DSL provider pulls ahead of competition

Seated next to First Lady Hillary Clinton, Knowling's presence was a symbolic showing of the company's rise to power--in political circles, on Wall Street and among its competitors.

Knowling was invited by the Clintons for his role as an Information Technology Association of America (ITAA) committee chairman, where he has worked to improve access to technology for minority groups and diversity within the Silicon Valley workplace.

One of three major providers of digital subscriber line (DSL) services, Covad is racing against Rhythms NetConnections and Northpoint Communications to install high-speed data connections in most of the nation's largest cities. Covad and the others primarily serve business customers, but will begin marketing to residential consumers later this year.

Although the rivals all went public within a few months of each other early last year, Covad appears to have the early lead in a high-stakes race.

The company installed more DSL lines last quarter than Northpoint and Rhythms combined, according to the most recent quarterly financial results.

During the fourth quarter, Covad installed 26,000 lines, bringing its total to 57,000 lines. Northpoint ended 1999 with 23,500 lines. Rhythms claims 12,500 in total.

At the same time, stock in Covad has continued to climb, trading in the mid-$70s per share recently, while Northpoint and Rhythms shares have slipped from their highs and currently trade in the low $30s.

Despite Covad's early success, its long-term prospects are not assured--primarily because the market is in its infancy. As the market matures, Covad will face even more intense competition, particularly as it enters the consumer market. A few of the sleeping broadband giants: well-funded local phone companies, cable operators such as AT&T and its Excite@Home service, and even the wireless and satellite alternatives that are on the horizon.

DSL providers lease copper phone wires from the local phone giants. After installing new equipment, Covad and others sell access to the high-speed lines via Internet service providers. Rhythms also sells its DSL service directly, but the process can be cumbersome.

Covad executives say their management team, solid execution and commitment to a series of behind-the-scenes electronic ordering and processing systems have contributed to their initial successes.

"After years in the communications industry, you really don't pay attention to the markets. You focus on the fundamentals, you stick to your business plans, and the market will take care of the rest," Knowling said.

Analysts also point to another Covad strength: It has been the most successful at installing electronic systems that allow it to process orders more quickly than the others and with as little interaction with the local phone bureaucracies as possible. Installing DSL has been a notoriously complicated and messy process.

"They talk computer to computer and they sort out a lot of problems electronically," said Mark Langner, a financial analyst at J.P. Morgan Securities.

"We have a zero-touch mentality," Knowling added. "We have most of the systems set up through an electronic process so the intervention of human hands is as limited as possible."

Langner, who maintains a "buy" rating on all three of the DSL competitors, says the execution leads to better partnerships.

"Covad has shown that it's executing, which means it's likely to continue to attract the best partners," Langner said. "The name of the game is 'he who gets the customer first wins.' You want to be partnered with the company that installs the lines first and fastest."

Although Covad's order-taking processes may be a step ahead for now, the company's competitors caution that the market is only beginning to take shape and that there will be room for plenty of players.

"We're very early in the market. This is a market that's going to be about millions of customers, not just thousands," said Rhythms CEO Catherine Hapka.

Indeed, all estimates point to huge growth in the DSL market.

Telechoice, a research firm focusing on communications, projects that by the end of 2000 there will be 2.1 million DSL lines installed. By the end of 2001 that number will reach 5.1 million.

International Data Corp. predicts that by 2003 the number of DSL households in the United States will jump to 9.3 million from the current 330,000, while Jupiter Communications expects 5.7 million DSL users by 2003.

"We haven't even had our first overnight yet on the climb to Everest," Hapka said. "I think I've got as many assets as they do and I intend to plant my flag first at the summit, no matter how the stock market looks at it."

Rhythms generates more revenue per customer than Covad and has installed its equipment in more phone company central office switching locations than Covad, she said.

Northpoint also believes the DSL race is only beginning to shake out.

"This race isn't over by a long shot. There will be lots of winners and Northpoint will be one of them," said Northpoint spokesman Jim Monroe.

Covad also had a crucial head start of several months, Monroe said.

"Considering that Covad started before us, we have gained considerable ground," he said. "We're growing subscribers at a rate faster than the others."

Clearly Northpoint, which claims partnerships with Microsoft and Radio Shack, and Rhythms, which has aligned itself with MCI WorldCom, have plenty to boast about.

Still, Covad has a market value of $7.2 billion, compared with Northpoint's $3.9 billion and Rhythms' $2.5 billion.

Analysts attribute Covad's stock price advantage to its ability to sell its story to investors and analysts.

"I think they've done a better job of telling their story and they've done a better job of dotting their I's and crossing their T's on the regulatory front," said Laurie Falconer, a DSL analyst at Telechoice. "They've been able to put on a public face that is positive despite problems with provisioning. They've just managed through it and weathered the storm in a better way, because they're all facing those issues."

Falconer said Knowling's recent State of the Union appearance is an example of the perceptions about Covad.

"It's just another time that they've done a good job in the public," she said. "It's all about awareness."

But even Covad executives, as much as they'd like to beat the DSL competition, admit that bigger competitors loom on the horizon.

"At the end of the day those guys (Rhythms and Northpoint) are going to get it together and have success," Covad's Knowling said. "The competition really is the phone company anyway, because that's the incumbent carrier that's got the lion's share of the market."