Covad files for bankruptcy

The company last week had announced its intention to seek bankruptcy protection, along with an agreement with its bondholders to eliminate its $1.4 billion in debt.

"The filing is a tool to expedite the agreement reached with our bondholders," said Covad spokeswoman Kathleen Greene.

The company is one of many troubled providers of high-speed DSL (digital subscriber line) access that have incurred much financial pain over the past year. DSL providers Rhythms NetConnections and NorthPoint Communications folded earlier this year.

Covad expects to pay a total of $283.3 million to bondholders and have $250 million in cash remaining that will enable it to keep running until the beginning of next year. The company estimates it will then need $200 million more in financing to reach a positive cash flow by the third quarter of 2003.

Under terms of the deal, Covad would pay 19 cents in cash to bondholders for every dollar of bonds held. In addition to the cash payout, holders will also receive 33 million shares, which equates to a 15 percent stake in the company.

The Santa Clara, Calif.-based company will also return the entire $26.5 million cash loan that it raised from holders of its 12.5 percent bonds.

Chuck McMinn, Covad's chairman, regards the restructuring as a victory and remains confident that the company can raise the funds needed to keep operating.

"Our bondholders would not have traded in their debt for stock in the company if they did not think those shares would be worth something down the road," said McMinn, who points out that the company actually needs less money to operate because it does not have to service any debt with interest payments.

Bondholders are getting paid almost $300 million for their benevolence, even though Covad has not defaulted on any of its bond payments.

Peter Kaufman, a partner at the Gordian Group, says Covad bondholders seem to have won favorable terms in the deal, considering that their influence to negotiate a restructuring was limited.

"Holders of bonds that are not in default traditionally have not had a seat at the table," he said.

Facing tough choices
The company might face some tough choices over how to best run its business. McMinn says that Covad still needs to grow its customer base as much as possible, but adding customers burns more cash compared to regular operating activities, which will not be affected by the restructuring.

Covad said that it had 330,000 customers at the end of the June quarter, with business users making up 51 percent of its customer base.

Covad charges its customers less than the actual cost of setting up a new connection and makes that money back over time. McMinn says the company takes a bigger hit to set up business customers, but gets paid back more quickly than through its consumer business.

So the company must strike a balancing act between its need to acquire customers, the cash it has to work with, and the time it takes to recoup its investment in new customers.

Even though the restructuring buys the company some time, it remains to be seen if more investors will step forward with a check.

The times for telecom upstarts have become leaner as many companies across the industry have trouble building their networks. Optical carrier 360networks filed for bankruptcy in June, when Level 3 Communications also cut 25 percent of its work force.

"There are a lot of telecom companies out there that have not been able to raise money or do M&A deals, regardless of their capital structure," said Henry Owsley, a partner at Gordian Group.