Many analysts are using the Hawaii Telcom bankruptcy as a sign of proof that a private equity firm with short term investment goals should not be running a business that is essentially an infrastructure business. You cannot blame all private equity groups.

I know plenty of private equity firms who actually have long term investment goals. These firms do invest in companies like asphalt and material recycling companies. Yes, some firms are actually interested in cash flow and not massively unrealistic returns. That all aside.

The tragedy with Hawaii Telcom is that the company could have been a success. The company could have been positioned not only as a local telephone company but as a gateway for the Pacific Rim. Satellite is not the fastest means of pumping tons of data back and forth across the Pacfic Ocean but trans-oceanic cable certainly is fast and there was a ton of it in the Pacific when the Carlyle Group bought Hawaii Telcom. The company itself could have been reorganized to do both local and long distance. Billing issues have been blamed as a principal factor in the company’s downfall. If this were true this would have to be the height of management incompetence.

I guarantee there will be investors who will claim that Hawaii Telcom spells the death of landline telephony. I disagree.

Wireless is the future but it cannot meet all of the bandwidth needs of any nation, including the United States.

I have never seen a company do well with building out its own billing infrastructure. Unless you were the size of the Baby Bells or Ma Bell, you were either going to buy off the shelf, pay the Bells for the billing support, or pay an external billing firm. If you chose to do it yourself, you were going to spend tens or even hundreds of millions of dollars. I have said this in the past, billing is mission critical. Unless you have personal experience in designing, building, and running billing systems, you then ought to pay someone else to do it. My gosh, if billing were that easy, a company like Amdocs would not have a business.

There were obviously other things going on in Hawaii Telcom and only a top-down and bottom-up operational and financial audit is going to ferret out the truth. Do the investors have a share of the blame? Yes. Once Carlyle took control of Hawaii Telcom, the company management team reported directly to Carlyle. Even if the private equity shop left decisions in the hands of the management team, the private equity firm is still to blame. You own it, it is your responsibility. But to be fair to the carlyle Group, lets wait and hear the findings.

As a side note, the operational audit needs to be reviewed by the industry. Every telecom carrier can benefit from reading the report. If it were the old Bell System, ongoing reports would be distributed throughout the system. Even if old lessons are being repeated, the repetition is worth it. Yes, I know in this competitive environment, investors don’t want to share data but do I need to remind everyone that telecommunications is a national security need as well?

The likelihood of a bankruptcy happening to another incumbent is slim but not impossible. Too often, inexperienced investors think Verizon and AT&T when they are talking about incumbents. What is often overlooked are the independents. The independent refer to those non-Bell owned incumbents that ran their own markets before the 1983 AT&T Divestiture. The term harkens back to the days before the Telecom Act and the days before the 1983 AT&T Divestiture. These independents are not CLECs, they are incumbents but in small overlooked markets (rural and some non-Tier 1). These small markets also tend to be overlooked by investors because there is no way for investors to quickly cash-out. However, there have been private equity firms acquiring independents since the Act was passed.

Investors need to note that prior to the Telecom Act of 1996, many of the independents were in the hands of families for generations. I know of a few independents that are now being run by the fourth generation of a family. These independents may be healthy because very little outside money has been taken in through either equity or debt. Hence, investors need to avoid assuming every independent is a distress candidate/

There are a few private equity shops out there now that have spent the last 13 years (since the passing of the Telecom Act of 1996) buying up independent access lines in the hope of a big future payday. There was and still is nothing wrong with these acquisitions. However, these shops often overpaid for those lines with the assumption that telecom would continue rising in value. In 2000, I recall firms paying as much as $10,000 per access line in a market that only a few months earlier was appraised at $2,000 per access line. One year later, the sector crashed and we fell into a recession. In 2001, these companies continued to gobble up independents at enormously high prices in order to capture dominance of the independent sector. Call it what you will, greed or unrealistic expectations, the bottom line is that such purchases have resulted in private equity firms still struggling to see a return on those lines.

Of course even the most patient of private equity firms will begin to ask how and when can they exit a deal. An independent is a great place to invest in for 7 years and up but at some point every private equity shop says: “enough when can I exit and how much can I get paid?”

When private equity got involved with these independents a great deal of money was spent rapidly upgrading the networks and not necessarily synergizing assets to gain economies of scale. You can run multiple networks without physically merging operations but at some point the operating cost of doing so becomes too high to maintain. The question for the private equity folks is: How were those upgrades financed? Was it new private money or debt? What were the terms of the equity investment or loan? Was the new money obtained at a high price?

Now could these independents file for bankruptcy? Yes. It can happen because of unrealistic expectations. Yes. It can happen because the private equity firms paid way too much for their entry into the telephone business.

Don’t think Verizon or AT&T, think independent. Investors need to focus on the independents.