2HRS2GO: Broadband stocks still look risky

COMMENTARY--One news feature's headline sums up a concern: Will broadband Net access survive a recession?

The answer is easy and obvious. Of course it will.

As someone who was there for the first post-beta roll-out of Time Warner's Road Runner cable modems, and moved west just in time to participate in the pilot test for PacBell's digital subsciber line (DSL) service, I can assure you that once you have a high-speed Internet connection, you never want to go back to dial-up speeds. Think of it like cable television; many folks (including me) saw absolutely no reason to get it, but once they had that little box sitting near their TV--my wife wanted the service--it became as much a part of their daily lives as the radio or telephone.

Yet there's a more immediate question. Will broadband access companies make it? Many of them won't. Some of them are already in various stages of dying.

As of early this afternoon, the market capitalizations of four nationwide DSL providers--Covad Communications (Nasdaq: COVD), DSL.net (Nasdaq: DSLN), Rhythms Netconnections (Nasdaq: RTHM) and NorthPoint Communications (Nasdaq: NPNT)--added up to less than $400 million. Or roughly a skin cell on the body of a regional Bell operating company.

Much of the DSL vendors' slide stems from the general market malaise. But one major contributing factor can't be blamed on the market: bad business.

The idea is profitability through scale. If you get enough customers, your network pays for itself. That's the theory behind all Internet service providers (ISPs), broadband or otherwise.

You may noticed that even before the stock market collapsed, not a single nationwide ISP was making money, with the notable exception of America Online. Internet access doesn't provide terribly good returns. AOL required a decade to turn profitable, and only reached that point because it funnels members through a proprietary world specially designed to mix a heavy dollop of advertising and e-commerce with the community content.

(Incidentally, Road Runner tried a similar combination in the very beginning, offering a cut-rate version of the service that limited the user to Time Warner's content. The company found out that few users wanted it; the people who do want that combination can just go to...AOL)

Consumers pay more for broadband Internet access, but the service also costs more to deliver. And competing with the Baby Bells itself isn't easy, not when they can match any DSL specialist's prices without incurring the extra costs of reseller fees and renting space in a central switching office.

The Baby Bells themselves might be the biggest threat of all. Companies like SBC Communications (NYSE: SBC), Verizon (NYSE: VRZ) and BellSouth (NYSE: BLS) know how to sell commodity communications services and how to package things so they won't lose money. And a Baby Bell doesn't have to build a network; it already owns one.

Even in a healthy market, DSL vendors would have had a rough time at best. In an environment like the one we have now, where capital has dried up and technology adoption is likely to slow in the face of falling consumer confidence, the DSL vendors have no chance. They're not even worth buying; see Verizon's abandonment of NorthPoint for details.

Cable services have better prospects, only because they tend to have deep-pocketed backers. Road Runner rests with AOL Time Warner (NYSE: AOL). Excite@Home (Nasdaq: ATHM) continues to be the subject of rumor and innuendo because of its relationship with troubled AT&T (NYSE: T), but the reality is that it's got a pretty decent base. @Home may not be the huge monster people expected, but it won't go away.

Whether its stock is worth buying is another matter. Even after a long slide, Excite@Home carries a market cap of nearly $2 billion. From a traditional valuation standpoint, it's not a cheap purchase, even if it is, technically, a penny stock.

That fairly sums up the situation for all the broadband service specialists. They are gamblers' equities at this point, having reached a point from which few stocks return.

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