The Worst Show on Earth

Partners fall, as DSL providers lose their grip.

Broadband was supposed to be a booming business, but someone forgot to tell the DSL service providers.

Mounting financial losses, funding shortages, logistical problems and fierce competition from the Baby Bells is ringing a sour note for major DSL providers (a.k.a. DLECs, for data local exchange carriers).

Indeed, Covad Communications, NorthPoint Communications and Rhythms NetConnections all are struggling to stay alive.

The DSL market took its latest tumble last week, when NorthPoint filed for Chapter 11 bankruptcy protection and Rhythms announced plans to cut 450 jobs, or 23 percent of its workforce. Only a few weeks earlier, Covad disclosed its second round of layoffs and some office closings.

The situation is especially troubling for ISPs and integrators that push broadband Internet access. Just ask Neil Toepfer, a former partner at WebDance Networks. Toepfer was forced to sell his company last year to Zooga.Net, due to the financial problems caused by his DSL providers.

Laments Toepfer: "The bottom line is DSL sucked a ton of important revenue out of our company, used up our capital, and eventually put us in a position where we had to sell out or shut down operations."

Unfixable? The sorry state of DSL service is easily explained, but not easily corrected. During the dot-com boom of late 1999 and early 2000, Wall Street favored rapid revenue growth and turned a blind eye to financial losses. In response, the DLECs built massive networks, but without using proper cost controls.

"The DLECs tried to grow too big, too fast, and couldnt do it," says Adam Giansiracusa, an analyst at Frost Securities.

The math never did add up. Analysts say it takes DLECs six months to 24 months to grow networks that generate positive cash flow. But the DLECs did not collect enough revenue to compensate for their low-margin business models.

Now, DSL providers cant find new money when they need it most. Venture capitalists are tightening their purse strings (see p. 26), Wall Street has shut the door on new offerings, and the bond market is reluctant to embrace new issues from debt-burdened DSL providers.

Lump all of those factors together, and many DSL providers wont have enough money to expand their networks. Even worse, they might not survive long enough to turn a profit.

Bellwethers The NorthPoint deathwatch began in November, when Verizon turned its back on an $800 million planned merger. NorthPoint collected $150 million when the deal was signed. But Verizons about-face left NorthPoint $200 million short of interim financing. The deals collapse also closed off another $165 million in potential bank financing.

NorthPoint ultimately chose bankruptcy to give it some breathing room, as it looks for another "strategic partner," according to president and CEO Liz Fetter.

"NorthPoints [bankruptcy protection] filing was not a surprise," says Michael Savner, analyst at Banc of America Securities. "We had them running out of money next month."

Meanwhile, competition is mounting, as phone companies, cable giants and Gigabit Ethernet specialists face off against the DLECs.

Some experts dont expect DSL providers to survive the war. "DSL is not going away, but there is no market for any of the independent DLECs," says Savner at Banc of America Securities.

Indeed, DSL provider subscriptions (460,000) are way behind Baby Bell DSL subscriptions (2.4 million).

"The Baby Bells are the real enemy," says Joe Plotkin, director of marketing for and a member of the United States ISP Advisory Committee. "They are squeezing all of us out of the DSL business—using monopoly control of the infrastructure to delay, deny and degrade the services competitors offer."

Adds James Nelson, operations manager for regional ISP KCNet: "Companies like Jato, NorthPoint and others are closing left and right, thanks to [the Baby] Bells monopoly."

Rhythms and Covad Communications say they have enough money on hand to fund operations until sometime in Q1 of 2002. NorthPoint, meanwhile, expects to hold an auction for its assets around March, pending bankruptcy court approval.

NorthPoint says several potential bidders have shown interest in the company, but analysts are skeptical. "Why take on debt and employees you dont need?" asks Giansiracusa. "Why not just wait for NorthPoint to go out of business and then take its customers for free?"

The Real Victims Dont expect ISPs to shed a tear for NorthPoint.

Many ISPs and DSL providers have been at loggerheads for months. Some ISPs took issue with Covad, which launched a Safety Net program in early December. Officially, Safety Net is designed to move customers with ISP troubles to another service provider or Covads own ISP, Many ISPs saw it as a ploy to steal their customers.

Other ISPs blame DSL resellers for some broadband problems. Jeff Lasman, the former owner of a small ISP in Riverside, Calif., says he got the cold shoulder when he tried to do business with major DSL providers and DSL resellers.

Some ISPs have tried to break bread with their DSL providers. Such was the case between WebDance and Ameritech. Even as their relationship improved, WebDances Toepfer believes Ameritech tried to steal its customers. WebDance complained to the Public Utilities Commission, but to no avail.

Until somebody steps up to offer timely DSL service, there will be no winners in the long-awaited broadband boom.

Just look at NorthPoint.