The move will reduce troubled Covad's operating costs by $75 million and beef up its cash reserves until July 2002. Covad, a nationwide wholesaler of high-speed digital subscriber lines, said the normal business operations of its other units will remain unaffected.
Shares moved up 16 cents, or more than 23 percent, to 84 cents by market close.
BlueStar is a Nashville, Tenn.-based Internet service provider serving small and midsized businesses in the Southeastern United States.
"This was not an easy decision to make, but one that we felt was important strategically in our drive to improve profitability," Covad Chairman Chuck McMinn said in a statement. "In the current financial market environment, BlueStar's cost structure is not sustainable and is not supported by its current revenue-generating capabilities."
The announcement follows a string of bad news for the company, which included a lawsuit from a competitor and the threat of being delisted from the Nasdaq because of its low share price.
Covad announced the BlueStar acquisition in June 2000 in an all-stock deal worth about $200 million.
Covad had previously come under fire for the acquisition. A wholesaler that provided high-speed Net connections to ISPs that in turn resold them at retail prices to consumers, Covad entered the retail market by acquiring BlueStar. Wall Street and some of Covad's ISP customers balked at the move, though Covad insisted the unit would not compete with its largest ISP customers. Instead, BlueStar aimed to sell DSL on a retail basis to consumers and businesses in rural and smaller markets.
Santa Clara, Calif.-based Covad also said it will make every effort to provide former BlueStar Internet customers with service from other Covad units.