal testimony regarding “disappearing earnings”; however, the testimony that followed merely reiterated that Plaintiff’s growth rates were too high, and the court cannot discern a refutation of Plaintiff’s criticism.
Each party has identified significant, credible shortcomings in the other’s DGM analysis. The parties have not
b. Cost of equity: CAPM (historical, ex post formula)
The parties agree that the CAPM is a widely accepted and widely used method to estimate the cost of equity. See WSATA Handbook at III-20 (CAPM one of “two most widely used and recognized methods for estimating the cost of equity”). Under the standard CAPM formula (also referred to as the “historical” or “ex post” formula), the cost of equity estimate is (1) the “risk-free rate” of return on investment plus (2) the product of (a) the “beta” factor (a number representing the company’s risk in relation to that of the average publicly traded company), and (b) the “market risk premium.” The market risk premium is the expected return in excess of the risk-free rate that an investor would demand; in other words, the sum of the risk-free rate and the market risk premium is the rate of return that a hypothetical investor could expect to derive by investing in a well-diversified portfolio of publicly traded stocks. See Brealey at 186, 205.
Cost of equity = Risk-free rate + (Beta * (market risk premium))
Market risk premium = market ratе of return – risk-free rate
Each party derived estimates using this basic formula, as well as variations discussed below.
The parties do not disagree significantly regarding the beta factor to be applied to Plaintiff. Tegarden determined an estimated beta of 0.58; Morin and Eyre estimated 0.60. Both estimates are supported by substantial evidence, and the court finds that the beta of Plaintiff was 0.60 based on the findings of at least one expert for each party.
Tegarden and Eyre each presented one historical CAPM estimate that used nearly identical inputs, with very similar results. For that estimate, Tegarden and Eyre
c. CAPM: Selection of risk-free rate
One reason Tegarden assigned little to no weight to his historical CAPM estimate was a concern that the federal government, as of the assessment date, had long been holding the Treasury bond rate below the rate that would have been set by the market. Specifically, Tegarden testified that the federal government’s practice of quantitative easing, starting around 2008, which included purchasing great quantities of its own bonds, “manipulated” the market by driving up the price, thereby reducing the yield to an artificial level. Thus, although Tegarden’s CAPM estimate applied the 2.25 percent long-term Treasury bond rate, he essentially rejected it. Morin shared Tegarden’s view but addressed the issue by using a risk-free rate of 3.9 percent derived from forecasts of future long-term Treasury bond yields. Morin gave about 16.7 percent weight to his CAPM estimate based on this higher risk-free rate (and based as well as on a “forward-looking” market premium discussed below).53
Defendant did not refute Plaintiff’s evidence that government actions resulted in lower actual long-term Treasury bond rates than otherwise might have occurred.
The court finds Defendant’s position as to the risk-free rate more persuasive. Plaintiff did not dispute that
The court concludes that the most appropriate risk-free rate is the rate of interest on long-term Treasury bonds as of the assessment date. The court finds that the federal government’s practice of purchasing large volumes of bonds may have lowered the rate but did not make the market illiquid or the resulting rate other than risk free. Morin’s proffered forward-looking rate relies on forecaster judgment and thus adds uncertainty to the rate set by the market. Therefore, the court finds that the risk-free rate for purposes of a CAPM analysis in this case was 2.25 percent.
d. CAPM: Tendency of historical, ex post method to understate cost of equity for low-beta stocks
Plaintiff’s expert Morin testified that cost of equity estimates using the historical CAPM (6.43% by Tegarden; 6.54% by Eyre) are too low because that method (which he referred to as the “plain vanilla CAPM”) has been shown to systematically understate the cost of equity for low-beta
e. Morin’s proffered correction (“empirical” CAPM)
Morin sought to correct for the tendency of CAPM to understate value by applying a variation known as the “empirical CAPM” or “ECAPM.” In oral testimony he summed up this variation as follows: “[Y]ou take the risk-free rate and increase it by 25 percent of the market risk premium and you eliminate the beta, the slope of the market risk premium by 0.75 * * *.”57 Appling the ECAPM formula, while otherwise using the same inputs, Morin’s ECAPM resulted in an increase in his estimated cost of capital by approximately 0.76 percent, compared to his CAPM (ECAPM 9.40% - CAPM 8.64%).58 Cornell testified that empirical CAPM is
“[M]ost courts use the standard model * * * So the idea that there’s an ECAPM out there that’s used is wrong, and the fact that the security market line is flatter than the pure theory projects, tends to be right. But * * * if you were to try to use that, you would have to update all the analysis using current data, which I don’t think has been done.”59
In response to this criticism, Morin testified that empirical CAPM continues to be discussed as an alternative to CAPM, referring to excerpts from several treatises. However, the court finds that the treatises merely support the fact that economists continue to criticize the “plain vanilla” CAPM formula as resulting in cost of equity estimates that are too low for low-beta businesses; the cited treatises do not refer to ECAPM as a way to correct that shortcoming. Even assuming that ECAPM has a track record of accurately correcting the disparity between the predicted results under CAPM and actual observed results over time, the court is not persuaded that ECAPM’s insertion of seemingly static weightings into a CAPM formula that otherwise consists of dynamic components (the risk-free rate, beta, and the market risk premium) will result in a reliable estimate of the cost of equity. Based on a lack of evidence that ECAPM is widely accepted, the court will assign no weight to Morin’s ECAPM estimates of the cost of equity.
f. CAPM: Plaintiff’s forward-looking, ex ante, method
Tegarden and Morin each presented cost of equity analyses that used an “ex ante” (forward-looking) market risk premium in the CAPM formula.60 Tegarden used a forward-looking market risk premium of 10.77 percent, derived from the “market-weighted average of the cost of equity capital” (13.02%) less the current long-term Treasury bond rate of 2.25 percent. For his average of the cost of equity capital,
Morin, too, used a forward-looking market risk premium, together with his forward-looking risk-free rate discussed above. Morin’s market risk premium was 7.9 percent, which is the average of the historical market risk premium (7.20%) and a prospective market risk premium derived from the S&P 500 Index (8.6%). Morin derived his prospective market risk premium by determining an expected market return on aggregate S&P 500 equities of 12.5 percent (lower than Tegarden’s 13.02%) and subtracting his risk-free rate of 3.9 percent (higher than Tegarden’s 2.25%). Morin did not provide a rationale for his weighting of his “raw” forward-looking market-risk premium by averaging it with the historical market-risk premium. With these inputs, Morin determined a cost of equity of 8.7 percent, similar to Tegarden’s 8.5 percent estimate.
Defendant’s witness Cornell criticized both Tegarden and Morin for using short-term (3- to 5-year) forecasts of the return on equity of publicly traded, dividend-paying stocks as their market rate of return. These rates, Cornell testified, are “mathematically impossible” to sustain when compared to the long-term expected growth rate for the U.S. economy. Cornell proffered as a more appropriate guidepost an estimated market risk premium of 5.20 percent contained in a publication by Professor Damodaran.61 Cornell also used the US Gross Domestic Product (approximately 4%) as a benchmark. Defendant’s expert Dr. Steven Kihm
g. Effect of Brealey range
Both Morin and Cornell referred to a range of market risk premium rates described in the Brealey treatise. Morin endorsed the range stated in the 2006 edition of Brealey:
“In their authoritative corporate finance textbook, Professors Brealey, Myers, and Allen conclude from their review of the fertile literature on the MRP that a range of 5% to 8% is reasonable for the MRP in the United States. My own survey of the MRP literature, which appears in Chapter 5 of my latest textbook, The New Regulatory Finance, is also quite consistent with this range.”
Cornell acknowledged that the Brealey treatise is “a very respected finance textbook“; he criticized two details relating to Morin‘s reliance on the Brealey range. First, Cornell claimed that the range should be updated to no more than 7.0 percent or 7.1 percent, as stated in the 2011 edition of the treatise. The court rejects this criticism because the 2020 edition of Brealey continues to declare as “reasonable” a range of five percent to eight percent. The 2020 edition states:
“Many financial economists rely on the evidence of history and therefore work with a risk premium of about 7%. The remainder generally use a somewhat lower figure. Brealey, Myers, and Allen have no official position on the issue, but we believe that a range of 5% to 8% is reasonable for the risk premium in the United States.”
On the other hand, the court finds Cornell‘s second criticism well taken: that Morin failed to account for the fact that the range for market risk premium in Brealey is calculated as a percentage above the current rate for short-term Treasury bills rather than the rate for long-term Treasury bonds (2.25%) to which all experts in this case have referred in their CAPM analyses. See Brealey at 169 (calculating hypothetical 7.7% risk premium on common stocks as 11.5% rate of return on common stocks minus 3.8% rate of return on Treasury bills). Plaintiff did not refute this criticism. Cornell testified that “[a]s of December 31, 2019, the yield on 3-month Treasury bills was 1.52 percent ***.” By this logic, the court finds that an apples-to-apples comparison requires that the range expressed in Brealey must be adjusted to refer to the same risk-free rate. When Brealey‘s range is adjusted to use the long-term bond rate (2.25%) as the risk-free rate, it becomes 4.27 percent to 7.27 percent (e.g., 5% - (2.25% - 1.52%) = 4.27%)).
Morin‘s determined market risk premium of 7.9 percent exceeds Brealey‘s adjusted top rate of 7.27 percent, as does Tegarden‘s estimate of 10.77 percent. Cornell‘s recommended rate (5.2%) is near the bottom of the adjusted Brealey range; the Gross Domestic Product benchmark is below the bottom of the Brealey range. The court finds that the Brealey range, as adjusted, is not in dispute, and the court adopts it as the reasonable range for the market risk premium in this case.
b. CAPM: Findings and conclusions
The court now summarizes its findings regarding Plaintiff‘s estimated cost of equity under the CAPM:
- The appropriate risk-free rate is 2.25 percent, which is the yield on long-term Treasury bonds as of the assessment date.
- Plaintiff‘s beta is 0.60, as determined by Morin and Eyre. Plaintiff‘s beta is “low” because it only slightly exceeds the midpoint between a risk-free investment and the level of risk of an average company.
- The cost of equity indicated by a historical CAPM is within the range of 6.43 percent to 6.54 percent, as determined by Tegarden and Eyre, respectively. However, historical CAPM likely understates the cost of equity for low-beta companies. Therefore, the court will select a cost of equity higher than 6.54 percent if supported by the evidence.
- The market risk premium is not more than 7.27 percent, derived as follows:
- Consistent with the testimony of Morin, and all of Defendant‘s experts, the range of reasonable rates of market risk premium is as stated in Brealey: five percent to eight percent, using short-term Treasury bills as the baseline.
- Consistent with Cornell‘s and Kihm‘s unrefuted testimony, the court finds that Brealey‘s published range must be adjusted by subtracting the difference between the rate of rеturn on long-term Treasury bonds and the rate on short-term Treasury bills.
- Consistent with Cornell‘s unrefuted testimony, the court finds that the rate on short-term Treasury bills as of the assessment date was 1.52 percent.
- The court computes the difference between the rate of return on long-term Treasury notes and the rate on short-term Treasury bills as 0.73 percent (2.25% - 1.52%), and the resulting adjusted range of reasonable rates of market risk premium as 4.27 percent to 7.27 percent.
- Within this range, the court determines the actual market risk premium as follows:
- The court first determines whether the low-beta understatement effect in finding (3) above requires any narrowing of the market risk premium range. Applying the inputs of a risk-free rate of 2.25 percent, a beta of 0.60, and the range of potential market risk premiums of 4.27 percent to 7.27 percent results in a range of the cost of equity from 4.81 percent to 6.61 percent. However, finding (3) above requires the lower end of this range to be raised to at least 6.54 percent. In turn, the range of reasonable market risk premiums must be raised to at least 7.15 percent (2.25% + (0.6 * 7.15%) = 6.54%). The court thus finds that the range of reasonable estimates of the market risk premium is 7.15 percent to 7.27 percent.
- Plaintiff presented evidence supporting a forward-looking market risk premium of 7.9 percent, based on returns on publicly traded stocks, which would result in a cost of equity of 6.99 percent. Defendant criticized this evidence as relying on excessively high returns on publicly traded stocks. However, the alternatives Defendant proffered to the court (market risk premiums of 4% or 5.2%) would result in respective cost of equity estimates of 4.65 percent and 5.37 percent, well below the too-low historical CAPM estimate (6.54%) that is at the bottom of the court‘s narrowed range. Plaintiff‘s evidence results in a cost of equity much closer to the limited reasonable range of 6.54 percent to 6.61 percent and is therefore more persuasive than Defendant‘s evidence. The court finds that the market risk premium was 7.27 percent.
- The court first determines whether the low-beta understatement effect in finding (3) above requires any narrowing of the market risk premium range. Applying the inputs of a risk-free rate of 2.25 percent, a beta of 0.60, and the range of potential market risk premiums of 4.27 percent to 7.27 percent results in a range of the cost of equity from 4.81 percent to 6.61 percent. However, finding (3) above requires the lower end of this range to be raised to at least 6.54 percent. In turn, the range of reasonable market risk premiums must be raised to at least 7.15 percent (2.25% + (0.6 * 7.15%) = 6.54%). The court thus finds that the range of reasonable estimates of the market risk premium is 7.15 percent to 7.27 percent.
- Plaintiff‘s cost of equity under the CAPM was 6.61 percent. (6.61% = 2.25% + (0.6 * 7.27%)
i. Cost of equity: “Build-up” or “risk premium” method
Only Plaintiff‘s experts Tegarden and Morin used a “build-up” method, also called a “risk premium” method, determining a cost of equity of 9.40 percent (Tegarden) and 10.2 percent (Morin). Under the build-up method, the cost of equity is equal to the sum of a risk-free rate (which includes an inflation premium) and a risk premium.
j. Build-up: Tegarden‘s method
Tegarden determined a risk-free rate of 4.30 percent. He testified that he derived this from the historical average yields to maturity of Plaintiff‘s own traded bonds (4.30%), after comparing two other categories of corporate bonds: (1) a “generic” set of corporate bonds issued by electric companies rated at BBB+ (3.81%), and (2) a second set of corporate bonds issued by electric companies (4.14%). He determined a risk premium of 5.70 percent by identifying the published historical arithmetic mean return since 1926 for large-company stocks (12.1%) and subtracting the long-term corporate bond total return since 1926 (6.4%), which is a difference of 5.70 percent. Although the sum of 4.30 percent and 5.70 percent is 10 percent, Tegarden testified that
k. Build-up: Morin‘s method
For his risk-free rate, Morin used the same forward-looking risk-free rate of 3.9 percent as under his CAPM analysis, derived from forecasts of future long-term Treasury bond yields rather than the current yield on long-term Treasury bonds as of December 31, 2019 (2.25%). He determined a risk premium of 6.3 percent using two methods. First, he computed the actual realized return on equity capital for the S&P Utility Index for each year, using the actual stock prices and dividends of thе index, and then subtracting the long-term Treasury bond return (the “income component of bond yields“) for that year. The result was 6.3 percent. Second, he examined the historical risk premiums implied in the cost of equity decisions rendered by regulatory utility commissions over the 1986-2019 period for which data were available, relative to the contemporaneous level of the long-term Treasury bond yield. Although the average spread was 5.59 percent, he observed an escalating trend of the risk premium and determined a 6.3 percent risk premium by statistical analysis of that trend.
l. Build-up: Defendant‘s criticisms and court‘s analysis
As to the risk-free rate component, the court sees no basis to depart from the 2.25 percent risk-free rate adopted as part of the CAPM discussed above. Tegarden offered no explanation for substituting Plaintiff‘s own historical bond rate (4.30%), and Morin‘s forward-looking rate of 3.90 percent suffers from the same uncertainty that the court already has found inconsistent with the purpose of a risk-free rate.
As to the risk premium, the court finds Morin‘s use of actual realized return on equity for the S&P Utility Index a reasonable method. Because Morin used utility data only, his result is more persuasive than Tegarden‘s approach using all large-company stocks and bonds. Defendant‘s only criticism of Morin‘s S&P Utility Index method is its reliance on historical data. Kihm in particular testified that historical earnings on utility stocks neither predict future
m. Conclusion as to build-up method
Taking into account Defendant‘s criticisms, the court adopts a modification of Morin‘s determination.63 The court finds that the build-up method results in an indicator of the cost of equity of 8.55 percent, consisting of a risk-free rate of 2.25 percent and a risk premium of 6.3 percent.
n. Yield capitalization: Conclusion as to cost of equity
The court finds that its analysis and conclusions discussed above under the CAPM method and the build-up method are comparable in the quality of supporting data and logic. The court therefore assigns equal weight to the indicators under each method. The court finds that the cost of equity is 7.58 percent, consisting of the average of 6.61 percent (CAPM) and 8.55 percent (build-up).
o. Yield capitalization: Flotation costs
Tegarden‘s estimate of WACC includes an upward adjustment of approximately 0.2 percent for “flotation costs,” defined as legal and underwriting charges a buyer would incur to actually acquire all of Plaintiff‘s property. Eyre‘s appraisal includes no adjustment for flotation costs. The parties do not dispute that these charges exist, and the parties agree that, as a matter of arithmetic, they can be accounted
p. Yield capitalization: Conclusion as to WACC
The court applies a weighting of 64 percent to the cost of equity (7.58%), and the court applies the remaining 36 percent weight to the cost of debt (4.25%). This results in a weighted average cost of capital of 6.38 percent.65
q. Yield capitalization: Constant growth indicator of value
The court applies the constant growth formula set forth above, which results in an indicator of a real market value for Plaintiff‘s system of $17,241,379,310:
| System Value | Cash Flow | WACC | Growth Rate | |||
|---|---|---|---|---|---|---|
| $17,241,379,310 | = | $1,100,000,000 | ÷ | (6.38% | - | 0%) |
r. Yield capitalization: Discounted cash flow model
The parties recognize the discounted cash flow (DCF) method of yield capitalization under the income approach, which attempts to convert the sum of future years’ cash flows into present value:
Value = Cash Flow Year 1 ÷ (1 + Rate) + CF Y2 ÷ (1 + Rate) + CF Y3 ÷ (1 + Rate), etc.
The length of the forecast period is a matter of appraiser judgment; a terminal value may remain after the end of the forecast period. See WSATA Handbook at III-14 to III-15. Eyre performed a discounted cash flow analysis, concluding an indicator of value of $23,500,000,000. Tegarden did not perform a discounted cash flow analysis; his discussion suggests that he viewed it as unnecessary given his assumption of zero real growth.
Eyre‘s DCF analysis relies entirely on the 2020 Plan as a forecast of future cash flow. His rate is the same WACC discussed above (5.60%). In the analysis above, the court has found the 2020 Plan unreliable as a measure of cash flow, and Eyre offers no new evidence or information in the context of his DCF. The court also has reached its own conclusion of WACC at 6.35 percent. For those reasons, the court gives no weight to Eyre‘s DCF analysis.66
10. Direct Capitalization (EBITDA)
Only Eyre used the direct capitalization method, which determines a single year‘s cash flow, then applies a multiplier, resulting in value:
Value = one year‘s cash flow * multiplier
Eyre selected $2,100,000,000 as his cash flow estimate.67 This amount is Plaintiff‘s earnings before interest, taxes,
Eyre selected 11.0 as his multiplier. He derived this by first determining the enterprise value of ten guideline companies, using the market value of their debt and equity securities, less cash accounts. He then estimated each company‘s normalized EBITDA based on EBITDA as reported on each company‘s Form 10K for the year ending December 31, 2019. Next, Eyre multiplied normalized EBITDA by a percentage published by ValueLine that represents an estimated growth rate for a cash flow that is not EBITDA, but which Eyre considers to be very close to EBITDA.
Having determined these base amounts, Eyre divided each guideline company‘s enterprise value by its normalized and growth-adjusted EBITDA. The result was a multiplier; for example, the lowest multiplier was that of Portland General Electric (10.0), and the highest multiplier was that of PNM Resources (16.3).69 The average multiрlier was 13.3, and the median was 13.0. Eyre selected a lower multiplier of 11.0 “to eliminate the effects of any non-regulated income that may be affecting the value of the guideline companies.” The result of Eyre‘s cash flow of $2,100,000,000 multiplied by 11 is an indicator of value of $23,100,000,000.
Plaintiff responds with numerous arguments, first, that using EBITDA as a measure of cash flow unrealistically ignores the importance of after-tax cash flow to
Plaintiff also argues that Eyre proceeded incorrectly by using the “market value of the publicly traded debt” when determining the enterprise value of the guideline companies. Defendant describes the point of Eyre‘s determination of enterprise value as “determining the market value of the company to the typical purchaser.” According to Defendant, “[t]his requires that the debt be valued at market value ***.” However, Ross testified that a purchaser acquiring all the debt and stock of Plaintiff would not buy the debt from bondholders at market price and retire it, but instead would assume the debt. This is because “most of the debt held by companies[] such as PacifiCorp[] is first mortgage bonds. And *** each of those first mortgage bonds are subject to early redemption provisions called ‘make [whole] calls.’ It‘s financially punitive to retire the debt early.” When assuming the debt, a buyer would become subject to the debt at its book or par value. Tegarden presented a table showing that the book value of the debt of each of Eyre‘s guideline companies was below the market value used by Eyre, and that Eyre‘s use of the market value of debt caused the collective enterprise value of the 10 guideline companies to be overstated by $5,454,000,000, which in turn caused Eyre‘s EBITDA multipliers to be overstated. Defendant argued that the use of book value of the debt “would be a mismatch,” but Defendant presented no evidence or reasoning to refute Tegarden‘s evidence that an actual acquirer of a utility such
Plaintiff asserts that Eyre miscalculated EBITDA for five of the ten guideline companies; Tegarden testified that Eyre incorrectly started with “operating income” and that the correct approach would have been to start with “net income.”70 According to Tegarden, this error caused Eyre to “not capture the full level of income as the starting point.” Tegarden presented a table showing that this error understated EBITDA by between 10 percent and 28 percent for each of the five comparison companies. Defendant argues that Eyre‘s method was an attempt to ensure that the EBITDA he determined contained only the regulated operating income of the guideline companies. But Plaintiff responds that the result is a mismatch between total company equity value in the denominator and something less than total company EBITDA in the numerator. Plaintiff also points out that Eyre selected 11 as his multiplier (a lower number than the 13.3 average multiplier of his guideline companies), without providing any computations showing why he chose 11, rather than 13.3 or some other number. Eyre‘s stated reason for that selection was “to eliminate the effects of any nonregulated income that may be affecting the value of the guideline companies.” The court finds that Eyre either tried to remove nonregulated amounts twice or simply did not act with transparency or care in computing EBITDA; this error undermines the reliability of Eyre‘s result.
Plaintiff levels other criticisms, some of which overlap with arguments in connection with other methods and computations. The court finds it unnecessary to address those points here because, for the reasons stated above, the court finds Eyre‘s direct capitalization/EBITDA approach substantially unreliable for the reasons stated above and will assign it no weight.
Having rejected other proffered methods under the income approach, the court adopts its constant growth indicator of value, determined using the CAPM and build-up (risk premium) methods of determining the cost of equity. As set forth above, that indicator is a real market value of $17,241,379,310 for Plaintiff‘s system.
C. Stock and Debt Approach
The stock and debt approach is a proxy for a sales comparison approach to value that can be useful when comparable sales are not available. See Level 3 Communications v. Dept. of Rev., 368 Or 303, 320, 490 P3d 149 (2021). Consistent with
The court sees no basis to analyze at length an approach upon which neither party relies. Accordingly, the court assigns no weight to Eyre‘s indicator under the stock and debt approach.
D. Conclusion as to Value of Plaintiff‘s System
Having considered the parties’ positions under the cost, income and sales comparison (stock and debt) approaches, the court concludes that neither party has carried the burden of proving the real market value for which it advocates. However, the evidence in total provides ample support for a conclusion of real market value. The court exercises its authority under
“When the determination of real market value *** is an issue before the tax court, the court has jurisdiction to determine the real market value or correct valuation on the basis of the evidence before the court, without regard to the values pleaded by the parties.”
As discussed above, in this case the court relies entirely on the income approach. The court determines that the real market value of Plaintiff‘s system was $17,241,379,310 as of January 1, 2020.
IV. ALLOCATION TO OREGON
The court now considers Plaintiff‘s assertion, as part of its valuation claim, that Defendant erroneously and improperly used an allocation formula that overestimates the real market value of Plaintiff‘s property sitused in Oregon. The formula in Defendant‘s rule consists of three factors: a “production” factor, a “generation” factor, and an “other plant” factor. Each factor relies in large part on the “original cost” of a portion of the system.71 The rule does not take into account any measure of depreciation. The first two factors, however, give some weight to components other than the cost of property, namely, the property‘s capacity to generate electricity and its actual generation in the prior year (weightings of 10% and 15%, respectively, in the production factor) and sales and revenues (weightings of 10% and 40%, respectively, in the distribution factor).72 Applying this for-
Plaintiff presented uncontested evidence that its property in Oregon is, on average, older and more heavily depreciated than Plaintiff‘s property system-wide. Tegarden testified that Plaintiff had made a relatively greater share of new investment in states other than Oregon in recent years. He presented a table showing that, in the overall system, net book value was approximately 65 percent of overall cost, while the net book value of Oregon property was approximately 52 percent of original cost.
Plaintiff contends that basing the allocation percentage heavily on original cost causes Oregon to “import value” from other states for taxation. The basis for this argument is that, “as a regulated utility, [Plaintiff] is only allowed to earn a return on the net book cost of its assets.” Therefore, according to Plaintiff, the Oregon property contributes relatively less to earnings than the proportion of value allocated to it. Plaintiff argues that this violates statutory requirements that the manner of allocation be “fair” and “just,” and that the allocation determine a “fair proportion” of Plaintiff‘s overall property.
Plaintiff quantifies its position by arguing that application of Defendant‘s formula “results in a 28 percent premium being added to the value of unitary property located [in] Oregon.” Plaintiff‘s expert Tegarden derives this “premium” by dividing the value Eyre allocated to Oregon under Defendant‘s rule ($3,712,400,000) by the net book value of Plaintiff‘s operating property in Oregon ($2,773,846,275), which yields $1.34 of value allocated to Oregon for every $1 of net book value of property in Oregon. Tegarden then compares the $1.34 amount to the ratio that Eyre‘s concluded value of the property in states other than
Plaintiff asks the court to apply an alternative allocation formula that consists of the average of two factors: (1) “gross investment” in Oregon, which consists entirely of the original cost of property in Oregon ($5,221,374,481) divided by gross investment in the entire system ($31,138,058,548), yielding a ratio of 16.7685 percent; and (2) “net investment” (net book value) in Oregon ($2,692,080,863) divided by net investment in the entire system ($20,267,281,826), a ratio of 13.2829 percent. The average оf the two factors is Plaintiff‘s proposed allocation percentage of 15.0257 percent. Compared to Eyre‘s rule-based percentage of 16.4995 percent, Plaintiff thus asks the court to reduce the allocation percentage by 1.4738 percent. If Plaintiff‘s allocation percentage of 15.0257 were applied to the court‘s concluded real market value of Plaintiff‘s system ($17,241,379,310), the result would be a real market value of $2,590,637,931, a reduction of $254,103,448 in the real market value of Oregon-situs property, or 8.93 percent.
The principal Oregon Supreme Court case construing Oregon‘s statutes governing allocation of value for central assessment purposes is Southern Pacific Trans. Co. v. Dept. of Rev., 302 Or 582, 732 P2d 18 (1987) (SoPac II). See also Alaska Airlines, Inc. v. Dept. of Rev., 307 Or 406, 769 P2d 193 (1989) (upholding airline allocation formula that included “flyover” time over Oregon in numerator of time-based factor). The property at issue in SoPac II was a “bridge” railroad owned by a corporation known as Cottonbelt that was a 99.7 percent subsidiary of the plaintiff Southern Pacific Transportation Company. See Southern Pacific Transp. Co. v. Dept. of Rev., 295 Or 47, 49, 664 P2d 401 (1983). As a bridge railroad, Cottonbelt connected traffic
The plaintiff appealed to the Oregon Supreme Court, seeking an adjustment to the allocation formula on the grounds that Cottonbelt, as a relatively more profitable bridge railroad, made a “disproportionate contribution to the value of the system.” SoPac II, 302 Or at 587. The Supreme Court affirmed this court‘s adherence to the allocation percentage determined at trial. The court found it a “fundamental flaw” to seek to determine the profitability of Cottonbelt as a standalone enterprise because Cottonbelt‘s property was used in a single, unitary business together with the property of Southern Pacific itself. Id. at 590-91. Apart from that major issue, the court found that the plaintiff had failed to prove that this court‘s apportionment formula had produced “an unfair result,” pointing out that the factors in the formula reflected “investment in, and usage of, the various parts of the railroad system,” including “[l]ine-haul tonnage and terminal activity, which Southern
Plaintiff‘s argument in this case has some similarity to that of Southern Pacific, as Plaintiff argues that its allocated Oregon real market value is disproportionate to the Oregon net book value on which it is allowed to earn a return. However, in contrast to SoPac II‘s facts, Plaintiff‘s asserted unfairness does have a basis in the physical characteristics of Plaintiff‘s Oregon operating property: it is, on average, older than the property elsewhere. Without deciding whether this case is factually distinguishable from SoPac II, the court turns to the standards for apportionment stated in that case and in the United States Supreme Court decision on which the Oregon Supreme Court primarily relied, Norfolk & Western R. Co. v. Missouri Tax Com., 390 US 317, 88 S Ct 995, 19 L Ed 2d 1201 (1968). In SoPac II, the court equated the Oregon statutory requirements of a “reasonable method,” and a “proper” or “fair proportion,” with the applicable requirements under the United States Constitution. 302 Or at 588 (“[T]hese rather vague [statutory] directives *** are essentially a codification of the limits imposed by the due process and commerce clauses of the United States Constitution[, which themselves] are much alike.“). The court turns, therefore to the United States Supreme Court‘s analysis in Norfolk & Western.
The issue in Norfolk & Western was the validity of a property tax allocation formula. The plaintiff acquired all of the rolling stock of Wabash Railroad Company in 1964, pursuant to a lease that required the plaintiff to pay applicable property taxes. See 390 US at 320. Although there was no material change in the rolling stock or in the extent of its use in Missouri for the year after the acquisition, the state taxing authority determined an assessed value for the rolling stock of $19,981,000, more than double the assessed value for the year before the acquisition ($9,177,683). See id. at 320-22. The state arrived at this amount by “follow[ing] the literal command of the statute,” multiplying the determined system value by 8.2824 percent, based on miles of track within the state vs. systemwide. The Court reaffirmed that the United States Constitution permits a state to determine the
- “Considerable latitude.” Because states may consider “going-concern value,” which is “not susceptible of exact measurement,” the states “have been permitted considerable latitude” in devising allocation formulas. Norfolk & Western, 390 US at 324; see also SoPac II, 302 Or at 589 (“wide latitude“).
- Value need not be “precise.” “A number of such formulas have been sustained by the Court, even though it could not be demonstrated that the results they yielded were precise evaluations of assets located within the taxing State.” Norfolk & Western, 390 US at 324. The cases “do not require any close correspondence” between the formulary result “and the value of property actually located in the State ***.” Norfolk & Western, 390 US at 327. “We repeat that it is not necessary that a State demonstrate that its use of the mileage formula has resulted in an exact measure of value.” Id. at 329. See also SoPac II, 302 Or at 591 (“Value assessment of the parts of a unit is necessarily a somewhat arbitrary process that must rely upon factors that are quantifiable: e.g., miles of track, terminal activity, track usage and property investment).
- “Gross distortion” is not permissible. Missouri‘s “rigid application of the mileage formula led to a grossly distorted result.” Norfolk & Western, 390 US at 326. “[W]hen a taxpayer comes forward with strong evidence tending to prove that the mileage formula will yield a grossly distorted result in its particular case, the State is obliged to counter that evidence or to make the accommodations necessary to assure that its taxing power is confined to its constitutional limits.” Id. at 329; see generally Jerome R. Hellerstein & Walter Hellerstein, I State Taxation ¶ 8.16[5] (explaining standard for determining percentage of distortion).
- Convenience and wide applicability of a formula do not justify distortion. “[N]either does the Constitution tolerate any result, however distorted, just because it is the product of a convenient mathematical formula which, in most situations, may produce a tolerable product.” Norfolk & Western, 390 US at 327.
Applying these standards, the Court concluded that the plaintiff must prevail, primarily because the increase in value was large and the evidence supporting it was lacking. See id. at 328 (“The difference between the assessed value and the actual value as shown by the evidence to which we have referred is too great to be explained by the mere assertion, without more, that it is due to an assumed and nonparticularized increase in intangible value.“).
This court now applies the standards set by Norfolk & Western and incorporated by SoPac II. The facts regarding the age difference as between Plaintiff‘s property within and without Oregon are uncontested; however, the court concludes that, as a matter of law, Plaintiff has not shown a “gross distortion” under Defendant‘s formula.75 The difference in allocated value in this case does not approach the 100 percent increase in Norfolk & Western. See 390 US at 326. As shown, if the court in this case seeks to isolate the effect of Plaintiff‘s requested allocation formula change, that change translates to a reduction in the tax base (real market value
The Oregon Supreme Court in SoPacII also identified other weaknesses with the plaintiff‘s criticism of Defendant‘s formula. See SoPac II, 302 Or at 592. The court concluded that Defendant‘s formula incorporated components (in that case, “line-haul tonnage” and “terminal activity“) that sought to measure some of the same determinants of profitability on which the plaintiff based its argument. Id. Similarly, in this case, Defendant‘s formula incorporates sales and revenue, in addition to giving modest weight to generation capacity and actual generation. Plaintiff has not persuaded the court that its proposed reliance on net book value would produce an allocation fairer than Defendant‘s. This is particularly the case because Plaintiff‘s proposed
The court finds that Defendant‘s allocation percentage of 16.4995 percent applies in this case.
V. CONCLUSION
Based on the foregoing, applying the allocation percentage of 16.4995 percent to Plaintiff‘s system value of $17,241,379,310, the court determines that the real market value of Plaintiff‘s property sitused in Oregon, as of January 1, 2020, was $2,844,741,379 prior to adjustments. Now, therefore,
IT IS THE OPINION OF THIS COURT that the real market value of Plaintiff‘s property sitused in Oregon, as of January 1, 2020, was $2,844,741,379, prior to adjustments for licensed vehicles and other locally assessed properties.
Notes
“The tax court shall recognize a rebuttable presumption of validity and correctness to have attached to the final determination of tax or assessed value from which and appeal or other proceeding may be taken to an authority independent of the authority making such first determination. The presumption shall remain with such first determination until the tax liability at issue is finally determined.”
This court continued to apply a judicial presumption of assessment validity until the Oregon Supreme Court abolished it in 1972. See J. R. Widmer, Inc. v. Dept. of Rev., 261 Or 371, 378, 494 P2d 854 (1972) (“The Tax Court (ORS 305.425(1)) and this court (ORS 305.445) review de novo without any presumption as to the correctness of the assessor‘s valuation.“).“HCLD cost indicators are generally not adjusted further to account for appreciation or depreciation. A deduction from HCLD for obsolescence is just as inconsistent as adding value to HCLD because some of the utility‘s property has increased in value since it was acquired, or because the utility‘s earnings are extraordinarily high for some reason (e.g., lax regulatory oversight). The practice of not adjusting HCLD for perceived obsolescence does not mean that obsolescence has not been considered and measured, since as noted previously, regulatory depreciation should, in theory, reflect all forms of obsolescence. The degree to which regulatory depreciation reflects an accurate estimate of market depreciation for a particular property is taken into account when reconciling the value indicators.”
WSATA Handbook at II-12.| 2020 Eyre Est. | 2019 | 2018 | 2017 | 2016 | |
|---|---|---|---|---|---|
| Depreciation (Eyre uses 8% growth rate) | $1,030,000,000 | $953,983,000 | $979,350,000 | $796,220,000 | $770,251,000 |
| Capital Expenditures (Eyre uses four-year average of these amounts) | $1,300,000,000 | $2,247,610,000 | $1,291,567,000 | $797,524,000 | $930,851,000 |
| 2019 | 2018 | 2017 | 2016 | |
|---|---|---|---|---|
| Depreciation | $953,983,000 | $979,350,000 | $796,220,000 | $770,251,000 |
| Deferred Income Tax | - $125,091,000 | -$202,299,000 | $75,165,000 | $145,070,000 |
| Total | $828,892,000 | $777,051,000 | $871,385,000 | $915,321,000 |
| Capital Expenditures | $2,247,610,000 | $1,291,567,000 | $797,524,000 | $930,851,000 |
| 2020 Eyre Est. | 2019 | 2018 | 2017 | 2016 |
|---|---|---|---|---|
| $43,000,000 | -$55,014,000 | $87,483,000 | $18,492,000 | $122,115,000 |
“The cost of debt is the current market rate for new securities. The embedded rate on securities previously issued is not a proper measure. In order to determine the cost of debt the appraiser should:
“(A) Refer to the rates for seasoned bond issues from Moody’s Utility, Industrial, and Transportation weekly news reports or other rating services for at least two months immediately prior to the appraisal date. This should be done by bond rating (Aa, A, Baa, etc.) and industry type.
“(B) Obtain information on new bond issues by industry type and bond rating from Moody’s Bond Survey or other publications for at least two months immediately prior to the appraisal date.
“(C) Consider recommendations on debt rates submitted by industry.
“(D) Select rates for each industry group by bond rating after analyzing the data in the steps above.”
In other words, the rule directs appraisers to both refer to “rates for seasoned bond issues” (paragraph (A)) and to “[o]btain information on new bond issues” (paragraph (B)). Nothing directs an appraiser to prefer, or to rely solely on, rates for new issuances.
“Some aрpraisers advocate using the actual coupon rates on existing debt (embedded debt). The logic is that during times of rising interest rates a prospective purchaser would most likely assume the existing debt rather than refinance. This position lacks merit because, even in the case of an assumption, debt with a low nominal interest rate will be discounted in the marketplace at an effective rate equivalent to the current cost of debt. The use of embedded debt rates in estimating the current cost of capital results in a capitalized earnings indicator which reflects high or low interest debt instruments at their face value rather than at their market value. Regardless of the regulatory practice of using embedded debt rates, their use is contrary to the market value concept.”
WSATA Handbook at III29. All evidence indicates that Tegarden relied on market data for yields to maturity, rather than coupon rates, when estimating the cost of debt. Therefore, the court sees no factual basis for Defendant’s criticism that Tegarden relied on “embedded debt,” as defined in the WSATA Handbook.
Weighted Average Cost of Capital = Cost of Equity weighted at 64% + Cost of Debt weighted at 36%
Weighted Average Cost of Capital = (7.58% * 64%) + (4.25% * 36%)
Weighted Average Cost of Capital = (4.85%) + (1.53%)
Weighted Average Cost of Capital = 6.38%
The distribution factor is a percentage based on the sum of (a) the ratio the Oregon portion of the original cost of the distribution plant bears to the entire system‘s distribution plant, times 50%; (b) the ratio the Oregon portion of the system‘s energy production sold in the prior year (in kilowatt hours) bears to the system‘s total such revenue, times 10%; and (c) the ratio the Oregon portion of the system‘s revenue from the sale of energy bears to the system‘s total energy sale revenue, times 40%. See
The other plant factor is based on the ratio of original cost of the Oregon portion of the remaining plant to the total original cost of the remaining plant. See
“Of course, this court makes a more searching review of the factual bases of an apportionment formula than does the U.S. Supreme Court. We exercise de novo review.
SoPac II, 302 Or at 590 (emphasis added). This court interprets the Oregon Supreme Court‘s reference to taxing “extraterritorial value” as encapsulating all of the standards in Norfolk & Western, which this court outlines and applies above. See id. at 589 (citing Norfolk & Western) (“The constitutional requirement of fair apportionment in property taxation means that a state may not tax extraterritorial value.“).