More than meets the eye

Covad Communications' recent move to drop business-focused Internet service provider DSLnetworks for unpaid bills was the result of a failed transaction—possibly a buyout attempt—by the DSL provider last year, a DSLnetworks official indicated last week.

Dan Melmed, DSLnetworks director of marketing, said he could neither confirm nor deny any soured acquisition. However, he emphasized that Covad's reasons for dumping the company on Feb. 7 ran deeper than nonpayment for services.

When asked if Covad attempted to acquire DSLnetworks, Melmed said he could not comment but added, “It's a possibility. If they had been, that would be further evidence of the fact that what they've been after all along is our customer base.”

Indeed, DSLnetworks asserts that cutting service to the ISP could yield Covad as many as 2500 of DSLnetworks' 10,000 total customers, 90% of which are businesses. In an effort to maintain its customer base, DSLnetworks filed an injunction last Wednesday against Covad in a California superior court to prevent the provider from soliciting its customers. The judge ruled in Covad's favor the following day.

“They're trying to cut off their resellers as much as possible,” Melmed said. “They've clearly been moving to a more direct model, and this is a way they can take ownership of the customer, which they didn't have.”

Negotiations for “certain transactions” began last spring between the two companies and continued for five months, Melmed said. During the negotiation period, Covad asked DSLnetworks to steer all qualified new customers to its service. In exchange, Covad agreed to waive at least part of DSLnetworks' monthly service fees, Melmed said.

A Covad spokeswoman said she was unaware of any acquisition plans or that the company had waived any fees. She said Covad reminded the ISP repeatedly that its service could be dropped if financial obligations went unmet and that the cut service should come as no surprise.

“There's never a time when a company that is purchasing a service from another company doesn't have to pay its bills,” the spokeswoman said. “Negotiations broke down on the amount they owed, and we felt it was necessary to terminate the relationship with them…. We sell them a service and expect to get paid for that.”

DSLnetworks, however, said that after months of negotiations it had established and agreed upon an incremental payment plan to reimburse Covad.

The shutdown caught the ISP completely off guard, Melmed said.

“They were more interested in taking our customers than honoring an agreement, which we had painstakingly negotiated,” Melmed said. “Finally, we did come to an agreement with them, and then they suddenly pulled the rug out from under us.”

Covad's dramatic stock devaluation was a “significant factor” in killing the proposed deal, Melmed said. When negotiations ended, Covad demanded DSLnetworks pay retroactively and in one lump sum for the five months of no-fee service.

“Part of the terms of this potential transaction was that we weren't responsible for payments for that five-month period,” Melmed said. “When it became clear that the transaction was not going to happen, we were left with a huge bill, and we weren't in a position to pay that full amount immediately.”

Neither company would comment on a specific amount of money DSLnetworks owes, but the Covad spokeswoman said it was between $1 million and $10 million.

Yankee Group analyst Michael Goodman speculated that Covad's decision to drop DSLnetworks was a move toward gaining customers.

“It's fairly clear that they need to be a direct seller because reselling does not make a lot of economic sense,” Goodman said. “At a high-level business model, it makes sense that they want to do that. They're going to do what they can to be the direct seller.”

Internet Express CEO Barry Diamond, whose company was also dropped by Covad, said the ISP agreed in August to give Covad its customers if Internet Express did not pay $1.5 million in overdue bills by last Sept. 15, which it did not.

“We looked at the whole situation and decided it made more sense to give Covad the customers than continue to lose money with whatever scenario they came up with,” Diamond said.