Charles McMinn

When the capricious winds of Wall Street shifted from network expansion at any cost to demonstrating profit, all CLECs slipped, many fell and some vanished completely. For Covad Communications, the damage report was enough to make even the most unflappable investor wince.

Since March 2000, the company closed 260 central offices, identified 19 ISPs that couldn't make payments as “distressed,” dropped some outright and cut 800 employees, which includes CEO Robert Knowling's resignation in October. Former Cisco Systems vice president and general manager Frank Marshall stepped into the CEO role on an interim basis.

Additionally, Covad had Nasdaq trading of its 98% devalued shares halted for a brief time and postponed its fourth-quarter and year-end 2000 earnings call three months to examine “complex accounting issues,” which revealed $907.5 million in quarterly and $1.44 billion in annual net losses.

Despite the laundry list of disappointments, Covad Chairman Charles McMinn is sticking to his guns. With enough capital to carry the company into the first quarter of 2002 and funding available through vendor financing, private sources and strategic partnerships, McMinn says Covad will endure.

“I don't really care whether the public markets come back in the short term,” he says. “The amount of cash we need to raise is small enough that we could raise it from other sources.”

To satisfy Wall Street's priority shift, Covad revamped its strategy in December to expedite its path to profitability. To that end, Covad took steps toward a more direct business model and reorganized its distribution channel mix around three outlets, utilizing two acquisitions made in 2000.

While maintaining its core wholesale division, Covad's LaserLink acquisition gave it a private DSL label called Covad Integrated Services. Additionally, Covad inherited a direct sales unit when it acquired BlueStar Communications, which spawned Covad Business Solutions.

During first quarter 2001, Covad showed signs of depending less on ISP resellers. In the first quarter, Covad resold 93% of its lines and provided direct service to 7%. At the end of fourth quarter 2000, those numbers were 97% and 3%.

As of April, the company had 319,000 total lines in service and was on track to hit its lowered year-end 2001 target of 440,000 to 460,000 lines. But competing with incumbent carriers pushing their own DSL services remains a problem, and some question the viability of Covad's wholesale business model. Critics say Covad's business plan — with or without the revamping — collapses because it relies on incumbents to provide lines.

“It made some sense when the ILECs were sitting on the sidelines and not interested in the market,” says Michael Goodman, an analyst at The Yankee Group. “Even if they price DSL at the same level as the ILECs, they're at a disadvantage because the ILEC has a better margin and its costs are lower.”

But McMinn says with its nationwide network in place, Covad does not mind taking a regional back seat to the bigger — though geographically restricted — players.

“We never said we had to be the number-one DSL provider in every ILEC region,” McMinn says. “We can be the number-two supplier in every region we're in and, on a nationwide basis, be the number-one DSL provider.”

With NorthPoint filing for Chapter 11 protection in January and Rhythms NetConnections' future precarious, Covad may become the last of the Big Three independent DSL providers to survive.

Not only has Covad benefited from fading competition, it's also reaped the benefits of picking up hobbled competitors' customers. After AT&T purchased all of NorthPoint's assets in March — except its customer base — more than 100,000 subscribers were stranded without DSL service. Covad snared 10,000 of defunct NorthPoint's customers immediately, and 15,000 more orders reportedly were pending.

“If Rhythms goes under, Covad will be the only independent DSL provider with the business-class, coast-to-coast presence in all major markets,” says Jeff Moore, senior analyst for network services at Current Analysis.

While McMinn is aware his hand strengthens as Covad's competitors weaken and while he welcomes NorthPoint's former customers, the mass customer migration was a bittersweet business victory that helped Covad but gave the DSL industry another black eye.

“It's not the right thing to do to strand 100,000 subscribers without service, but, that said, we did see a significant upturn in orders,” McMinn admits. “In the end it will allow us to load our network more quickly, but I wouldn't want to repeat it.”

Though some analysts and investors say Covad is a great acquisition prospect, McMinn says he isn't interested. With a total focus on DSL and nationwide footprint that offers symmetrical services across all regions, McMinn says Covad, the incumbents and DSL subscribers are all better served if the company remains independent.

McMinn pointed to SBC Communications' $150 million investment and six-year, $600 million commitment as evidence that even the incumbents see the value in using Covad out of region.

Covad is focused on generating the profitability Wall Street demands rather than creating false perceptions about Covad's worth.

“The best image-building we can do is to execute,” McMinn says. “We're not trying to spin our way to success — we don't need to do that. As long as we execute, we're in control of our own destiny.”