Covad Comes Back from the Dead

Just a few months ago, Covad Communications Group Inc. looked like one more Internet flameout. After building the largest network in the country for offering speedy Net access over digital subscriber lines (DSL), the company got hammered by the dot-com bust. In 2001, a third of its customers stopped paying their bills, and Covad was delisted from NASDAQ for not being able to close its books properly. The coup de grâce came in February, when the Federal Communications Commission said that, as a general policy, the local phone giants would no longer have to lease their phone lines to broadband rivals such as Covad at low wholesale prices. With its business plan in tatters, the stock, which topped $60 in 2000, fell below $1. Says CEO Charles E. Hoffman: "It was kind of like they moved the goalpost in the middle of the game."

Then it got moved back. In a surprise decision on Aug. 21, the FCC issued the final details for the broadband deregulation plans announced in February and put Covad back on solid footing. The commission grandfathered Covad in under the old rules -- so the phone giants would still have to offer the Santa Clara (Calif.) company wholesale rates for its existing customers. That will give Covad time to execute a new strategy: teaming up with long-distance carriers to offer Net and basic phone services together. BusinessWeek has learned that Covad is close to finalizing a deal with MCI to market Covad's broadband Net access jointly with MCI's local and long-distance phone service. This follows a similar deal Covad has with AT&T, which has been offering a voice and Internet access package in New York since July and plans to expand to 12 more states by yearend. MCI declined to comment.

Hoffman is carving out a niche as a natural ally for the long-distance carriers. AT&T, MCI, and others need to offer broadband access to compete with the voice and data bundles being sold by regional Bell carriers and cable companies. Covad, which spent $2 billion to build a cutting-edge network that reaches 96 top U.S. markets and a sophisticated billing system, can offer the long-distance players rock-bottom wholesale rates because of some smart moves and tough cost-cutting. It wiped out most of its debt in bankruptcy, it laid off nearly 75% of its workforce, and it dropped a pricey effort to establish its own consumer brand.

Investors like the strategy. Covad's stock has risen from $1.01 in late July to more than $3. "Covad has become an arms merchant for the long-distance carriers to fight against the Bells," says analyst Vik Grover of investment boutique Kaufman Brothers, who thinks Covad could have more than 1 million Net-access lines by 2005, up from 381,000 in 2002.

Of course, Covad's success depends on a continuation of the battle. Some analysts think AT&T and MCI will one day be acquired by the Bells. If that happens, the local phone giants may use Covad's network to serve customers outside of their home territories, but the Bells likely would use their own networks to push DSL wherever possible. Meantime, Covad is offering its wholesale service to other voice carriers and corporations so they can market to their customers. A seven-month-old partnership with AOL Time Warner Inc. (AOL ) is Covad's fastest-growing account. Says analyst Scott Cleland, chief executive of investment research firm Precursor Group: "Covad is making the best of a bad situation."

That's becoming a Covad hallmark. Despite having laid off so many of its employees, Covad has boosted customer service and increased its sales to small companies, which bring in most of the profits. "Finally, the market is starting to pay attention," says Hoffman. And this time it's not to see another former Net star crash and burn.

By Peter Burrows in San Mateo, Calif.

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