OT COVD - not a microcap, probably the largest dollar volume OTC BB, but a remarkable story, currently at the low end of a very volatile trading range. Many of you know the story. Now in the low 2's, from the 7's.
April 18, 2004
DIALING IN COMPETITION
Rerouting Telecom Law
Covad's Ride From Boom to Bust and Back Again
By James S. Granelli, Times Staff Writer
SAN JOSE — Few people appreciate the highs and the lows of a
competitive telecommunications industry better than Chuck McMinn.
For five years, the co-founder and chairman of Covad Communications
Group Inc. was hard-pressed to stop Wall Street from throwing money at
him to build what grew into the only nationwide high-speed
digital-subscriber-line, or DSL, network.
After spending $1.3 billion, Covad found itself insolvent in 2001 as
its technology-oriented business customers failed by the handfuls. But
it was out of Bankruptcy Court in four months, and has since become a
nimble navigator in the fast-changing telecom world.
Local phone competition ushered in by the Telecommunications Act of
1996 has taken many twists as regulators have tried to come up with
adequate rules. Covad has felt each bump along the way.
Covad, which hasn't earned a profit from operations since its founding
in 1996 , is arguably more responsible than any other firm for
bringing down the price of high-speed Internet access.
That was McMinn's goal from the start.
"We saw an opportunity to take the price down from several thousand
dollars a month to the simple tens of dollars a month," he said. Baby
Bells such as SBC Communications Inc. weren't going to do that because
"they owned the customer," he said. Until San Jose-based Covad and its
ilk came along, "they were the only game in town for all this
connectivity."
Written off at times by analysts and investors, Covad is one of the
new competitors to have clawed its way through the industry's morass
and turned its fortunes around. It is becoming a full-fledged provider
of voice and data services through its recent purchase of GoBeam Inc.,
which uses a technology known as voice over Internet protocol, or
VOIP, that transmits voice over the Internet like e-mail.
"They've regained their footing quite well, and they're very
well-focused on what they're doing," said Charlie Carr of tech
research firm Gartner Inc.
As the largest independent DSL provider, behind only the four Baby
Bells, Covad mainly sells wholesale services to resellers such as AT&T
Corp. and WorldCom Inc.'s MCI unit. It even counts the Bells among its
customers, reaching a deal last week to share lines in Qwest
Communications International Inc.'s 14-state Western territory.
"We're kind of like Switzerland," said Chief Executive Charles
Hoffman. "We work with them all."
A onetime engineering executive at Intel Corp., McMinn learned to
strive for ever-faster microprocessors and to push down prices to
build demand. Watching the phone companies, he saw an opportunity to
do the same thing with Internet access.
The Bells had long had DSL technology, he maintains, but they
effectively kept it under wraps by pricing it as if it were as
precious as the expensive dedicated lines that big corporations use to
move electronic data quickly. And, analysts have said, the Bells
didn't even want to market DSL for fear it would cannibalize their
highly profitable business in those T-1 lines.
Spokesmen for Bell companies say their companies didn't have the
technology ready for the mass market until 1998.
DSL is much cheaper to deploy than T-1 lines, mainly because it can
use the existing copper wires that connect nearly every home and small
business to the nation's phone network.
Covad began selling DSL in San Francisco in late 1997 through start-up
Internet service providers, or ISPs, that sprang up in high-tech's
boom days. It was the first commercial launch of high-speed service.
"We thought that this business was going to evolve the way the
cable-TV or the paging or the cellular businesses did," McMinn said.
"There would be this whole flurry of companies, each building a
network in an individual city, followed by some sort of roll-up into a
national provider."
Instead, Covad got what he called a "very serendipitous opportunity."
Wall Street investment bankers told Covad executives they didn't have
to wait until the San Francisco effort panned out. They could get
funding right away and start putting splitters and equipment in other
major markets and sell through thousands of ISPs nationwide.
With only 50 subscribers, Covad raised $135 million in 1998 to go into
the top six metropolitan areas. The next year, it raised nearly $1
billion more through an initial stock offering and two bond offerings,
building out into the 53 biggest markets by the end of 1999. It
continued expanding in 2000, almost exclusively as a wholesale
provider to ISPs such as Southern California's Flashcom, Internet
Express and Accelerant, all now defunct. EarthLink Inc. became its
biggest customer.
But with losses mounting in the tech industry and stock prices out of
whack, Wall Street soon turned off the spigot. Companies failed by the
hundreds. In one three-month period in 2001, nearly a third of Covad's
ISP customers went bankrupt. Covad tried with limited success to
continue providing service directly to the homes and businesses served
by those failed ISPs.
Hoffman joined the company in 2001 to help turn around operations.
"Revenue was dramatically impacted, and the board started looking a
little closer and found out, 'Oh gosh, there's $1.4 billion in bond
debt without a good way to pay that off,' " he recalled.Creditors and
company executives hammered out a reorganization plan that Covad took
to Bankruptcy Court. The company filed its petition and plan in August
2001, and was out of court in December. Bondholders ended up with 19
cents on the dollar and 15% of Covad's stock.
Then competitive and regulatory pressures began weighing in. As the
Bells gained authority under the Telecom Act to offer long-distance
service, they began selling bundles of services, such as local, long
distance and DSL, leaving Covad with little room to pick up the bigger
profit margins in direct DSL sales to consumers and businesses.
Last year, Covad lost $100 million, or 44 cents a share, on revenue of
$389 million.
During the retrenchment, McMinn and Hoffman had fired 65% of the
workforce, rearranged debts and deals and started building up direct
sales to small businesses, rather than wholesaling. Direct sales grew
from 4% of revenue to 20%.
The company is back in expansion mode with plans to boost direct sales
further by offering voice and data with technology from GoBeam. The
purchase of GoBeam for $48 million in stock is expected to be
completed in May.
Covad also is putting VOIP-enabled DSL gear into 200 telephone
exchanges to bring its total to 2,035 sites nationwide. Its network
will be able to reach 50 million homes in 35 states, including the top
100 markets
"The good news for us is you need broadband for VOIP, and we're a
natural ally for that," Hoffman said.
Covad has converted its DSL switches to handle voice as well, and
analysts see that as a smart move. "As VOIP becomes more important,
Covad's situation improves," said analyst Blair Levin at Legg Mason in
Washington.
Only a year ago, the company was in a funk with VOIP just a "someday"
dream. The Federal Communications Commission had ruled that the Bells
would no longer be required to share lines with DSL providers, a rule
that primarily affected Covad as the only national DSL competitor.
"The night before the vote, When we found out we were losing it, it
was pretty devastating," Hoffman said.
But the FCC also required the Bells to provide rivals with access to
lines and gear at wholesale prices. Covad quickly found DSL partners
in MCI, Sprint and other long-distance carriers that had started
offering local service on Bell lines. A month before the FCC vote,
Covad had signed a little-noticed accord to supply DSL to AT&T's new
local customers.
Last month, however, a federal appeals court threw out those
competition rules, putting Covad's DSL strategy in jeopardy. But the
decision is leading some companies to reach contracts among
themselves, as Covad and Qwest did. Covad also is negotiating with
other Bells.
Also last month, Covad agreed to sell the latest DSL gear — capable of
downloading information at 3 megabits a second, or twice as fast as
current DSL — to America Online Inc. users.
For Covad customers such as EarthLink, it's all about having
competition that the 1996 telecom act promised. "I think competition
is very, very healthy," said Steven Dean, EarthLink's information
technology director. "I want local exchange carriers to lower prices.
I want to leverage them against each other."
For Wall Street analysts like Vik Grover at Needham & Co. in New York,
Covad's ability to alter its business plan quickly is going to help
the company grow significantly. "Covad," he said, "is a transition story." |
