Reading the Tea Leaves

Three companies make major moves. Is Hawaii near a tipping point?

August, 2005

Walter Dods abruptly stops his rundown on why the $1.6 billion deal of the year, the sale of Verizon Hawaii to the Washington, D.C.-based Carlyle Group, is a good local development. The icon and advocate of business in the Aloha State is addressing how a global investment firm with $29.6 billion under its thumb – a group specializing in buying and selling companies for sizable profits – can be billed an Island partner, returning the state’s largest telecommunications company to “its local roots.”

Consider that, just last year, Hawaii watched Carlyle sell off Horizon Lines to Castle Harlan for $650 million after buying it in 2003 for $300 million. Then in May, Carlyle, whose former advisors or partners include President George H.W. Bush, former Secretary of State James Baker III and former British Prime Minister John Major, finalized a deal to buy off the Hawaii arm of Verizon for $1.6 billion.

For the people?

“People who know me in this town, know I am for local companies,” says Dods, his voice lowered, responding to the public doubt with his personal testament. “I wouldn’t be a part of this without the community commitment.”

The nod from the recently retired chief executive officer of BancWest Corp. is no small token. Besides goodwill, Dods’ backing includes a consortium of local investors, who put up half-a-million to $3 million each. Dods says the group of high-level Hawaii executives – whom he declined to name – provided nearly 10 percent of the equity for the purchase. He calls it a sound investment, given Carlyle’s history and management expertise in telecommunications.

However, Dods, who was made a board member of the new company, says what is more important is that Carlyle has created, out of a division of a large Mainland company, a stand-alone company called Hawaiian Telcom – a company that will live or die on its success in winning over the market in Hawaii. “I have watched the business community for so long and watched so many companies leave. This bucks the national and global trend of consolidation]. It’s refreshing.”

Not everyone is convinced. Whether Hawaiian Telcom is good for residents and businesses in Hawaii or just its investors is an open question to some. Dods’ personal testament on the commitment of Carlyle is perhaps the strongest endorsement yet. Sustained investment in infrastructure and new services will be the best indicators and will be measured over years, along with community involvement and contributions.

Two major developments in the high-tech industry – the $137 million sale of Blue Lava Wireless to Los Angeles-based Jamdat Mobile Inc. (NASDAQ: JMDT) and the plans of Hoku Scientific to seek a $62.8 million initial public offering – also have people talking about the implications for the state. Hawaii has eagerly sought to develop the state as a high tech center. Are the sales of Blue Lava Wireless and Hoku Scientific’s IPO evidence that day is about to arrive? Some experts think so.

The ultimate significance of those deals will also take time to unravel. Predicting the outcome today is a little like reading tea leaves, and fortunes can often change with time. However, these three multimillion-dollar Hawaii deals are worth a closer look.

Rebuilt for a Local Market

Over two decades, industry giants GTE and later Verizon shipped off dozens and dozens of back-office jobs to the Mainland to consolidate functions. So the first order of business for Hawaiian Telcom, on its way to being a stand-alone company, is bringing those jobs back, says CEO Michael Ruley.

Hawaiian Telcom is putting up more than a $100 million to “rebuild” its back offices, including adding marketing and managerial positions in finance, human resources and information services. The number of Hawaiian Telcom employees is expected to jump to 1,900, an increase of more than 200. The Carlyle sale did not include Verizon Wireless services; so the company is also building a wireless team.

Ruley says Hawaiian Telcom will become more efficient and responsive to the local market. “Sometimes you become too big that you are inefficient,” Ruley says. “We are large, but not so large that we can’t be nimble.” That means everything from calling a customer service representative in Hawaii, who can pronounce the name of your street, to a sales department that will be out in the community to talk about what services people need, Ruley says.

Meheroo Jussawalla, senior fellow in telecommunications at the East-West Center, says her biggest criticism of Verizon Hawaii was that it failed to substantially invest in new infrastructure. “It was a monopoly situation, whether it was Oahu or the Big Island or wherever, there was no competition,” Jussawalla says. She remains unconvinced Carlyle will handle the infrastructure differently, because the monopoly remains. Says Jussawalla: “I have no faith.”

Ruley is firm that the investment into Hawaii infrastructure will come, after Hawaiian Telcom has completely shifted off the old Verizon system by early 2006. To get the return on its investment, Carlyle has to make Hawaiian Telcom a stellar operation, he explains. That means getting the customers to buy in, literally. “Ultimately, that is what it comes down to in the marketplace. Customer satisfaction,” Ruley says.

For 2004, Verizon Hawaii reported $492.8 million in sales, down 4.9 percent from $518.4 million in 2003. The company is No. 14 on the Hawaii Business Top 250 list this year, down from No. 12. Ruley says he expects Hawaiian Telcom to come in just shy of $600 million in sales for 2005.

Ruley says the prospect of Carlyle eventually selling the company should not scare people. Hawaii is not a great fit for many large Mainland operations, so the likely sale of the company will be to the public, creating a corporation similar to Hawaiian Electric Industries Inc. (NYSE: HE). That way it will always be a local company, he says.

Falling Blocks, Building Blocks

In the mid-1990s, Henk Rogers wanted to start a U.S. company that would manage the licensing of the computer game Tetris. Rogers, who had been instrumental in landing Tetris for Nintendo in the late 1980s while in Japan, was also eager to come back to Hawaii where he had attended the University of Hawaii. But Rogers describes the venture-capital funds available here at that time as “cute.”

“I talked to some venture capitalists and their entire fund was not enough for my plans,” he says. He moved to San Francisco instead and founded Blue Planet Software. In 2002, he decided to develop Tetris for cell phones. Rogers says by that time Hawaii had established tax credits for high-tech companies and venture capital was more substantial. So he opened Blue Lava Wireless at the Manoa Innovation Center. The company took off and Rogers ended up not needing outside investment or tax credits.

Rogers says from the get-go he knew the ultimate destiny for Blue Lava was a buy-out or IPO. The cyclical nature of the high-tech industry means only large companies tend to survive the doldrums. In mid-April, Rogers sold Blue Lava and the exclusive wireless telephone rights to Tetris worldwide to Jamdat for $137 million.

Got Fuel-Cell Membranes?

Hoku Scientific, a startup attempting to develop more efficient and less expensive fuel-cell technology, followed by registering in late April for a $57.5 million IPO. (At press time, the IPO was valued at $62.8 million). Dustin Shindo, chairman and chief executive officer of Hoku, declined to be interviewed, because the company has now entered the “quiet period.”

The company’s filing with the Securities and Exchange Commission says that the company is poised to tap a burgeoning fuel-cell market worldwide. The filing also notes that the company has accumulated a $6.5 million deficit since its inception in March, 2001. Hoku’s revenue to date has been derived largely from service contracts with Sanyo Electric Co. and Nissan Motor Co. Also, Hoku was awarded a fuel-cell development contract with the U.S. Navy in May. Hoku’s IPO would be the first in Hawaii since 1999.

The First of Many?

Rob Robinson, executive director of the Pacific Asian Center for Entrepreneurship and E-Business at the University of Hawaii, calls Hoku a homegrown organization, benefiting from local tax credits and local organizations mentoring and investing in it. Robinson says there are other homegrown tech companies developing in the pipeline, such as Hawaii Biotech, Hoana Medical and Nanopoint Inc. “Hoku represents a model for how we hope the other high-tech companies in Hawaii will develop.”

Blue Lava Wireless, though, Robinson says, tipping his hat to the entrepreneurial savvy of Rogers, “is a very different deal. Henk happened to be here in Hawaii. Frankly, he could have done it anywhere.” However, Robinson says he hopes that Blue Lava Wireless convinces people high-tech companies can be successful in Hawaii. Phillip Bossert, executive director and CEO of High Tech Development Corporation, says he believes Hawaii is finally reaching its tipping point, where growth in high-tech gains enough momentum to spur continued, more substantial growth. Something Jussawalla says Hawaiian Telcom could help foster by increasing infrastructure investments.

For Rogers, it is just a matter of time. He says Hawaii is at a point where “enough people are thinking about high tech to make it work.” Rogers made it a condition of any deal for Blue Lava that his 50 part-time and full-time employees were kept in Hawaii. He wanted to make it possible for young, intelligent tech professionals to stay in Hawaii and work. Rogers also believes high tech is the best future economic engine for Hawaii.

“We are the West Coast of the states and the East Coast of Asia. We are culturally diverse. Anything we create here will work on both sides of the ocean,” Rogers says. “This is going to be a high-tech center for the world.”

Only time will tell if that’s really in the tea leaves.

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Scott Radway