CLECs ON THE PRECIPICE: GST goes bust; e.spire aims for turnaround

Mounting debt and a lack of interested buyers led GST Telecommunications to file for bankruptcy last week, raising questions about the viability of some competitive local exchange carrier business models.

GST's Chapter 11 filing in the U.S. Bankruptcy Court for the district of Delaware was of little surprise to analysts and investors. Despite recent sales of its NAMS software division and proceeds gained from the sale of stock in Global Light Telecommunications, GST faced a severe cash shortage.

As of May 5, the company's cash and available cash equivalents totaled $16.8 million, down from more than $40 million at the end of March. Management attributed the decline to unexpected delays in anticipated revenue from the company's conduit and fiber network construction activities. Trading on GST was halted Wednesday with its stock price at 61/64.

Spotting an opportunity, Time Warner Telecom announced a tentative agreement to buy "substantially all the assets" of GST for $450 million in cash. The fire sale would give Time Warner Telecom about 252,000 miles of fiber and 37,988 customers in 49 cities in California and seven other states: Arizona, Idaho, Hawaii, New Mexico, Oregon, Texas and Washington. GST has 15 voice, 22 frame relay and 41 ATM switches in operation.

"Time Warner would be paying about 50cents on the dollar," said John Bauer, managing director of Ladenburg Thalmann.

However, the sale to Time Warner Telecom is subject to approval by the bankruptcy court and state and federal regulators, and the carrier may not be the only potential buyer. A company needing a West Coast presence - McLeodUSA, for example - could easily start a bidding war, Bauer said.

Founded in 1994, facilities-based integrated communications provider (ICP) GST started with a single product focus: providing dedicated transport to businesses. With deregulation and the rise of the Internet, it acquired companies to enter businesses such as Internet access and the selling of dark fiber, but GST had trouble integrating those properties.

And the company wasn't getting the operating cash flow it needed to offset its upfront debt, said J. Cannon Carr, senior analyst at CIBC World Markets. "The telecom business changed radically underneath them."

The changes occurred because facilities-based carriers have a slew of costs in what is a commodity business and have had difficulty matching the integrated services of larger providers when selling to businesses, said Rob Norcross, vice president of Mercer Management Consulting.

"The old [competitive access providers] ultimately consolidated and got bought out by large carriers," Norcross said. "GST and some of the others ended up without a home."

Another ICP with recent troubles, e.spire, remains afloat but resembles GST in many ways. The companies are comparably sized in terms of fiber route miles, revenue and cash flow losses, and both recently have had to restate earnings as a result of accounting miscues - GST in the area of construction revenues and costs, e.spire in the booking of dark fiber sales. But that's where the similarities end, Bauer said.

e.spire has a stronger management team, having lured Omnipoint Communications veteran George Schmitt into the chairman and interim CEO spot. It also has stronger momentum in its voice and Internet businesses and strategic backers ready to infuse the company with capital, Bauer said.

Honeywell International, Greenwich Street Capital Partners and the Huff Alternative Income Fund - a mutual fund run by e.spire Vice Chairman William R. Huff - committed $175 million in new equity financing since the beginning of this year.

e.spire currently boasts $130 million in cash and cash equivalents on hand and another $200 million that it can draw on from banks and investors, Schmitt said. And at its current cash burn rate of $20 million per month, Schmitt expects that to be more than enough to see the company through the end of 2000, at which time it expects to be cash-flow positive.

"Funding and access to capital is going to be the No. 1 issue for CLECs in the next, 12 months," Carr said.

But the company still faces a host of challenges, including renegotiating covenants on bank debt, fixing a billing system that allowed more than 500 customers to go unbilled for up to 12 months, and growing its Cybergate Web-hosting business while dialing down less profitable voice and dial-up Internet services.

e.spire has not ruled out selling non-core assets - including dark fiber and duct space in geographies where the company operates as a switchless provider - but it has yet to receive attractive offers, Schmitt said.

You win some, you lose some - and with the FCC's rulings, everyone usually doesn't go home happy. The situation is no different for rules regarding the unbundling of network elements, the revision of which went into effect last week. In this instance, the winners appear to be incumbent carriers, and the losers appear to be switchless competitive carriers.

The FCC's ruling on unbundled network elements (UNEs) was meant to clarify vague language in the Telecommunications Act of 1996. In theory, unbundling allows competitors to lease portions of an incumbent's network to provide services. By doing so, incumbents would be more likely to offer additional innovative services to match those offered by the competitors.

Under the revised ruling, incumbents must provide unbundled access to six of the original seven network elements: loops and subloops; network interface devices; dedicated and shared transport; signaling and call-related databases; operations support systems; and local circuit switching, with the exception of larger customers in major urban markets.

Circuit switching was exempt.

Although the unbundling of the six elements should be advantageous to competitors, the FCC did leave the incumbents some elements to resolve on their own. As part of the ruling, incumbents are not required to unbundle their operator services and directory assistance services. Perhaps more puzzling to some is the exclusion of access to packet switching and DSL access multiplexers.

"We asked the commission to reconsider its decision on packet switching, and that is still with the commission," said Jonathan Lee, vice president of regulatory affairs for CompTel.

The order is a problem for some competitors but not for all. It will really have a greater impact on providers that are not facilities-based.

"It will affect you differently, depending on which CLEC that you are," said Jonathan Askin, general counsel of the Association for Local Telecommunications Services. "If you are someone like Covad or Rhythms, for example, it won't be a problem because their plan is to build out their own. And a lot of them are moving faster than the incumbents anyway."

Although the ruling is effective, the petitions to reconsider have yet to be denied, Lee said. "They will probably be addressed in August," Lee said, noting that the FCC told a Washington circuit court to hold all appeals in advance because it planned to act quickly on the reconsideration petitions.

"Right now, the appeals are inactive because the FCC has said they would take action of some sort," Lee said.

In addition to concerns about the UNE remand, ALTS also started an "open the networks" campaign, demanding that the FCC develop and enforce more policies on the incumbents, Askin said.

"Our goal is to redirect the FCC and to keep incumbents from foot-dragging and architecting their networks in non-competitive ways," he said.

But clearly, the FCC doesn't always do everything the competitive providers want.