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DSL Prime News: Covad and Rhythms

DSL Prime reminds us that although Covad is in Chapter 11 bankruptcy proceedings, the company continues to operate. Meanwhile, Rhythms is selling assets at fire-sale prices. Anyone need a cheap local broadband network?

by Dave Burstein DSL Prime [August 30, 2001]

"The world needs Covad. Without them, the Bells will just continue to get all the subscribers, raise prices, and offer bad service."
—Mike Lunsford, Earthlink in the final issue of The Industry Standard.

Covad: a damned good chance
Bankruptcy was inevitable, but may not be the end
Simple summary: Covad will keep operating for several months, and customers are not in danger. Debtfree at the end of the proceedings, they have a good chance of raising the several hundred million it will take to become profitable. Wish them luck—the system needs some competition.

The market bid up the price of Covad when the company announced plans to package a Chapter 11 filing, with support of the majority of the bondholders—many of whom will profit handsomely, because they bought at 10 cents on the dollar and will cash out at 19 cents plus a third of the company.

The planned result—Covad clears $1.4B of high interest debt out of the way, and now becomes interesting to investors who might put in the $200-400M required to bring Covad to a profit. Covad may file a plan as early as September 15, and hopes to secure bondholder approval soon after. One kicker in the deal is that $257M—nearly all Covad's cash—is reserved to pay bondholders, whether a plan is approved or not.

Until now, Chuck McMinn has been turned down by investment groups staring at the billion dollars of bonds that would need to be paid off before they saw any return; now you can buy the entire company and fully fund it for a billion dollars less. No one will speak up until after the 11 is settled, but I had that kind of financing, I'd take the gamble.

Chapter 11 helps the debtor
The minute Covad files as debtor-in-possesion, the entire legal process tilts towards keeping the company alive, saving jobs, and paying back debt only secondarily. Covad will be able to repudiate leases and contracts, including the overpriced DS3's the network is burdened with. If Covad can demonstrate to the judge they have a reasonable chance to become profitable, they will emerge as a new, debtfree entity. Creditors can object, but Covad claims a majority of the bondholders have already approved the deal. The interest savings will be in the hundreds of millions.

Covad's 330,000+ customers mean they are not NorthPoint or Rhythms
Covad predicts they reach breakeven in 2003, with 500-600K customers. Most of the ISP writedowns are behind them, and they can return to rapid growth if customers continue to sign on. With the network built and the debt eliminated, Covad can make money at dramatically reduced prices. Mike Lunsford's comment above makes clear Covad is underpricing the bells, and AOL and MSN, the massive uncommitted ISPs, have very tempting pricing offers available. If Covad is stable, they'd be foolish not to jump right on.

Better service and a lean operation give them an edge
The bells have been ineffectual in the business market, protecting their T-1 lines and continuing to have service problems. Our book's provider chapter echoes the practical advice of almost everyone in the business: the independents have been giving better service. The New York Times and others got this story wrong, suggesting buying from a single source, the bell, because their control of all parts should make for better service in theory. The evidence is overwhelming; Covad and other specialists have been doing a much better job.

Negative: customers will be scared
A reporter from D.C. called, wanting to do a piece about small business choices in broadband. He told me many were afraid of providers going out of business. That fear—a rational one—will be Covad's second biggest problem—after raising the money it needs.

Rhythms R.I.P.
If I had money, I'd buy the network in my town
The loss of a nationwide competitor is a tragedy for consumers, as well as the thousands of Rhythms employees who worked so hard only to have their dreams smashed. Everyone's jumping after their customers, including IP (a Texas regional with prospects, despite numerous layoffs), Covad, Broadview, Megapath and Focal (recapitalized and also cutting employees).

Rhythms has spent over $200,000 per CO to equip cages with excellent DSL equipment (Cisco, Copper Mountain, Paradyne), that will sell for pennies on the dollar. If they accept bids for sections of the network, this is a once-in-a-lifetime opportunity to buy a high class ready-to-run network. I'd buy my town if I had the bankroll, and people who jump in now, at these prices, should have excellent prospects.

We are journalists, not investment advisers; invest at your own risk and do further research.

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

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1. DSL Prime News	4. Prime News Briefs: People
2. DSL Prime on Covad and Rhythms	5. SBC's Nefarious Plan
>3. Prime News Briefs: Technology	6. DSL Prime Editorial