Are more ILEC bankruptcies on the way?

Late last year, the telecom industry experienced a relatively uncommon occurrence: the bankruptcy of an ILEC, Hawaii Telcom. Bankruptcies of CLECs were an everyday happening during the telecom bust earlier this decade, but incumbents usually have had larger, established customer bases generating sufficient revenue to keep them afloat.

Will this be an isolated case or should we expect more ILEC bankruptcies? And what will happen now to the Hawaii Telcom business?

Hawaii Telcom wasn’t a typical ILEC. It was created when Verizon sold off its lines in the islands to private equity firm Carlyle Group. There was a lot of private equity in failed CLECs six years or so ago — and at that time, some industry observers questioned whether the private equity investment model, which seeks quick returns from a resale, was appropriate for the capital-intensive telecom market. Private equity–owned companies tend to have a lot of debt and can’t afford to miss growth targets. And as Bill King, president and managing principal for JSI Capital Advisors, pointed out in a recent phone interview, “Some highly leveraged incumbents could be in trouble.”

The good news is that most incumbents are not in that category. Private equity buyers have pretty much exited the telecom sector, said Frank Gallagher, managing director for Stifel Nicolaus. “The sins of telecom occurred in the late 1990s, and the industry never got a chance to get back into party mode,” he said.

King believes some other telco may buy Hawaii Telcom’s assets, but he refrained from predicting which that might be. “They’ve been trying to hawk the company for all of 2008,” he said. “The traditional buyers — the Windstreams of the world — kicked the tires but decided it was not the right time to do this. The usual suspects would be more interested if it were in the continental U.S. Nobody wants to do a huge cash deal, and that’s what this would take. Whoever buys it will get it cheap.”

The Hawaii Telcom experience may not bode well for future Bell company access line sales, Gallagher said. Many industry observers have pointed to Carlyle Group’s difficulties with creating its own back-office systems — and customers’ ensuing dissatisfaction and abandonment — as a key reason the company was unable to meet its revenue targets. And as Gallagher pointed out, other companies buying RBOC lines could face the same challenges. “When you buy access lines from an RBOC, you don’t get billing, integration and operations support,” he said.

Even if it could still find buyers, a company such as Verizon may not want to court the bad PR and instead may opt to handle future access line sales as a spinoff of a separate company, Gallagher said.