Subsidy restrictions force Sandwich Isles to retrench

Sandwich Isles Communications, the Hono­lulu-based company criticized by federal regulators for spending excessive amounts to provide telephone and broadband service to customers living on Hawaiian homelands, is scrambling to cut costs and find new revenue sources now that its federal subsidies have been drastically reduced.

Among the options being pursued by Sandwich Isles is a move to acquire Hawaiian Telcom’s phone lines on Hawaiian homelands despite Hawaiian Telcom’s objections. Sandwich Isles is seeking regulatory approval to add 5,000 Hawaiian Telcom phone lines to its own 3,000 lines, which would allow Sandwich Isles to increase its customer base and potentially offset some of the revenue it is losing due to newly enacted restrictions on the amount it can draw from the ratepayer-supported Universal Service Fund.

Sandwich Isles is one of roughly two dozen mostly small telecommunications companies nationwide that will take a significant hit from the Federal Communications Commission’s decision to cap the amount of USF subsidies telecommunications companies can claim for serving "high cost" areas. The new cap of $250 per customer per month represents a major reduction in revenue for Sandwich Isles, which drew $858 per customer per month from the fund in 2011 before the FCC began phasing in the limits.

The subsidy is paid for by a $2.50 to $2.75 monthly tax on every land-line and cellphone bill. The subsidy paid to Sandwich Isles averaged $25.6 million per year over the past five years.

Sandwich Isles officials have defended their use of the subsidies, citing the high expense of installing more than 500 miles of terrestrial and undersea fiber-optic line to connect Hawaiian homeland households spread across five islands.

Sandwich Isles asked the FCC to make an exception in its case and allow it to continue getting more than the $250 per line per month cap. The FCC rejected the request in May, saying such a move would allow Sandwich Isles to "retain a number of significant and wasteful expenses totalling many millions of dollars, including significant payments to a number of affiliated and closely-related companies." The ruling continued, "We conclude that Sandwich Isles has certain expenses that appear grossly excessive and unreasonable."

FCC said the affiliated companies are controlled by relatives of Sandwich Isles President Albert Hee, and questioned whether Sandwich Isles could have extended its service at much lower costs using unaffiliated companies.

In addition, the National Exchange Carrier Association, a nonprofit telecom industry group, has said the capacity of the Sandwich Isles network far exceeds expected demand and that there were more economical alternatives available to the company.

The subsidies Sandwich Isles receives from the USF are by far its largest source of revenue. The $858 per customer the company received in 2011 dwarfed actual revenue from residential customers, which ranged from $17.95 for a single land line to $69.95 for its "Hulili Loa" bundled service combining local and long-distance calling with high-speed Internet access.

Hee, the brother of state Sen. Clayton Hee (D, Kahuku-Kaneohe), said the reduction in the federal subsidy is "significant and could be devastating" to Sandwich Isles.

"We are currently looking at all alternatives to restructure the company and especially our debt in an attempt to reduce expenses and to sustain the company as a viable rural telephone company that will continue to provide modern telecommunications capabilities to the beneficiaries of the Hawaiian Home Lands," Hee said in an email.

Sandwich Isles borrowed more than $400 million from government and private-sector sources to fund development of the network.

Sandwich Isles had been planning to seek acquisition of Hawaiian Telcom’s Hawaiian homelands lines as part of its growth strategy even before the FCC slashed its USF subsidies, Hee said. But the timing is even more critical now that Sandwich Isles is facing a cash crunch.

"If SIC (Sandwich Isles) is able to increase its revenues from the expansion of its (service) area it would be a welcome benefit," Hee said.

It isn’t the first time Sandwich Isles has attempted to take over Hawaiian Telcom assets. Sandwich Isles was one of the companies that bid for the state’s largest phone company in 2009 when it was in bankruptcy. Sandwich Isles’ $400 million offer was rejected by a bankruptcy court judge in favor of a reorganization plan submitted by Hawaiian Telcom management.

Hawaiian Telcom has asked the FCC to deny Sandwich Isles’ request to take over Hawaiian Telcom lines on Hawaiian homelands.

"This extraordinary request seeks to eliminate wireline competition in portions of Hawaii, and appears to be an effort to evade the Commission’s recent decision to cap SIC’s (Sandwich Isles’) eligibility for universal service subsidies," Hawaiian Telcom said in a filing with the FCC.

Expansion of Sandwich Isles’ service area "could result in yet another unjustified subsidy windfall for (Sandwich Isles), diverting funds that could be used more effectively elsewhere, including Hawaii," according to Hawaiian Telcom.

Sandwich Isles estimated there are about 7,000 Hawaiian Telcom customers living on Hawaiian homelands. In its filing Hawaiian Telcom put that number at closer to 5,000. There are 9,800 households on Hawaiian homelands, according to the Hawaiian Telcom filing.

Hawaiian Telcom’s predecessor companies provided telephone service to Hawaiian homelands before Sandwich Isles was created in 1995.

Hee maintains the creation of Sandwich Isles helped bring a higher quality of telecommunications service to Hawaiian homelands after years of neglect by Hawaiian Telcom’s predecessor companies. He cited an example of the Department of Hawaiian Home Lands seeking to build 12 homes in the Makuu area on Hawaii island in 1990. The phone company at the time, GTE Hawaiian Telephone, wanted $1 million plus land rights to provide only party-line service, Hee said.

"Most of these customers that are brought onto (Sandwich Isles’) network will almost immediately see improvements in the quality and scope of services provided," according to Sandwich Isles’ filing with the FCC.

Hawaiian Telcom, in its response, said it was committed to providing its latest technology to all customers on Hawaiian homelands.

"Hawaiian Telcom is investing and upgrading its network to provide its next generation fiber network offering home phone, internet, long distance, wireless and (television) services to current customers located on DHHL (Department of Hawaiian Home Lands) properties at competitive prices," according to the filing. "If permitted to do so Hawaiian Telcom is prepared to extend these same services to residents and businesses on other developed DHHL properties."

Carolyn Flores, who lives in a DHHL development in Lahaina, Maui, said her family is generally satisfied with Sandwich Isles’ land-line service but that it doesn’t get used much because she and her children have cellphones.

"The only person that doesn’t have a cellphone is my husband. The land line is mostly for him," said Flores, 57. Sandwich Isles does not offer cellphone service.

Sandwich Isles does offer broadband service, but Flores said her family chose to get their Internet connection through Oceanic Time Warner Cable. Flores said her family also has Oceanic Time Warner for its cable television service, which Sandwich Isles does not offer.

"I like that they (Oceanic) have an office right here in Lahaina so they can respond quickly if there is a problem," Flores said.

In addition to trying to take over Hawaiian Telcom lines on Hawaiian homelands, Sandwich Isles hopes Congress acts to restore some of the subsidies the FCC has cut. Hee, along with a handful of executives from small phone companies in Alaska and New Mexico, testified in June before the House Subcommittee on Indian and Alaska Native Affairs that their businesses will suffer as a result of the subsidy cuts.

Hawaii Rep. Colleen Hana­busa, the ranking Demo­crat on the Republican-controlled committee, said legislation is one option that could be pursued to help Sandwich Isles.

"We are looking into all possibilities, including legislative solutions. However, given the complexity of this issue we are continuing to meet with the parties involved to see what other options are available to address the concerns of the tribal telecommunications firm," Hana­busa said in an email.

Sandwich Isles is one of 26 mostly small telecommunications companies nationwide that received subsidies exceeding $250 per line per month from the Universal Service Fund in 2011. No. 1 on the list was Beaver Creek Telephone Co. in Washington state, which received $1,571 per line per month.

Critics of the subsidy contend that there are far less expensive ways to provide telecommunications services to rural areas.

Even accounting for the lower subsidies put in place under the USF reforms, the FCC could provide service to rural areas at a fraction of the cost using cellular technology, according to George Mason University professor Thomas Hazlett, a former chief economist at the FCC.

FCC data show that 99.8 percent of the U.S. population lives in the coverage area of a mobile telephone operator, Hazlett wrote in report released this month titled "Unrepentant Policy Failure: Universal Services Subsidies in Voice and Broadband."

"A consensus among expert economists is that instead of improving network coverage or benefiting telecommunications users," Hazlett wrote, "the subsidies have been wasted, padding the costs of rural phone companies and delivering only pennies on the dollar, if that, in social value."