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Download; Desperate times for DSL…

Download; Desperate times for DSL… – Company Business and Marketing

Vincent Ryan

Verizon pullout tops barrage of bad news Data competitive local exchange carriers Covad Communications, NorthPoint Communications and Rhythms NetConnections already were having a down week when Verizon Communications dropped a bombshell: Verizon was ripping up the $800 million agreement to merge its DSL business with that of NorthPoint’s.

As to the reason behind the pullout, Verizon cited NorthPoint’s “continuing decline in revenues, an erosion of its customer base, an increase in expenses due to write-offs for increased bad debt and, as a result, a material increase in net losses.”

NorthPoint recently chopped $6 million off its previously reported third quarter earnings because ISP customers were delinquent on payments. It also had its market capitalization cut in half since the announcement of the Verizon deal.

The RBOC ended the deal under the agreement’s clause that allowed it to back out if NorthPoint experienced “a material adverse change” in its business. Verizon, which still has a $150 million stake in NorthPoint, also said it had no obligation to arrange for the data CLEC to receive additional funding.

NorthPoint President and CEO Liz Fetter was surprised by the move. “I am stunned to get the news after months of conversation with Verizon on the strong business opportunities available to the combined entities,” she said in a prepared statement. “Verizon was not entitled to terminate these agreements, and we are exploring all our options, including funding options and legal remedies.”

“Given current market conditions, Northpoint’s funding options will be minimal,” said Brent Bracelin, broadband analyst at Pacific Crest Securities. “It certainly paints a pretty grim outlook for NorthPoint.”

NorthPoint has about $150 million in cash, but that will be “chewed up pretty quickly,” and the company will need additional funding in the first quarter of 2001, Bracelin said.

The Verizon pullout means more trouble for other data CLECs, said Jason Marcheck, broadband analyst at The Strategis Group. “It will go a long way to scare off private investors and venture capitalists who, up to now, have been throwing money at these companies,” he said. “The problem [with data CLECs] is they burned cash like it was free to deploy the facilities. The demand is there, but the actual process of turning up customers isn’t.”

Covad and Rhythms, two other data CLECs that have seen their shares dip into the low single digits and had their market caps whittled away, are also in danger of running out of funds in the tight capital markets, Bracelin said.

Last week, Covad announced it was laying off about 400 employees – 13% of its workers – and closing its Alpharetta, Ga., call center to save money. In addition, Covad is halting the expansion of its nationwide DSL network to “just over 2000 central offices” and plans to rely “almost exclusively” on its rollout of line sharing for customer orders received after the first of the year.

Although Covad has about $1 billion in the bank, it has a larger debt load to service than other DSL providers. Covad also attributed a revenue shortfall in its latest fiscal quarter to capital-constrained ISPs.

Meanwhile, Rhythms said last week it was deferring payment of a $5.1 million quarterly dividend to holders of preferred stock because of stipulations in its outstanding debt agreements that prohibit it from paying dividends with cash. Rhythms would have had to sell about 4 million shares to pay the dividend, a move the company termed “inappropriate.”

The data CLEC’s cash, investments and restricted cash total $748 million, and the company said its operational needs are funded through the end of 2001. Rhythms announced an additional $50 million in vendor lease financing last week, which sources said was from Cisco Systems, from which Rhythms previously borrowed about $75 million.

Meanwhile, privately held DSL provider Zyan Communications laid off more than half of its 260 employees in a restructuring designed to get the company to profitability “within 60 days,” said Tom Bracken, Zyan’s vice president of marketing. Zyan, which provisions Covad and NorthPoint lines, had to cut off the customers of some of its nonpaying ISP resellers, Bracken said.

Market struggles for DSL providers are creating an environment ripe for consolidation, said Dan Moffat, president and CEO of New Edge Networks, a DSL provider that serves smaller markets.

“If somebody had $1 billion or $2 billion and a tremendous amount of resolve, they could own the DSL market, period,” Moffat said. “And there are people positioning to do that.”

Incumbent LECs (ILECs) might be the likely suitors, but buying one of these companies would cause the profitable ILECs to take a significant hit to EBITDA, he said.

Moffat declined to identify which companies might be positioning for a takeover but likened the scenario to the wireless industry a few years ago. “[Craig] McCaw was able to get a war chest and buy up troubled licensees,… which he used to create Cellular One,” he said.

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