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Lessons From the Hawaii Telcom Bankruptcy

Hawaii Telcom, the incumbent local exchange telephone company, has filed for bankruptcy protection. Press accounts attribute this outcome to increased competition, the company’s struggle to finance capital spending while making debt payments, a significant downturn in the economy, as well as the difficulties in the transition following the leveraged buyout of the company from Verizon Communications Inc.

I have a few other bogus and credible explanations that may offer greater insights. When something like this happens, it seems too easy for the culprits to evade responsibility by invoking the “perfect storm” explanation as appeared in the press account above. No person or group bears any specific responsibility. Bad things happen like the breaching of flood gates and levees in New Orleans. The perfect storm defense does not just shift the blame, it deflects the responsibility and accountability issue by claiming something akin to force majeure, an unavoidable event, or series of unfortunate events.

Another bogus defense invokes the “destructive” aspect of capitalism and competition. Joseph Schumpeter, an Austrian economist coined the phrase “creative destruction” in the early 1900s to refer to the long run creative and production benefits accruing when new firms replace failing firms. Some economists consider competition destructive if after a short period of low prices, competitors exit the market and consumers end up worse off by having fewer choices as surviving firms raise prices to recoup previous losses.

In HawTel’s case the firm’s troubles have not resulted primarily from macro-level assaults on its bottom line by the business cycle, VoIP and the cost of capital. As to destructive competition, few if any informed industry observers would declare local exchange telephony a natural monopoly, entitled to insulation from competition presumably in exchange for rigorous rate of return, public utility regulation.

The massive fees extracted from the leveraged buyout of HawTel, coupled with a vastly greater debt burden, sank the firm. Time after time state and federal regulators accept the pitch that a merger or acquisition will serve the public interest by “promoting competition” and “enhancing productivity and efficiency.” In reality some leveraged buyouts make the deal makers rich and the public worse off. A firm saddled with far greater debt may not have the wherewithal to handle its vastly higher debt load. The so called efficiency gains result by firing workers and cutting corners on customer service, maintenance and infrastructure upgrades. In HawTel’s case the house of cards fell down, and it may appear that the Carlyle Group, the private equity firm buyer of HawTel, ends up with a losing investment. I suspect that with close forensic scrutiny of the deal, the Carlyle Group, was able to extract ample upfront fees to abate if not eliminate the financial harm resulting from HawTel’s bankruptcy. Hawaiian wireline telephone subscribers probably will not end up harm free.

By Rob Frieden, Pioneers Chair and Professor of Telecommunications and Law

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