Covad announces Chapter 11 with a twist

Thanks to a unique agreement with bondholders to retire its $1.4 billion debt load, troubled nationwide DSL provider Covad Communications says it will file for Chapter 11 protection later this month and emerge in January as a debt-free entity scheduled to become cash-flow positive by the third quarter of 2003.

Under the deal, Covad will pay its bondholders $283.3 million—19 cents on the dollar—and give them stock to retire the debt and leave the company with $250 million in cash. A majority of the bondholders have agreed to the plan, which Covad plans to present to a bankruptcy judge in an effort to get the agreement extended to all the company’s bondholders, according to Covad Chairman Charles McMinn.

Unlike last week’s Chapter 11 filing of fellow DSL player Rhythms NetConnections—expected to result in the dissolution of the company—McMinn characterized Covad’s bankruptcy action as a rebirth.

“We’re pretty excited about the prospect of getting this done and about the prospect of the business going forward, as a result,” McMinn said.

Indeed, without the burden of repaying $1.4 billion in debt, Covad’s business hopes look much brighter. McMinn said Covad needs only to convince investors to give the debt-free company $200 million to reach cash-flow-positive status—a much easier task than trying to coax $400 million to $700 million from a hostile capital market when Covad had $1.4 billion in existing debt under the previous restructuring plan.

Also, assuming Rhythms’ demise, Covad will be the only nationwide DSL company that offers the symmetric DSL (SDSL) service favored by businesses.

The agreement with the bondholders is a “good deal” for Covad that may make its largely wholesale model viable, said Mike Goodman, senior analyst at The Yankee Group.

“What you’re seeing, more or less, is that they got their network for free. It’s totally changed the dynamics of the business model,” Goodman said. “Before, you had to generate enough revenue to cover your costs—your capital outlays plus your debt payments. But they’ve created a model where you don’t have to make any debt payments, at least to this point.”

If it can emerge debt-free, Covad should have little trouble getting investors to give it $200 million in financing, although the bankruptcy action will make the terms of the investment less favorable, Goodman said.

“Seeing that they have no other debt certainly puts them in a better position to raise some capital,” he said. “On the other hand, anyone who is going to lend to them … is not going to give [Covad] very good terms—they’re going to get very tough terms, in fact. And that is going to be a challenge to them in finding financing.”