DSL Service Falters as Providers Crumble

Rhythms plans shut down, Covad files Chapter 11, and DSL competition wanes.

Tom Mainelli, PCWorld.com

(Editor's note: PCWorld.com's broadband survey invites your comments; responses are entered in a drawing for $500.)

At first glance, everything appears normal at the Web site of DSL provider Rhythms, where hipper-than-thou models invite you to check service availability in your area. Only a keen observer will notice the small-font headline low on the page that reads "Chapter 11 and Network Status Update."

Several clicks later you reach a company statement that outlines its plans to suspend all network services within 31 days of the August 10 posting date and lay off 75 percent of its workforce (about 700 people) in the meantime. The company sent a similar message to its subscribers.

It's unclear how many individual users and businesses will be left without service--Rhythms isn't returning phone calls. The company claimed 83,000 customers in March.

But what is clear is that serious problems plague the DSL market and that Rhythms is just the latest well-funded broadband services firm that has been unable to compete with entrenched regional Baby Bell companies. Another notable recent casualty is Northpoint Communications, which stranded thousands when it abruptly stopped service in March.

Most frustrating to Rhythms customers: Just eight days before the suspension notice, the company had filed to reorganize under Chapter 11 of the federal bankruptcy code. While shutting down was noted as a possibility, Rhythms was apparently planning to stay in business.

Covad Follows

The sequence of events at Rhythms isn't making it easy on the folks at Covad, another major DSL provider struggling to compete with the regional telecommunication companies such as SBC and Verizon. Covad has also filed for Chapter 11 protection from creditors, effective August 15, but intends to remain operational. Executives insist the move helps ensure the company's long-term viability.

But telling that to skittish DSL customers isn't easy, says Abhi Ingle, Covad's vice president of marketing.

"Many people see Chapter 11 as the beginning of the end, but that's not the case here," he says. This is a prepackaged Chapter 11 filing designed to help Covad wipe out its debt, he says.

Covad will continue to serve its more than 330,000 direct and indirect accounts indefinitely, Ingle says. The bankruptcy filing allows the company to eliminate more than $1.4 billion in debt, making Covad a more attractive investment.

Its proposed restructuring will pay Covad's bondholders at 19 cents on the dollar. But the company will be debt-free by January 2002. Then, it needs an additional $200 million to keep operating until it reaches profitability, expected in the second half of 2003.

Market Shift Blamed

So what happened to the once high-flying Covad? The market changed virtually overnight, Ingle says.

"A year ago we were focused on building out our network, and we grew the network at a furious pace," he says. In the third quarter of 2000, everything changed. Wall Street decided it wasn't about being big, it was about being profitable, he says. Covad reacted by radically slowing its network deployment, scaling back development plans, and closing one of three customer service centers.

Last year, Covad spent about $500 million building its network. This year it will spend only about $15 million to maintain the existing network structure.

Despite its radical cutbacks, a cash crunch hit Covad as its funding dried up, along with the budgets of many of its customers. More and more of Covad's ISP partners couldn't pay their bills. By the end of 2000, more than 33 percent of Covad's ISP customers were in arrears.

Things have settled down, with only about 12 percent of Covad's clients defaulting on payments, Ingle says. In the meantime, Covad is refocusing on filling up its existing network. To become profitable, Ingle predicts the company needs to double its customers to just under 750,000.

Flawed From the Start

Analyst Adam Needles, director of research with DVG Research, wants to be optimistic about Covad's survival because he's a fan of competition. But he's not convinced Covad can pull it off.

"They never had a stable business model," he says. "There are tremendous obstacles to people coming in and trying to compete." The independents generally provide better customer service than the Baby Bells, which nonetheless offer better stability.

Stability stems partly from the simple fact that the Baby Bells control the phone lines into homes and businesses. This means companies like Covad must rely on their competitors to provide the line and service necessary for independent DSL companies to provide their service. It's a rocky relationship, and has recently become a litigious one, with Verizon suing Covad over the DSL provider's loud complaints of poor service.

While the Baby Bells provide the "last mile" connection, DSL providers must build the rest of their high-speed networks. It's an expensive proposition. In fact, years ago the groundwork for advanced communication services was often subsidized by the government, Needles says. Today, Covad and its compatriots assume massive debt to build the infrastructures necessary to offer these services, he says.

These competitive companies "always had a ticking time bomb" on hand, as they raced to boost subscriptions while keeping prices low. "It was a violation of basic economic principals. You don't build a communication network in quarters; it takes decades," Needles says.

Bells Rooting for Covad?

While analysts and industry-watchers often pit Baby Bells SBC, Verizon, and the others against competitors like Covad and Rhythms, SBC spokesperson Fletcher Cook considers cable services the competition, and suggests other DSL firms are actually allies.

Cable has 70 percent of the broadband market and no real competition in most markets, Cook says.

"All DSL providers are pulling for each other," Cook says. It's DSL versus cable. Covad may be competition, but the company is also valuable because it's helping win people to DSL instead of cable, he says.

"Sure, we'd love for customers to come to us instead, but we'd rather have people on DSL--even if it's not us--than on cable," Cook adds.

Of course, not everyone considers DSL providers one big happy family. Mike Lunsford, executive vice president of broadband at national ISP Earthlink, doesn't buy SBC's goodwill sentiments toward Covad and other competitors.

"If it gets down to just the Baby Bells, you'll see them raising rates and eliminating marketing development funds," he says. Already SBC has slowed its DSL marketing, while waiting for the competition to die, he says.

As proof, Lunsford points to SBC's recent slowdown in adding new DSL lines. SBC added 250,000 lines in the fourth quarter of 2000. In the first quarter of 2001, it added 180,000 lines; and in the second quarter, just 80,000 lines, Lunsford says. (At the end of the second quarter of this year, SBC claimed more than 1.3 million DSL customers.)

"It's a constant downward growth pattern," Lunsford says. The reason? "Why rush it if I'm not worried about losing customers to Covad?" he says.

Doubling Up

Earthlink wants Covad to survive, because many of its own customers connect to DSL through Covad, Lundsford adds. However, it's also an SBC reseller.

"We're transport-agnostic," Lunsford says. In fact, Earthlink draws on services from the Baby Bells and their DSL competitors, as well as cable, satellite, and fixed wireless firms to provide broadband to more than 346,000 customers. It looks for at least two broadband providers in each market.

Fewer than 5000 Earthlink subscribers will lose their broadband connection when Rhythms shuts down its network, he says. Earthlink is scrambling to offer those customers a broadband alternative before their service ends.

However, Lunsford expects only about 70 percent will move to a new carrier through Earthlink. And they'll likely have some hassles in the transition, although they'll get to keep their existing e-mail addresses and won't incur any additional charges.

"I wish I could say it would be invisible to customers," he says. The fact is, however, some people will experience outages, he says.

If Covad were to close, Earthlink would be more significantly affected, Lunsford says. That's why it's important to have a second option in every area, and Earthlink is verifying that in light of Covad's Chapter 11 filing. Today, about 80 percent of Earthlink customers could move to another broadband provider through Earthlink, he says.

However, even reasonably painless shifts in service will push more customers toward the Baby Bells eventually, notes DVG's Needles. His own company subscribes to an ISP that uses Rhythms. While they promise a backup provider is in place, he's wary of the process.

Consumers need to decide if they want to depend on a competitor that may not be around a year from now, he says. "Maybe you want to go straight to the Baby Bells--at least they're stable."