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SBC Gains From Covad's Cash Problems

Covad Communications might be getting $135 million to help ease its immediate Chapter 11 bankruptcy concerns but SBC Communications is getting the lion's share of the bargain with Tuesday's announcement to forget a deal struck last year.

On paper, the deal is a good one for Covad, which gets an immediate $135 million cash infusion from one of its owners and the elimination of a $15 million co-marketing fee. But in reality, the data competitive local exchange carrier (DLEC) is losing nearly $600 million in resale business guaranteed by SBC officials.

Joe Isbrand, a SBC spokesperson, said that Tuesday's deal with Covad Communications provides more flexibility to provide high-end nationwide digital subscriber line (DSL) service.

"Our focus is on being able to reach new customers, that's how we're looking at it," Isbrand said. "The ($75 million) pre-payment that we made to certainly doesn't limit the amount of services we can provide over the next 10 years. It better positions SBC to provide the products and services that customer demand may call for.

Certainly, $75 million over 10 years is much, much easier to achieve than the $600 million in six years specified in the original agreement, a deal made back in the heady days when the sky was the limit for DSL deployments. While Isbrand wouldn't give numbers of actual SBC customers on the Covad network, he did say they would continue marketing in those areas.

Covad, the largest independent DSL provider in the nation with 346,000 customers, is in desperate need of cash-on-hand to appease judges as part of its Chapter 11 bankruptcy proceedings. Executives have done a good job trimming its $1.4 billion debt down to under $100 million by an aggressive campaign of operational costs and convincing bondholders to take a huge cut to their investment in order to get pennies back on the dollar.

Chuck Haas, Covad co-founder and executive vice president of marketing and strategy, said the new deal puts his company back on track as a fully-funded business and even puts money in the bank to hold in reserve.

"At the high level, this funding provides Covad a fully-funded business plan which is what we've been striving for since the restructuring of our $1.4 billion debt," Haas said. "With this SBC deal, we've not only fully funded our business but have a nice cushion of additional cash. It's a great deal for Covad since it provides for no dilution for our existing shareholders."

In a statement to its customers earlier today, Charles Hoffman, Covad chief executive officer, rushed to explain that the funding relief from SBC will help get the company back to cash-flow positive in 2003.

"This infusion of capital is one of the final steps in our plan toward financial stability for Covad," he said.

The $135 million deal between Covad and SBC calls for the following:

  • A one-time $75 million pre-payment by SBC for (undetermined) Covad services within the next 10 years, payable when Covad gets out of bankruptcy court.
  • A $50 million four-year loan, with Covad assets as collateral.
  • A $10 million restructuring fee to Covad to avoid its $600 million resale agreement.

But the deal has long-term ramifications that benefits six percent equity owner SBC, the largest provider of DSL services in the nation. It's a pact Covad could look back at with a rueful shake of the head over opportunities lost.

Covad executives are well aware of the potential losses down the road, but according to Haas, the needs now outweigh any possible future gain.

"(The $600 million pact) was an economic tradeoff that we looked at pretty closely," Haas said. "the fact that we could get the money we needed today to get fully funded far outweighed the future promise of future revenue. Nothing's stopping SBC coming back and striking another deal (like the one last year)."

SBC has been back pedaling lately from the DSL industry, despite its vow to include 80 percent of its customers with DSL service, part of its vaunted Project Pronto initiative. The deal with Covad struck last year was meant to expand SBC's DSL presence outside its telco borders.

The broadband initiative, made by SBC executives at a time to appease Federal Communications Commission regulators over its pending acquisition of rival Ameritech, has stalled in recent months. A dearth of broadband subscribers and what its boss calls heavy-handed regulation by the FCC.

Edward Whitacre, Jr., SBC chairman and chief executive officer, lashed out at the FCC during a recent conference call to investment analysts. He said that the telecommunications industry is more heavily regulated than ever before, despite passage of the Telco Act, a fact that has SBC in a bind.

"Today's regulatory rules and uncertainty artificially increase costs, affect how we invest our capital and how we market our products and services," Edward Whitacre, Jr., SBC chairman and chief executive officer said in a press conference recently. "Our DSL services are burdened with regulation that our cable modem competitors do not face. Meanwhile, regulators are considering additional rules to regulate our DSL and other advanced services in the future. No responsible company could justify fully deploying broadband capabilities and investing in new advanced networks in the face of this uncertain environment."

Tuesday's deal is a two-part win for the incumbent LEC (ILEC): not only does it cancel approximately $450 million in DSL services to another company, it gives SBC room to migrate all its DSL business to its newly-acquired DSL Internet service provider (ISP) arm, Prodigy.