Burned
or Buttered? Making the Case for Independent DSL Providers
By Keith Markley
"DSL is toast" is a pronouncement that could have come from any number of so-called "industry experts".
The conventional wisdom today is that independent (non-ILEC) providers of xDSL technologies or companies selling ISP services over those networks will not survive as going concerns. To prove the point, industry pundits and financial analysts alike cite the bankruptcies of NorthPoint Communications Group Inc. (www.northpoint.net), Flashcom (www.flashcom.com), Jato Communi-cations Corp. (www.jato.net) and others and look woefully at the collapsed market capitalization of the broadband communications players.
But do the current end-of-the-world views really reflect what's going on in the marketplace? Is the collapse of share price evidence of a fundamental flaw in the so-called Broadband DSL Model? That is not necessarily the case.
The overarching mistake made by most of the industry pundits is the tendency to collectivize the sector. Too many observers regard all data LECs (DLECs) and broadband ISPs (BBISPs) and their business plans as identical, and they expect the companies to succeed or fail as a group.
This group-think has led to an overreaction in pessimism today, just as it created an overly enthusiastic environment last year, when financiers and investors virtually threw money at any business plan predicated upon broadband or Internet access. Last year's "sky's the limit" group-think about the broadband access market was as off-base then as the collective bell tolling is inaccurate now.
Today's problems and challenges are real and there's no trivializing their seriousness. But management teams are not, as some are suggesting, pounding away at fundamentally flawed business models.
It is not preordained that the DLECs and BBISPs are going to yield the broadband-access field to the RBOCs and the cable TV monopolies. Not all, but many, independent providers are going to survive and succeed.
To negotiate the road to success, however, will require that independent providers draw the right lessons from this current experience and then apply them going forward. Unless the proper lessons are learned, otherwise healthy carriers will be frozen out of the marketplace, their investors will see no returns, and their customers will be frustrated in their expectations for new, exciting broadband-based services.
The situation in the broadband Internet industry today parallels the carnage of the commercial real estate market in the late 1980s. Glib, but not true. When the bottom fell out of the real estate market in 1989, business withered because people stopped coming through the doors, not because the financial markets had pulled the plug.
But the situation within the DSL industry is just the opposite. The industry cannot keep pace with demand, while it is the financiers who have become skeptical. And what is most perplexing is that the defections seem to stem from a bout of amnesia about what the business case was in the first place.
The DLEC/BBISP business plans that have gone to market have shared a number of similarities, such as allocating large capital expenditures to build out network infrastructure; securing revenue-producing customers; selling new, high-margin enhanced services; periodically returning to the capital markets on a scheduled basis for further expansions; and accomplishing all of this within a timeframe that points to a three- to six-year breakeven point.
As businesses were developed, most companies discovered intense pent-up demand and adjusted their plans for even more aggressive expansion, which further pushed back expected break-even dates. The two necessary external assumptions underlying this cycle were continued intense market demand and that financial markets would continue to fund the expansion on a periodic basis. Financial markets encouraged this arrangement.
For the first couple of years, many of the companies were successfully tracking their plans. But right in the middle of the schedule, just as many of the DLECs and BBISPs were set to go back to the market for the next round of financing, the market got wobbly and changed the rules of the game.
Suddenly, investors jettisoned the expansion benchmarks and raised the banner of near-termed profitability. The change caught many companies short at the most vulnerable time. Companies, not prepared for the change in circumstances, found themselves scrambling to curtail planned expansions in order to conserve cash. Presumably, if they could not adjust in time to cut their cash-burn rates and conserve capital to weather out the storm, they risked future survival.
But this does not describe all companies.
There are companies that have been slightly less aggressive, more focused and at a stage in their plans where the capital market retrenchment has not been a body blow. DLECs and BBISPs can slash (and in some cases have slashed) cash-burn rates. In short, there are some companies who are prepared to prove the model sound, even under the changed circumstances dictated by skeptical financiers.
There is no mystery about how the DLEC/BBISP business case can re-establish its credibility. Companies need to build an efficient business at a measured pace and sell services at reasonable and compensatory rates. And, despite the conventional wisdom, this is precisely what many of the remaining players are doing.
There is no one broadband model, successful or otherwise, upon which to judge the health of the entire portfolio of DLECs and BBISPs. Players entered the market using very different strategies. Some sought large unit volume; others placed an emphasis on being sales
organizations, utilizing other carrier's facilities. Some companies tried to be the low-cost provider to the low paying subscriber; some focused on enterprise accounts. Some players focused on facilities as a strategy, while others focused on products and owning the customers.
The important issue is that many companies have approached the growing broadband communications market with very different models, and it's important to note that, while the companies may be categorized the same, they are usually quite different. So, while the their basic models may appear similar, significant qualitative alternatives in conducting the business do exist.
No one doubts that there is a huge pent-up demand for broadband access and an almost giddy anticipation for new, enhanced broadband services. Forecasts for DSL use seem to be understated with each new study. According to a compilation of industry research, DSL would garner some one million customers in 2000. Yet, in a recent report, one of the forecasters, IDC (www.idc.com), in tallying actual DSL year-end 2000 users, found some 4.5 million subscribers in the U.S., with DLECs, CLECs and IXCs accounting for nearly 80 percent of those.
An experience with a customer at DSL.net Inc. punctuates the research with a sense of the intensity of the demands. In November, DSL.net received a customer complaint letter, in which the customer catalogued a list of the company's shortcomings in getting him services. At the end of the letter, where DSL.net expected to find a request to cancel service and receive a refund, the customer asked the company to "please fix my DSL service ASAP."
Yet, conventional wisdom consigns DLECs to failure because "you can't build a business case just selling access."
As it turns out in practice, that is not quite true. You can build a business selling access at a reasonable fee to people willing to pay for it. Yet, it is true that DLECs build stronger business when they add on enhanced, well-margined products to include with that access. Services drive revenue. Adding offerings such as data access, web hosting, e-mail, firewall security and storage can drive up revenues, margins and profit dramatically.
There is no denying the current unfriendliness of the capital markets to independent DLECs. The prospect of tapping the capital markets for investment today, while not impossible, is certainly a daunting prospect for any DLEC management team.
However, there are DLECs/BBISPs that were not caught short in the capital market freeze and that have sufficient funds to slash cash burn rates and continue to capture share in markets they're already in.
The focus of these companies will be in capturing continued efficiencies, selling services and convincing financiers that these benchmarks warrant continued investments in the space. Just as investors have not written off the entire competitive telecom sector because of the failures of companies like GST Telecommunications Inc. (www.
gstcorp.com) and ICG Communications Inc. (www.icgcomm.com), so too, would investors do well to look for quality DLECs and BBISPs that have a solid business plan.
Keith Markley is president and COO of DSL.net Inc. (www.dsl.net). He can be reached at 203-782-7409 or kmarkley@dsl.net.
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