Post-Rhythms, Eyes Turn To Covad
By Jeanie Stokes
from the April 16, 2001 issue of Broadband Week
The beat's barely going on at Rhythms NetConnections Inc., and DSL industry observers are wondering whether that signals more potential storm clouds for fellow national provider Covad Communications Group Inc. as well.
Amid increasing signs that it would not likely survive on its own, Denver-based Rhythms has put itself up for possible sale and pushed co-founder, chairman and CEO Catherine Hapka out of office effective May 1.
While Englewood, Colo.-based Rhythms isn't quite out of cash, its auditors, PricewaterhouseCoopers LP, told the Securities and Exchange Commission in the company's annual report there's "substantial doubt" about Rhythms' future given its recurring operating losses, total stockholders' deficit and a notice from one of Rhythms' leasing companies, GATX Capital Corp., that Rhythms is in default on some of its debt provisions.
Moody's Investors Service, the Wall Street credit rating company, lowered its ratings on $1.3 billion of Rhythms' debt to reflect a financial performance that has fallen short of Moody's expectations "and our concern that Rhythms lacks the liquidity to sustain its capital needs in the intermediate term."
In the wake of national DSL provider NorthPoint Communications' fall into bankruptcy and subsequent shutdown last month, the two surviving "national" players--Rhythms and Covad--are seeing increasing scrutiny about their financial health as well as whether they'll be catalysts for further consolidation of the DSL business.
Santa Clara, Calif.-based Covad delayed its annual SEC report filing until this week because of accounting problems. While it hasn't released financial details for the year, Covad says it had 319,000 lines in service as of March 31. However, 15 percent of those still aren't generating any revenue because customers can't pay.
The real issue for Covad is cash flow, not line growth, says Morningstar Inc. analyst Michael Hodel. "It's hard to credit a firm for adding paying customers when it's impossible to tell if the accomplishment will have any meaningful impact on the company's ability to continue as a going concern."
Epoch Partners analyst Todd Fernandez says studies show that when companies delay 10K filings, the probability of default or a bankruptcy filing increases substantially.
As of Dec. 31, Rhythms had $505 million in cash and investments. Combined with available lease financing, that's enough to fund operations into January 2002, the company says.
That gives Rhythms a little breathing space, but not much. Rhythms hired Lazard Freres & Co. as investment bankers to evaluate a possible sale, strategic partnership or joint venture and debt or equity financing or restructuring.
"Lazard presumably will bring in bondholders early, looking to cut a pre-packaged deal and avoid the cuts NorthPoint was forced into," says Dave Burstein, editor of DSL Prime, a newsletter that tracks the industry.
A federal bankruptcy court approved the sale of most of NorthPoint's DSL assets to AT&T Corp. for $135 million, in a deal that essentially shut down the NorthPoint network and left its customers scrambling to find new broadband service.
Rhythms shares, which first sold publicly in 1999 for $21 each, traded recently at 19 cents, down from a 52-week high of $35.62. The Nasdaq market plans to issue a formal notice to de-list the stock because of its failure to meet listing requirements. Rhythms hadn't received the de-listing notice as of April 2, and says it isn't sure whether it would appeal the decision.
The stock's vanishing value has raised eyebrows about Hapka, who made more than $10 million on shares she sold with the company's consent between March and August, even as the stock was losing value. Hapka also was paid more than $811,000 in salary and bonuses last year. By staying on the payroll through May 1, she qualifies for the rest of a retention bonus valued in excess of $500,000.
Steve Stringer, Rhythms president and chief operating officer, has added the title and duties of CEO to his current position.
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