DSL Prime 

By Dave Burstein
DSL Prime

April 11, 2001 - There was no joy in DSLtown last week as the media wrote the obituary for NorthPoint, and sounded chimes for Rhythms, where CEO Catherine Hapka was forced out. She joins Bob Knowling, Marc Zionts, Andy May, and other good managers summarily executed in the wake of the Internet bust.

The LA Times, the NY Times, the Merc, CNET, Reuters, USA Today, MarketWatch, Computerworld, Dow Jones, the Austin Statesman, and several more called us for comments, as they heard the pleas of 100,000 users stranded by NorthPoint's bankruptcy. But our lead story is how CT Tel is picking up the pieces of Digital Broadband, while XO and Focal are also expanding rapidly.

Variety: Viva Verizon Video
Offering $M's to studios for video rights
MGM, Warner Bros, Sony and Disney will be joining Verizon's team at the Beverly Regent Wilshire, where Scott Hettrick reports "The offer is almost too good to be true; studios would have little or no cost since Verizon would run and maintain all operations, and is even offering to pass through the entire transaction fee for each movie purchased." Variety added that Verizon had already ordered $M's of Fujitsu settops.

The move is coming from Verizon Avenue, the renamed OnePoint basement DSLAM operation that Verizon bought last fall. Verizon is also close with Intertainer, which is live with movies in Cincinnati and Denver. Disney is working on Movies.com and Sony on Moviefly, to do VOD directly rather than through Enron or other middlemen. The VDSL vendors are drooling at the equipment prospects, but in-building ADSL can reliably deliver enough bandwidth for two MPEG video streams encoded at 2-4 megabits, quality comparable to DVD.

New Hope for the Dead!
CT Tel picks up Digital Broadband network in 70% of state
CEO David Epstein believes that starting with prebuilt facilities and equipment bought at distress prices will yield profits quickly. He will be able to serve 70% of America's most affluent state with an emphasis on business service, including advanced voice features.

Epstein comes from the ISP business (Javanet, RCN) and has taken over a 17-year-old company with 100,000 telephone resale customers. Cisco was the main secured creditor and they are providing strong support. He'll compete with SBC's SNET, but few others. Rhythms did the groundwork to open the state, but neither they nor Covad are very active.

Both Chuck McMinn and Bob Knowling of Covad have told us, in separate interviews, that building strength market-by-market would have created a stronger company. Many in the industry believe Epstein's strategy—of being the second provider in a focused market—is likely to succeed.

Vitts is available in New Hampshire, Vermont, and part of Mass; Harvardnet and the other parts of Digital Broadband are also for sale. Like NorthPoint, the offers are for pennies on the dollar: we hope someone takes them on.

Joseph Bellace of Jeffries reported they are adding over 30K more each week, with 90% customer self-installs and a yearend goal of 2.6M served. (He echoes our doubt they can go quite that fast.) 800 COs are equipped, with 2,100 more scheduled, and 90% of the country to be covered quickly. Siemens/TI has been the key supplier, but Alcatel has just been added, and ECI retains some (probably small) share of the mix.

CLEC shutdown in Germany: Teldafax bankruptcy
World Access of the US bought 70% of Teldafax, a wired and wireless provider with DSL plans as well. But facing default on its own bonds, could not make payments to prevent DT from shutting down circuits on 4/5. Germany has seen the largest CLEC buildout in Europe, with massive financing from vendors and the public market. Most will fail, but it's too early to pick winners or losers. Europeans have the same complaints of unfair competition as in the US, and similar financial challenges. Most countries are only permitting ADSL for now, waiting for G.shdsl to ship before approving a symmetric service, so competitors have few ways to differentiate services.

Rhythms for sale
Hires Lazard Freres to make a deal before cash runs out
"Felix the Fixer" has retired to diplomacy, but Rohatyn's old firm remains one of the sharpest on the Street. While Rhythms staff works almost all night taking a flood of NorthPoint orders, the moneymen are pulling the plug, spooked by the incredibly low bids for NorthPoint. (Kleiner Perkins, Hicks Muse, Viking, Brentwood, Sprout, and related parties control about 30% of the stock, management less than 10%).
They didn't have much choice, not when Price Waterhouse wrote, "These factors raise substantial doubt about Rhythms' ability to continue as a going concern."

Lazard's been hired to "explore strategic alternatives, including sale," but the twenty-five cent stock price indicates the market believes any sale will wipe out stockholders and look for bondholders to take a haircut as well. (I hope, of course, the market is wrong—after all, they valued the DLECs over $18B not so long ago.)

Lazard will presumably bring in bondholders early, looking to cut a pre-packaged deal and avoid the courts NorthPoint was forced into. Any change of control could trigger an obligation to promptly repay $800M in bonds—a requirement that dissuaded MCI from purchasing Rhythms last summer. Rhythms, unlike NorthPoint, may have the luxury of time, with the company claiming their $500M January cash on hand will last at least six months more. But the 10K filing points to ominous signs:

"In January 2001, one of our leasing companies, GATX Capital Corporation (GATX), notified us that an event of default had occurred under our lease program due to our failure to meet the operating cash flow covenant." (10K) Default like this may accelerate repayment demands, and the company has no obvious means to cover them. This could eliminate the cash, and force imminent action.
Over $1B in bonds and preferred stock are ahead of other investors. Their prices, pennies on the dollar, reflect an assumption that even in bankruptcy little would be recaptured. No bidder valued NorthPoint's operation.

NASDAQ has threatened to "de-list" the stock.
A $5M investment in WinFire just three months ago has no apparent value, as FreeDSL has shut down. They presumably also face losses on $15M invested in @Home and $2.5M in Megapath. Insurers are also questioning their contribution to Tom Lafleur's $15M settlement for early stock options.
While they continue to pay rent on 1,850 colos, only 1,400 are active.

Cisco, which is cutting back, accounted for 21% of sales in 2000. Telocity was another 16%
Although MCI's Bernie Ebbers said DSL would be crucial for 2001, there's no evidence MCI is taking the 100,000 lines they planned. Qwest seems another likely suitor, but Joe Nacchio is looking for bargains, and passed on NorthPoint at $150M. Rhythms debt alone is twice NorthPoint's.

$832.3 million of long-term debt and approximately $451.3 million of mandatorily redeemable Preferred Stock stand senior to any common stock.

Qwest is currently renegotiating their contract to "take or pay" a substantial number of connections from Rhythms. We haven't seen the original, but it's likely to have loopholes that Rhythms may need to contest in court.

Moody's is clear that Rhythms cannot raise cash on the public markets, and current investors are unlikely to invest more.

Those are the business problems; management giving itself a raise last month is a major PR problem as well. But I disagree with a generally wise observer in The Industry Standard. Hapka should not be derided for selling a small fraction of her stock last year. No one believes Bill Gates has been pessimistic about Microsoft for the last half decade as he sells stock to diversify holdings. The downturn has made clear that anyone who doesn't set aside some reserves is a fool, not a sensible manager.

After the demise of NorthPoint, customers are proving scared of dealing with CLECs. The telcos have always had a big edge: Rhythms makes that clear, saying "We believe that we compare unfavorably with many of our competitors with regard to, among other things, brand recognition, existing relationships with end users, available pricing discounts, CO access, capital availability, and exclusive contracts. We may not be able to compete effectively in our target markets. The ILECs are larger, better capitalized, have stronger brand recognition, offer a wider range of products and services, own the copper lines, and have many more existing relationships with potential end users than we do."

100,000 stranded NorthPoint users
The emergency was a key test of the Telecom Act, which by and large flunked. It failed to protect consumers when problems arose: neither regulators nor competitors were able to step in and protect the users. If the Internet is a public necessity, like railroads and insurers, notice should be required before cutting service.

Why isn't Mike Powell, now in effective control of the FCC, taking the lead on this issue? Why isn't the press and the public demanding that he make a plan before the next problems—price hikes and diminished coverage—hit home?

Verizon starting to do the right thing for NorthPoint customers
A month for DSL installs is crippling in general, and totally unacceptable in the circumstances, and Tom MacGuire, Verizon VP, is taking an active role to reduce that time. They have arranged hot cutovers from NorthPoint to Rhythms, are ready to do the same for Covad, and are working with others whose DSL deployment has been quiet, including companies to watch, Focal and XO. They are prepared to make most of the moves quickly, including results in days, rather than weeks, in many cases.

Consumers, your ISP should work with the actual DLEC to co-ordinate with Verizon—thousands of moves are in the works already.

Imperial banks said "customers be damned"
The ISPs were ready to pay the requested $2.4M to keep the lines live for a month, so that they could move customers without interrupting service. Covad, Rhythms, NorthPoint, and even the bells were working on the technical details. But NorthPoint was now controlled by the bankers, and looking for maximum return, they held out for even greater payments-and gave no guarantees they could keep the system live. The ISPs had to give up.

Government action was too little, too late
40,000 of NorthPoint's subs were in California, and the PUC ordered NorthPoint to restore service. No money, said the remaining folks at NorthPoint-a falsehood. In fact, the $135M payment from AT&T will not close for a month, and the banks are releasing funding to keep the facilities being sold in NorthPoint's possession. If the PUC could effectively threaten a lien on those assets, the banks would surely have allowed the network to live—the total cost involved was just a few percent of the $135M.

The Verizon lawsuit goes on
If NorthPoint wins, the clear damages are $1B, and the contract prohibited cancellation due to "acts, events, changes, or effects that are generally applicable to the data industry, (B) the United States economy or (C) the United States securities markets generally or the Nasdaq Technology Index in particular."

While no independent lawyer is clear on the meaning of these phrases, Rhythms' 10K filing provides an independent viewpoint. "The current general economic downturn is adversely affecting our industry and customers. In the last 12 months, the U.S. economy has suffered a sharp decline. The telecommunications industry has been particularly hard hit by this downturn."

Discovery and pretrial proceeding should stretch into 2002, but a shadow will hang over Verizon until the case is resolved.

Covad to 319,000; 25K NorthPoint lines signed up

Financials still on hold
Line-sharing is close to 100%, and the self-install program announced last fall is finally in place, allowing Covad to reduce operational costs and delays. They currently are requiring NorthPoint transferees to wait for new lines, but are talking with the telcos about direct switching.

But a delayed financial report has produced enormous uncertainty, with fears of problems beyond the 51,000 lines not being recognized for revenue. ISPs continue to report intense negotiations on outstanding debt, as Covad tries to find mechanisms for avoiding surprises in financial reports.

Incoming
-Betsy Bernard is the new leader at AT&T, of course. We're sending her a CD of Broadway's Betty Buckley to apologize for our typo.
-Justin Beech at DSL Reports did a great job covering NorthPoint. Beyond his clear skills as a reporter/analyst, he's proving that the new model of Internet journalism—inspired by the comments from users—does uncover news. Few journalists can take the time to cover a company in depth.
-Companies—especially the large telcos, have taken advantage of that journalistic absence. But the Internet is ending that free ride. Regional reports, like the Chicago Tribune's coverage of SBC's Pronto cutbacks, come to national attention, and user problems, typically unnoticed, now are reported worldwide.
International
-EAccess in Japan has installed 16K customers, and has as many more in the queue, with 200 COs lit (112 in Tokyo, 46 in Osaka). They look to reach 200K customers within the year, draw on strong ISP ties. NTT hasn't released Q1 numbers, but the massive growth will be later in the year.
-Point Topic, one of the most useful sites covering DSL around the world, has a new edition of their Worldwide Directory. You can get the free summary by emailing overview@point-topic.com.
-Romania plans 1,000 DSL subscribers before the end of the year.
-Golden Telecom plans service in St. Petersburg and Novgorod in Russia

Deals
-Covad will work with Compaq on a program for business.
-Moon Global of California offered $100 per Flashcom customer to take over the contracts of as many as 2,000 customers served by Verizon. M/M Internet and Linkline were also bidders, according to DSL Reports. Earthlink is actively looking for similar acquisitions.

Chips
-Doug Goodyear of Tioga is looking for a buyer for Silicon Value, the design shop purchased last year.
Competition
-Video on demand is "the holy grail" for the cable companies, per Brett Miller of A.G. Edwards. This implies that DSL will have to offer it as well, to be competitive. Intertainer is in live production, and folks like Disney are watching closely; the telcos, burned by Blockbuster, are looking for more reliable partners.
People
-Jeff Blumenfeld, General Counsel of Rhythms and one of Washington's strongest advocates of competition, left his post as of March 31st. He led the breakup of AT&T, and is one of the most influential Washington attorneys.

Stock Market
-Verizon's $43B of debt means Moody's threat to downgrade the bond ratings will become crucial to corporate strategy. Most of Moody's discussion centered on the $10B Verizon needs to pay for wireless spectrum and buying Price Communications, which was to have been funded with an IPO for wireless. But Moody's also warns of Verizon problems if they make additional purchases or investments; yet another reason they backed out of the NorthPoint deal, perhaps, and are not proceeding with plans for out of region. In DSL, Verizon is full speed ahead for subscribers, so far, but slow in capital investments such as upgrading remote terminals for DSL.
-Joe Nacchio of Qwest is looking brilliant for his dismissal of the business prospects of wireless, with competition limiting the return on the enormous investment required. SBC, like Verizon, will face a company-wide squeeze.
-Voice over DSL pioneer Tollbridge is ready to release good news about a financing round, after a tough period that saw several folks leave. Because they work with IP, they have strong prospects on the cable side as well, and potential advantages for folks with Cisco DSLAMs.
-Winstar's 43% layoff and desperate financial position ($5B in almost certainly bad debt) is a dangerous sign for the building-oriented service providers, who plan to serve similar customers.
-Copper Mountain, Netopia, and Elastic Networks are all trading close to the value of their cash in hand. All are companies that have earned respect, and have cash on hand to recover, we hope have prospects the market hasn't recognized.

Copyright 2001 Dave Burstein.The DSL Prime Newsletter is reprinted with permission.