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Competitive local exchange phone companies (CLECs) and regional Bell operating companies (ILECs) looking to expand outside their own markets are the most likely buyers of assets from troubled digital subscriber line (DSL) companies, financial analysts say.
But finding the right buyer for a company like bankrupt NorthPoint Communications Inc. isn't going to be easy, now that the inherent problems of the standalone DSL industry have become endemic.
Pure play DSL has shown itself to be a much tougher environment to operate in than anyone thought, with difficult problems to resolve in operations, provisioning and buying connectivity from ILECs that are the main competitors for an independent DSL provider.
"These companies have been looking for partners for a long time without success," says Bank of America Securities analyst Doug Shapiro.
NorthPoint filed for Chapter 11 on Jan. 16 as its cash rapidly dwindled after Verizon Communications bailed out of its plan to invest $1.3 billion in the DSL service provider. Among its estimated $500 million in assets are DSL access multiplexers, or DSLAMs, the central office devices that intermix voice and DSL traffic onto a customer's DSL line. NorthPoint also owns or leases co-location space at telephone company central offices and ATM switches in the metropolitan areas where they operate.
Those are assets that logically might be sought by a Bell company that wants to expand outside its home region, a long haul provider looking for last-mile solutions, another large DSL player or a regional CLEC, analysts say.
One asset that's not available is a body of customers, because NorthPoint sold its services through Internet service provider (ISP) partners. "Owning the customers is key in the telecom business," says Gerard Klauer Mattison analyst Rachael Rennert.
San Francisco-based NorthPoint hoped the bankruptcy filing would give it breathing room from its $485 million in debts and allow it to find a buyer. Chief executive officer Liz Fetter says she talked with about 10 potential buyers, including Qwest Communications International Inc. and WorldCom Inc., in the six weeks after the Verizon pullout, but couldn't nail down a deal.
Other companies mentioned by industry watchers as potential buyers include regional DSL provider McLeod USA or Craig McCaw's XO Communications. Neither company responded to phone calls about their interest.
While there's plenty of strategic rationale for buying DSL assets, there's not a lot of financial rationale, Shapiro says. The 180-degree turn the industry experienced, literally within a matter of a few weeks late last year, caught companies and investors by surprise.
The DSL companies were victims of the capital markets drying up before they could generate positive cash flow, Rennert says. "They under-estimated how much capital it would take to get to cash flow positive."
The DSL providers also failed to recognize early on that, down the road, their ISP customers were likely to have liquidity problems of their own and be unable to pay their bills.
Survival for the DSLs now depends on finding someone with deep enough pockets to shell out the considerable cash needed to get them to profitability.
"How many companies can handle the extensive operating losses it's going to take to bring these companies to EBITDA positive?" Shapiro asks. Taking on a company like NorthPoint could seriously dilute the buying company's earnings per share. Still, Shapiro believes a buyer for NorthPoint assets at bankruptcy's fire-sale prices will emerge.
The other two major nationwide DSL carriers, Covad Communications Inc. and Rhythms NetConnections Inc, have begun to retrench-paring workforces and scaling back operations hoping to ride out this period of scarce outside funding. Their business plans also are evolving away from DSL pure plays as they begin to offer more integrated telecommunications services.
Covad and Rhythms "will be successful, if everything falls into place," Rennert says. "If we have another fall 2000, where the funding dries up, then they won't."
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