Bandwidth Wars: DSL Providers Implode, As Stock, Bonds Wither Away
Tuesday April 3 4:59 PM ET
NEW YORK (Reuters) - Stock market investors aren't the only
ones taking a beating from the implosion of high-speed Internet
access companies that desperately need cash but can't get it.
Bonds sold by the companies that promised national digital
subscriber line, or DSL, service, have lost more than $2.3
billion of their value, analysts said.
And what's left is nearly worthless.
Money-losing Covad Communications Group Inc. (NasdaqNM:COVD - news),
NorthPoint Communications Inc. and Rhythms NetConnections Inc.
(NasdaqNM:RTHM - news), the three companies most reliant on DSL,
are either out of business, or may be heading that way,
analysts said.
``We have no evidence of a company that can succeed in making
a DSL-only strategy successful and profitable,'' said Goldman
Sachs & Co. in a report dated Monday.
Last month, NorthPoint, which had as many as 100,000 business
customers, shut down its network, and sold its assets at fire
sale prices.
This week, Rhythms warned it may sell itself, and that its
auditors are now assessing it by the ``going concern''
standard used for troubled companies. Late Tuesday, Chairman
and Chief Executive Catherine Hapka quit.
Meanwhile, Covad has curtailed its expansion plans.
Share prices have already slid more than 98 percent for Covad
and Rhythms, and the Nasdaq has delisted NorthPoint. Covad
shares closed Tuesday at $1-1/32, down 3/16, or 15.4 percent,
after a 52-week high of $49. Rhythms shares lost half their
value on Tuesday, closing at 5/32, after a year high of $35-5/8.
Such declines obviously don't bode well for bondholders.
So what happened?
``It all comes down to funding, funding, funding,'' said
Chris Martinelli, a senior telecommunications analyst for
CIBC World Markets Corp.
In other words, there isn't any, at least not any more.
And it's not just the pure DSL providers, but other Internet
access providers with more diversified businesses that are
being beaten. This week, for example, PSINet Inc. (NasdaqNM:PSIX
- news) and Teligent Inc.(NasdaqNM:TGNT - news) warned that
their auditors may start assessing them by that same, ``going
concern'' standard.
Markets Clam Up
DSL companies have been battered by the slowing U.S. economy,
heavy competition, the inability of many customers to pay
their bills, and a marked tightening of capital markets.
The money the companies needed to grow, so easy to get in
1998 and 1999, vanished, years before the companies could
have ever hoped to turn profitable.
``It takes four to six years to break even, and when money
isn't there to keep you going, you're toast,'' said Dave
Burstein, editor of DSL Prime, an industry newsletter. ``No
one can raise cash this year. It doesn't mean the original
business plans were crazy, but that's what's hitting everybody.''
Worse, the ``ISPs,'' or Internet service providers, that did
much of the DSL providers' marketing and provided much of
their revenue, started going under themselves.
This, analysts said, has proven crippling, if not fatal.
``In retrospect the DSL companies probably should have gone
directly to the customer, but they would have had substantially
higher marketing costs,'' said Martinelli. ``When the ISPs
started going out of business, they got into a jam.''
There was yet another problem -- the companies' dependence
on former regional Bell phone companies such as SBC
Communications Inc. (NYSE:SBC - news) and Verizon
Communications Inc. (NYSE:VZ - news) to provide networks to
deliver their services. That didn't work, especially because
SBC and Verizon were not only partners -- they were competitors.
With a respective 767,000 and 540,000 DSL subscribers at the
end of 2000, SBC and Verizon are the two largest U.S. DSL
providers. And subscribers often preferred to sign up directly
with them, analysts said, in part because they were companies
whose names they knew.
``DSL companies were overly reliant on the Bells for the
provisioning of services and long-cycle times, which made it
more time-consuming and frustrating to sign up customers,''
said Robert Rock, a fixed-income telecom analyst for John
Hancock Funds in Boston. ``It created an extra layer of
complexity.''
In short, ``the Bells have won in keeping DSL a monopoly,
especially to residential customers,'' said Goldman Sachs,
which helped underwrite some of NorthPoint's bonds. And even
there, all is not well; last month SBC hiked its retail rates
25 percent, and slowed its own DSL expansion.
Little Hope For Recovery
Covad's bonds are now trading below 10 cents on the dollar,
Rhythms' below 9 cents, and NorthPoint's at about 1.5 cents.
Given this situation, bondholders, who come ahead of shareholders
in the pecking order, can hope only that the capital markets
turn around fast enough for Covad and Rhythms, an unlikely
prospect, or that the companies can get good value for their assets.
Still, as Rock put it, ``the future is probably that the assets
get sold at distressed prices.''
That's what happened to NorthPoint, which sought bankruptcy
protection in January. On March 22 a bankruptcy court let
AT&T Corp. (NYSE:T - news) buy its assets for a mere $135
million.
``The value people put on it gave no value to the customer
base,'' said Burstein. ``The difficulty of taking on equipment,
other than what your own network is designed for, is severe.
There's almost no market for an arbitrary piece of equipment.''
And with AT&T presumably now out of the market to buy more
DSL assets, it's an open question what Covad and Rhythms
could be worth, or how much bondholders could recover.
``All I would say is I'm bearish,'' said Martinelli.
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