The Death of Telecom

By the time you read this, Rhythms will have become the second national DSL provider this year to have closed its doors and turned off service to thousands of businesses and consumers. Following in NorthPoint's footsteps earlier this year, Rhythms announced in early August they will seek bankruptcy protection, and provided advance notice of the pending shutdown of their network. Covad Communications Group, the parent company of Covad Communications, the nation's largest DSL provider, has filed a pre-packaged bankruptcy plan (however they are quick to point out this does not involve the DSL service provider, as we will discuss below). Even Excite@Home, the largest cable Internet ISP, recently filed for bankruptcy, and sold their assets to AT&T Broadband.

So why has the Internet Service Provider (ISP) industry in particular (and the telecom industry as a whole) been suffering this year? In short, they suffer from marketing a commodity product in an extremely competitive industry. Fortunately there are several things we can do to protect ourselves during this shakeout.

What Went Wrong

Are all ISPs in trouble? No. Are all DSL providers in trouble? No. This is an industry where a large investment is necessary to provide service, and that service is provided at a fairly small cost. Many ISPs were trying to gather new customers so quickly to prevent losing them to competitors that they were unable to keep up with the demand for services, especially billing.

ISPs have experienced these growing pains since the Internet became widely available just a few years ago with modems. However with the national DSL providers acting as middlemen, serious trouble at one ISP could now affect the middleman, and in turn other ISPs' customers. When the smaller ISPs could not pay their bills, the DSL providers could not maintain the required cash flow, and experienced financial difficulties of their own.

To be fair, the problem is not squarely on the smaller ISPs, as the DSL and Internet "backbone" providers should have better forecast falling prices before investing billions in new equipment. The recent stock market downdraft also severely limited access to new capital.

Why Covad Is Different

In Covad's case, their parent company has set up a voluntary, pre-packaged reorganization to retire about $1.4 billion in long-term debt. Bondholders will receive a partial payment plus stock as compensation. The parent company claims that all subsidiaries including DSL services are completely unaffected and will continue operating as normal. The financial press generally hails Covad's pre-negotiation strategy as a pioneering approach which will likely be used as a model by other companies (see for references).

Covad's remaining hurdle is to raise $200 million in financing to finance operations through Q3 2003, when the company expects to be cash-flow positive. This is a far cry from the $400-700 million required before the debt restructuring. Covad's 330,000 customers (in addition to those migrating from Rhythms) provide a much larger cushion than either NorthPoint's or Rhythms' customer base, and their planned debt reorganization will strengthen their balance sheet for potential investors.


To begin, clients should realize the relationship of an ISP to their business. Many of our clients use ITS to provide their web hosting services. With this setup, in case of difficult accessing the Internet the web site and e-mail will still be active and the client can simply use a dialup or other service temporarily if an outage occurs.

While we feel DSL provides the best cost/benefit ratio to businesses, there are other ways to connect to the Internet, such as T1 service. Similar to DSL in that it is a direct, always-on connection, a T1 line provides up to 1.5 Mbps of speed, or 30-40 times that of a dialup modem. The down side is that the cost is significantly higher than DSL, typically ranging anywhere from $600 to $1500 per month depending on the ISP used and service available.

One should note that T1 providers are not immune to financial troubles either! More than one of our clients had set up service with T1 providers which went under earlier this year.

In the end, perhaps the best advice is a "buyer beware" strategy when choosing your company's Internet and telephone service. The coming years will likely see a large consolidation among telecommunications and Internet providers. One can only hope that consumers will benefit in the long run by enjoying a bigger Information Superhighway, and not an empty road.

ITS continues to refer clients to DSL providers, and we feel we have been partnering with two of the best national DSL ISPs, both of whom use Covad to provide their service. We can also refer clients to both local and national T1 providers.

Selecting an Internet provider is no longer as simple as choosing the cheapest offering. Consumers now must also evaluate the financial health of their provider.

October 2001

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