Spending money to earn more money is a fiscally sound principle of doing business, but short term investors often decry increased spending as harmful to the value of a company’s stock and dividend payout. That is why Hawaiian Telcom (HawTel) earns mixed reviews from Wall Street about the company’s aggressive infrastructure improvement project, a fiber to the neighborhood network that intends to bring television, phone, and faster broadband service to an increasing number of Hawaiians.

HawTel’s stock price has bounced up, down, up, and then down again as investors digest the company’s ongoing effort to reinvent itself as a 21st century telecom company.

The Old HawTel

HawTel’s fiber buildout began on the island of Oahu in 2011, eventually passing 27,400 homes on the island. At the end of 2011, 1,600 (6%) of those homes signed up for the service. That’s an acceptable number, especially for a service barely promoted. HawTel does not mention the television service on its primary website, and approaches potential customers one-on-one with in-person and targeted mail marketing.

At the end of the second quarter or 2012, HawTel TV had 6,400 subscribers. The company hopes to have an additional 50,000 homes enabled for its TV service by the end of 2012, with the goal of enabling 240,000 households across Hawaii over the next five years. HawTel hopes to eventually capture 30% of the Hawaiian market.

HawTel’s principal competitor is Oceanic Time Warner Cable, which provides traditional cable service across the Hawaiian Islands. HawTel had been at a substantial disadvantage competing with Time Warner’s television package and faster broadband service. But the fiber upgrades are allowing at least some customers to purchase speeds up to 50/10Mbps, slightly faster than what the cable operator offers.

Time Warner has taken note of the phone company’s re-emergence as a strong competitor, targeting Oahu with special promotional offers that lock customers in place with triple play discounts designed to make it inconvenient to switch providers.

The New HawTel

Unfortunately for HawTel, fiber upgrades do not come cheap, and the company’s earnings have taken a hit.

Capital expenditures totaled $41.2 million for the six-months ended June 30, 2012, up from $35.4 million for the six-month period a year ago due primarily to investments in broadband network infrastructure and expansion of video enabled households.

Hawaiian Telcom reported an 18 percent decline in second quarter earnings, which it blamed primarily on broadband network expansion.

The company also announced it lost another 6% of traditional landline customers during the second quarter, but that was offset by expansion in its broadband and television service. For HawTel, the solution to ending landline losses is to upgrade their network to compete with the types of communications services consumers are interested in buying today.

But those plans can and do conflict with at least some stock traders who are interested primarily in short term financial results. Spending can cut into profits, so some analysts downgrade stocks of companies spending the most, even if only to compete more effectively down the road.

So far, HawTel executives have not been discouraged carrying their network expansion plans forward. In July, Hawaiian Telcom announced it would acquire Wavecom Solutions Corporation’s local exchange carrier business in a stock purchase transaction valued at $13 million.

Wavecom’s undersea fiber network

The acquisition would give Hawaiian Telcom access to Wavecom’s fiber optic network connecting the main Hawaiian islands. Wavecom, formerly known as Pacific Lightnet, Inc., serves more than 1,700 customers across Hawaii.

In an application with the Federal Communications Commission, HawTel officials said access to Wavecom’s 400-mile undersea telecommunications cable network will permit the company to expand and enhance its broadband and television services beyond Oahu to other Hawaiian islands, and help position the company to effectively compete with Time Warner.

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/Hawaiian Telcom TV Tour.flv[/flv]

Watch a HawTel-produced video tour of the company’s new TV service.  (4 minutes)

Phillip Dampier

While tech fans in Kansas City rejoice over 1Gbps broadband for $70 a month, the average broadband user will think long and hard about the prospect of paying $840 a year for broadband at any speed.

That is why Google Fiber-delivered broadband in and of itself is not a cable/phone company-killing proposition.

We too easily forget our friends and neighbors that seem clueless satisfied with their 3Mbps DSL account from AT&T that they were sold with a phone line package for around $60 a month. Web pages slow to load and constantly-buffering multimedia? In their world, that means “the Internet is slow today,” not their provider.

Phone and cable companies have the internal studies to back up their claims that price matters… a lot. Those who treat the Internet as a useful, but not indispensable part of their life are going to be a tough sell at $70 a month. In fact, it is my prediction many future income-challenged and older customers will splurge on Google’s free-after-paying-for-installation 5Mbps service, satisfied that speed is currently “good enough” for the web browsing, e-mail, and occasional web video they watch on their home computer.

That is why Google was smart to offer the ultimate in “budget Internet.” Free after the $300 installation fee (thank goodness for the interest-free budget $25 payment plan) is far better than $20-25 a month for 1-3Mbps service many cable and phone companies offer their “light users.” It also brings Google’s fiber into the customer’s home, a perfect way to up-sell them later or offer other services down the road.

But the smartest move of all was Google’s very-familiar quasi-triple play package price point — $120 for broadband and television service (they really should bundle Google Voice into the package and cover the phone component for those who still want it). With the phone and cable company charging upwards of that amount already for after-promotion triple-play service, the sticker shock disappears. It’s no longer $70 for broadband, it’s $120 for everything. That is a much easier sell for the non-broadband-obsessed.

It also provides Google a critically-important broadband platform to roll out other services, including those that will appeal to customers who don’t have the first clue what a megabit or gigabit is all about. They don’t really care — they just want it to work and deliver the services they want to use hassle-free.

For Google Fiber to prove a profitable proposition, the search engine giant has to:

• Find a way to manage the huge infrastructure and installation costs, especially bringing fiber lines to individual homes. Middle-mile networks with fiber cables that string down major roadways, but ultimately never connect to individual homes and businesses are far less expensive than providing retail service. Google’s $300 installation fee is steep, but manageable with payments and even better when customers commit to a multi-year contract to waive it;
• Offer the services customers want. An incomplete cable television package can be a deal-breaker for many customers who demand certain sports or movie channels. Although younger customers may not care a bit about cable television service, they also may not be able to afford the $70 broadband-only price. Google will need to attract families, and most of them still subscribe to cable, satellite, or telco TV. They are also the most grounded customers, an attractive proposition for a company dealing with high infrastructure expenses that will take years to pay off. It’s harder to cover your costs selling to a customer still in school and likely to move after they graduate in a few years;
• Sell customers on the hassle and inconvenience of throwing out the incumbent provider in favor of fiber, which will require considerable rewiring. It is one thing to express dissatisfaction with the local cable or phone company, it is another to take a day off from work to return old equipment and have unfamiliar installers in your home to provision fiber service. Some don’t want the hassle or lost time, others won’t switch until they get around to cleaning their messy house or apartment before they invite Google inside;
• Deliver an excellent customer service experience. Google’s current level of support for its web-based services would never be tolerated by a paying broadband/cable customer. Google will have to learn as they go in Kansas City, but first impressions can mean a lot;
• Expansion to get economy of scale. It is highly likely Google Fiber is a marketplace experiment for the company, and one it will study for a long time before it decides where to go next. Google’s “beta” projects are legendary and long, and if their fiber experiment does prove successful (or at least potentially so), the company will need to expand it rapidly to enjoy the kinds of vendor discounts a super-player can negotiate.

Verizon FiOS is the largest fiber to the home network in the United States. Their “take rate” of customers willing to sign up for the service has not exactly put incumbent cable companies into bankruptcy, even with $300-500 reward debit rebate cards and ultra-cheap introductory rates. Motivating subscribers to switch has never been as successful as theory might suggest. But Verizon has also shown other providers they can hard-negotiate significant discounts on hardware and equipment, and price cutting sessions have become ruthless.

At least Google has set its targets at reasonable levels. Only between 5-25% of eligible families have to commit to signing up for service in each “fiberhood” for Google to proceed with service rollout in that immediate area. That’s a realistic target with all of the factors necessary to deem the project a success.

Indianola, Iowa has relied on community-owned and non-profit Indianola Municipal Utilities (IMU) to deliver gas and electric service to the community of 15,000 for more than 100 years. Now customers in south-central Iowa will soon be able to purchase broadband service from the utility as it prepares to open its fiber-to-the-home network to residential customers.

Partnering with Mahaska Communication Group (MCG), IMU will be in the triple-play business of phone, broadband, and cable television by October.

Iowa’s public broadband network has served institutional and large commercial users since being installed in the late 1990s. But residential services were not available until recently.

Wholesale service comes primarily from Iowa Network Services via a SONET protected fiber optic ring, with redundant access going from and to Indianola. Multiple direct connections to Tier 1 backbone providers also ensure reliability and speed.

MCG intends to compete against cable providers like Mediacom and phone companies that include CenturyLink and Frontier Communications. MCG will market three broadband services in Indianola:

• 25/25Mbps – Available for as little as $5/month when bundled with a triple-play package including phone and television service;
• 50/50Mbps – Targeting homes with multiple users.  Download a 2 GB movie file in 1 minute;
• 100/100Mbps – For multiple users with high bandwidth demands and business customers. Download a 2 GB file in 30 seconds.

The triple play package, including 25/25Mbps broadband, TV and phone service will sell for $99.95 a month. That is the ongoing rate, not an introductory teaser that expires after 6-12 months. Standalone broadband customers can purchase 25/25Mbps for $39.95 a month. Upgrading broadband speed will be fast and affordable: $5 a month extra for 50/50Mbps service, $10 a month more for 100/100Mbps service.

Mediacom charges considerably more for its broadband service, which has vastly slower upstream speeds and usage caps. CenturyLink locally provides 1-3Mbps DSL service for many customers in the area.

MCG promotes its forthcoming service as a vast improvement over what phone and cable companies sell locally:

• The network is locally owned and operated and their employees live and work in the region. MCG does not use offshore call centers for customer support;
• MCG has no contracts, term commitments, or early cancellation penalty fees;
• No usage limits or speed throttles — and the speeds are fast in both directions;
• No introductory prices that leave customers with a higher bill after 6-12 months.

The municipal utility says it welcomed other Internet Service Providers, including CenturyLink and Mediacom, to sell services over their public fiber network. Neither provider has shown any interest.

[flv width=”640″ height=”450″]http://www.phillipdampier.com/video/Indianola Iowa Fiber 3-29-10.flv[/flv]

Introducing Indianola, Iowa and its new community-owned fiber to the home network, an important upgrade for a community 15 miles from Des Moines. (4 minutes)

Comcast last week told Wall Street three important facts:

1. They have plenty of capacity to handle increasing broadband traffic and can deliver faster speeds;
2. They are reducing the amount of money they invest in broadband;
3. They are still moving forward on usage caps and usage billing experiments.

Comcast CEO Brian Roberts told investors the company was well positioned to handle increasing broadband traffic and monetize its usage.

Wall Street liked what it heard. Valuentum Securities Inc., called themselves “big fans of Comcast’s cash flow generation.”

“We’re big fans of the firm’s Video and High-Speed Internet businesses because both are either monopolies or duopolies in their respective markets,” Valuentum concludes. “Further, we believe that both services have become so sticky and important to consumers that Comcast will be able to effectively raise prices year after year without seeing too much volume-related weakness.”

An other way to raise prices is to cap broadband usage and charge customers extra for exceeding their allowance, a plan Comcast has begun testing.

“As you know we announced two different flavors of plans,” Roberts said. “One was capacity linked with the tier that subs are buying and [the other] was just being able to buy blocks of capacity.”

Roberts is referring to Comcast’s pricing experiments now being rolled out in markets like Nashville. The tests will determine whether customers will pay higher prices for different tiers of broadband based on variable speed and usage allowances or whether a flat cap with an overlimit fee is the better way to go.

Roberts

“[Hard] caps are gone,” Roberts said. “We raised the amount people could consume to 300 gigabytes as a base limit. We have not announced the markets for the roll outs yet but I would expect something shortly.”

Comcast used to have a 250GB hard cap which, if exceeded, could result in termination of a customer’s account. Now the company is pondering whether a consistent 300GB cap with an overlimit fee is a better choice.

But Roberts also acknowledged Comcast has plenty of capacity and flexibility to adjust its broadband offerings to compete.

“[…] We have a great network that has tremendous flexibility and capacity to offer more speeds than we offer today and we’re constantly hoping that new applications and needs develop,” Roberts said in response to a question regarding potential competition with Google Fiber.

Comcast added 156,000 new high speed data customers, an 8% increase, over the last quarter. At the same time, the company lost 176,000 video subscribers.

The importance of Comcast’s broadband service was underlined by the fact broadband revenue was the largest contributor to cable revenue growth in the second quarter, with revenue increasing 9%. Comcast attributes that to rate increases, a growing number of new broadband customers, and the 27% of current subscribers upgrading to higher speed services.

Comcast does not and will not have to spend a growing amount of its capital on its broadband service. Comcast cut spending on its network by 5% in the second quarter to $1.1 billion. That represents 11.4 percent of cable revenue earned by Comcast. So far this year, capital expenditures have dropped 2.4% to $2.2 billion — 11.2% of its total revenue.

These days, much of Comcast’s capital expenses support the company’s expansion into business services. The company also expects considerable reductions in spending from completion of its transition to digital — freeing up capacity on existing cable systems instead of spending money to upgrade them. For the full year, including its business services expansion, Comcast expects spending on its own network to be flat.

Comcast’s new X1 platform (Image courtesy: BWOne)

In other Comcast developments of note:

• In June Comcast rolled out its new X1 cloud based set top platform in Boston and is currently launching X1 in Atlanta. Comcast is marketing the upgraded platform first to HD Triple Play customers, who can upgrade for a one-time installation fee. The company plans to roll out the new upgraded platform in five major markets by the end of this year, with a greater expansion in 2013;
• Comcast has increased broadband speeds, particularly in competitive markets, for no additional charge;
• Streampix now offers twice as many titles as the product offered at launch in February;
• Comcast has rolled out its marketing partnership with Verizon Wireless to 22 markets nationwide;
• The company’s ongoing rebranding under the Xfinity name now has a new catchphrase: Xfinity — The Future of Awesome;
• Nearly 75% of Comcast’s customers now take at least two products and almost 40% are signed up for the company’s triple play package;
• Comcast has saved more than $8 million by reducing the number of occasions the company will send technicians to customer homes. The cable company is heavily promoting self-install kits, which has brought a 65% increase  in the number of customers who install Comcast equipment and services themselves.

Time Warner Cable last week intimated the only thing keeping faster cable modem speeds from Kansas City customers is consumer demand and they are not worried about the arrival of Google Fiber’s 1Gbps broadband speeds.

The cable operator claims they have the advantage in Kansas City, as the first provider to offer a triple play package of voice, broadband, and television service. Time Warner also says they are constantly working on new, innovative services, including the much-touted “tablet remote” the company says it already offers customers in Kansas City in the form of apps available on the Android and iOS platforms.

“We always have the ability to adjust our network to keep up with demands from consumers [for faster broadband speeds],” Time Warner Cable said.

Cable operators and phone companies have traditionally argued there is little consumer demand for gigabit broadband speeds because the services most customers access online don’t need or cannot support that level of speed. Cost has also usually been a factor, and many operators point out the majority of their customers are satisfied with speeds of 20Mbps or less.

“We’re ready to compete any day, anytime, anywhere, with anyone,” said Time Warner Cable spokesman Mike Pedelty.

AT&T, which has been providing U-verse in parts of Kansas City since 2007 says it isn’t threatened by Google Fiber either.

Chris Lester from AT&T Media Relations notes AT&T now offers U-verse to more than 400,000 households in and around Kansas City and claims the company has gotten a “great response” from consumers, but declined to specify exactly how many of those households have actually signed up for service.

Both the dominant cable and phone company in Kansas City are betting on subscriber loyalty and consumer resistance to change to maintain their subscriber numbers. Statistically, they have a good chance of holding most of their current customers, at least for now.

The threat of Google’s fiber fast speeds may not be limited only to Kansas City, however. The Wall Street Journal has learned Google may be intending to bring its fiber network to other American cities, as long as they are not already served by Verizon’s FiOS fiber-to-the-home network.

Incumbent cable operators facing new competition from phone company IPTV (AT&T U-verse, Verizon FiOS) have not lost as much business as they first anticipated. In most cases, only 25-35% of customers eventually left for a satellite or phone company competitor. The older the subscriber, the less likely that customer is to consider a change, unless the service is poor or the price becomes unaffordable.

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/KCTV Kansas City Competition for Google Fiber 7-26-12.mp4[/flv]

KCTV in Kansas City talks with AT&T and Time Warner Cable about their newest competitor.  (2 minutes)

No cable operator has reported alarming results from subscriber defections, either from competition or cord-cutting behavior, and Wall Street analysts are watching subscriber numbers closely.

So far, reports on the ground indicate AT&T and Time Warner Cable are following the playbook first established when any new broadband provider arrives on their turf — aggressively market discounts tied to a contract with a stiff early termination fee to discourage customers from switching. At least one local provider has been reportedly sending salespeople door to door to try and lock customers in with a multi-year service contract. When that does not work, both companies use their customer retention departments to offer customers cheaper service in a last ditch effort to keep them from heading for the door.

Even with those defensive measures, some investors still see Google’s new fiber service as something new and different in the broadband marketplace — “the most disruptive thing since Gmail,” concludes Business Insider‘s Matt Rosoff.

Rosoff says Google Fiber could completely change the broadband landscape in the United States much the same way Gmail changed e-mail.

Back when Gmail launched, the other free email providers like Hotmail and Yahoo Mail were offering less than 5MB of storage — that’s five megabytes,” Rosoff writes. “Google trumped them all with 1GB of free storage. With so much storage, there was no need to trash anything. You could archive it and keep it forever.”

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/Fox Business News Google Stirs It Up 7-26-12.flv[/flv]

Fox Business News explores Google Fiber and finds phone companies telling reporters consumers don’t need 1Gbps broadband.  (2 minutes)

Gmail has since captured a large share of the email market, while also paving the way for Google’s increasingly profitable business apps. Some also argue Google’s “save everything online” approach was like training wheels for the cloud computing concept, where consumers think less about local storage and more about going online to access content. Google Fiber’s speeds make accessing online content effortless, and with no usage caps, customers need not ration their usage.

As of Monday, Google has already achieved the minimum number of needed homes to install Google Fiber in several, mostly affluent, Kansas City neighborhoods.

Rosoff says much like Gmail exposed the weaknesses of former email leaders like Hotmail, Google Fiber embarrasses incumbent Internet Service Providers and illustrates just how slow they have been to innovate.

“Google Fiber makes the cable-based ISPs look pathetic,” says Rosoff. “It promises to offer speeds up to 1,000Mbps downstream and upstream, for only $70 a month.”

In comparison, Time Warner Cable charges $100 for 50/5Mbps service in Kansas City. AT&T’s U-verse can only offer up to 24/3Mbps service, and it charges well over $50 a month for that, except on a new customer promotion. Both Time Warner and AT&T also sell “lite use” packages from 1-6Mpbs for $20-25 a month — service Google intends to give away for free after a $300 installation fee.

Many industry observers suggest Google is using its new fiber network in part as a hedge against market abuse from dominant cable and phone companies who are fiercely opposed to Net Neutrality and favor monetizing broadband usage.  Both are serious threats to Google’s business model which seeks more usage, not less. The more time consumers spend online, the more likely they will be exposed to a Google ad, use a Google product, or purchase a current or forthcoming service owned or partnered with the search engine giant.

Early indications from Kansas City show the cable and phone companies do have something to be concerned about. In more affluent areas of Kansas City, Google passed the minimum number of households willing to commit to the fiber service in just two days. Enthusiasm has been so overwhelming, tech entrepreneurs drooling for fiber service are hiring door-to-door promoters to visit nearby residents to encourage them to show their interest, in some cases even paying Google’s $10 pre-registration fee on their behalf.

More than 20 percent of the eligible “fiberhoods” in Kansas City, Mo. have already passed their signup goals. In poorer, mostly minority neighborhoods, Google is still waiting for their first pre-registration. In less affluent Kansas City, Kan., Google is finding considerably less interest, and pre-registrations are running below goal in all but three “fiberhoods.”

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/WDAF Kansas City Competitors Gear Up For Google’s Challenge 7-26-12.flv[/flv]

WDAF says competing cable and phone companies cannot deliver the speeds Google Fiber will offer, but they are betting consumers don’t need or care about faster broadband speeds. (3 minutes)