SBC Divorces Covad, Courts Yahoo!

SBC gave Covad $150 million now to get out of $600 million in DSL guarantees down the road, and then forged an alliance with Yahoo!, causing speculation that there may be a Yahoo!/SBC merger in the future.

by Jim Wagner of internetnews.com [November 15, 2001]

In a deal-making flurry of a week, SBC ditched long-term obligations to Covad Communications, and prepared to hide its services behind the friendly Yahoo! brand name. This week's deals follow SBC's buy back of Prodigy, which was until recently one of the largest independent ISPs in the United States.

The Yahoo! deal will give SBC access to a company with a positive image, and also to valuable content, allowing it to compete with AOL and MSN, both of which have their own sources of content to offer subscribers.

Too bad, Covad
Covad Communications might be getting $135 million to help ease its immediate Chapter 11 bankruptcy concerns but SBC Communications (NYSE:SBC) is getting the lion's share of the bargain.

On paper, the deal is a good one for Covad, which gets an immediate $135 million cash infusion from one of its owners and the elimination of a $15 million co-marketing fee. But in reality, the data competitive local exchange carrier (DLEC) is losing nearly $600 million in resale business guaranteed by SBC officials.

Covad, the largest independent DSL provider in the nation with 346,000 customers, is in desperate need of cash-on-hand to appease judges as part of its Chapter 11 bankruptcy proceedings. Executives have done a good job trimming its $1.4 billion debt down to under $100 million by an aggressive campaign of cutting operational costs and buying back company bonds for pennies on the dollar.

The $135 million deal between Covad and SBC calls for the following:

• A one-time $75 million pre-payment by SBC for (undetermined) Covad services within the next 10 years, payable when Covad gets out of bankruptcy court.
• A $50 million four-year loan, with Covad assets as collateral.
• A $10 million restructuring fee to Covad to avoid its $600 million resale agreement.

It's a pact Covad could look back at with a rueful shake of the head over opportunities lost. Covad executives are well aware of the potential losses down the road, but according to Chuck Haas, Covad co-founder and executive vice president of marketing and strategy, present needs outweigh any possible future gain.

"(The $600 million pact) was an economic tradeoff that we looked at pretty closely," Haas said. "the fact that we could get the money we needed today to get fully funded far outweighed the future promise of future revenue. Nothing's stopping SBC coming back and striking another deal (like the one last year)."

SBC has been back pedaling lately from the DSL industry, despite its vow to include 80 percent of its customers with DSL service, part of its vaunted Project Pronto initiative. The deal with Covad struck last year was meant to expand SBC's DSL presence outside its telco borders.

The broadband initiative, made by SBC executives when they needed to appease Federal Communications Commission regulators over a pending acquisition of rival Ameritech, has stalled in recent months.

Tuesday's deal is a two-part win for the incumbent LEC (ILEC): not only does it cancel approximately $600 million in DSL services to another company, it gives SBC room to migrate all its DSL business to its newly-acquired Internet service provider (ISP) arm, Prodigy.

Yahoo!
But SBC isn't moving its subscribers to Prodigy. The company now says that its subscribers will belong to a newly-created SBC/Yahoo! co-brand program. It's a move that increases the likelihood of an SBC/Yahoo! merger down the road.

The terms have already been set in the possible marriage, with SBC officials pointing out that billing and customer support on the new co-brand will continue to come from the Bell company.

It's a simple affiliate program. Yahoo!, officials said, would receive a monthly check based on the amount of customers it had in its possession. Yahoo! officials would not release the amount it would receive per subscriber.

For Yahoo! (NASDAQ:YHOO), the deal means it can reach into its broad base of customers and sign them up for DSL, turning its broad readship into a monthly revenue generator.

Terry Semel, Yahoo! chairman and chief executive officer, said monthly DSL subscribers are going to be a necessary ingredient in his company's business plan going forward.

"Access relationships will play an increasingly important role moving forward," Semel said. "As more and more customers transition to broadband in the future, this gives us a chance to provide a superior product offering. This model lets us diversify our revenues outside our premium and advertising revenues."

Semel said the Yahoo! co-branded service will feature its normal online content of news, online communities and multiplayer games, and extra online storage space for its subscribers.

For SBC, it has one of the largest content providers and portals in its corner now, providing top-notch news and online communities, a desirable quality for any access provider. The Baby Bell also gets a percentage of Yahoo!'s non-subscriber revenues (i.e., advertising dollars).

Yahoo! officials said that while it didn't sign any exclusivity contracts with SBC to broker the deal, the portal company has no intention on working with cable Internet providers in the future.

This is surprising, considering SBC has decided to slow down its DSL deployment in its coverage area due to financial difficulties and the fact that cable Internet growth far outstrips DSL around the nation, according to a recent report.

Ed Whitacre, SBC chairman and chief executive officer, said the company would start "encouraging" its current crop of Internet subscribers to switch to the Yahoo! co-branded service, a sure sign that SBC is pinning its DSL future on the Yahoo! name.

"The end game is very clear, we want to transition all of our broadband and dial-up customers to the co-branded SBC/Yahoo! world," Whitacre said. "There's obviously going to be a transition at this point, it will probably start with new customers first and then we will go back and transition the different subsets of customers from the former platform to the Yahoo! platform."

Where content is king
A co-branded partnership gives both companies equal standing with other high-speed Internet access/content provider giants, like AOL Time Warner (NYSE:AOL) and the Microsoft Network (NASDAQ:MSFT).

The largest and second-largest (respectively) dial-up Internet service providers in the country have a wide variety of content to go with their access and have been making splashes in the Internet community with their moves into high-speed services.

James Kahan, SBC senior executive vice president of corporate development, said it's all about content. The broadband provider that can bring the content with the access wins.

"The winner of the broadband war will be the company that delivers the best broadband-powered content, communication services and features to its customers," Kahan said. "Together, we'll provide SBC's Internet customers with superior information and communications services."

Both AOL and MSN, each with its own vast arsenal of online content, have been ramping up their efforts to enter the broadband world—AOL with its large cable network and MSN with its new DSL deals with all the incumbent local exchange carriers (ILECs), SBC included.

Yahoo! and SBC officials said they haven't begun looking at a price structure for the new service.

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