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Net access providers struggle to pay broadband bills

If Internet service providers were hospital patients, many of them would be in critical condition right now.

If Internet service providers were hospital patients, many of them would be in critical condition right now.

PSINet, a significant Internet services company, said Thursday that it has retained investment bank Goldman Sachs to explore "a strategic alliance or the possible sale of all or a portion of PSINet."

That follows ICG Communications' filing for bankruptcy earlier this week and a second restatement of earnings from Covad Communications after it said it could not collect from more of its ISP customers than it first thought.

Analysts and company executives believe that a variety of factors, such as lower-than-anticipated profit margins and a shortage of investment capital, including large up-front installation costs and exorbitant advertising spending, have contributed to the troubles of several broadband Net access providers. As a result, many floundering ISPs eventually will be acquired or could simply go out of business, experts say.

"There are 500, 600, 700 broadband ISPs clamoring for market share. They've all been given venture capital to go out and build a brand," said Mark Langner, a senior research analyst at Epoch Partners, a technology investment banking firm. "A lot of ISPs made some bad decisions about how to spend that money over the past 18 months, and now those chickens are coming home to roost."

The malaise in the ISP industry has also affected the once high-flying network equipment sector, forcing see story: Lucent's loans gone bad heavyweights like Lucent Technologies to warn of profit shortfalls and blows related to bad loans among some of its start-up ISPs and competitive local phone customers.

Rapidly emerging problems among several ISPs are, in some respects, curious for an industry that is growing exponentially. But with the entire industry going after the same set of customers, a contraction among competitors was overdue, according to some.

Analysts and executives believe the trend may portend consolidation and is a sign that only the largest providers, such as America Online, Microsoft's MSN and EarthLink on the Net access side, and Qwest Communications International and WorldCom, among others, on the business side, will dominate the market.

The recent travails of Covad, a sizable wholesaler of high-speed digital subscriber line (DSL) Net connections, see story: Telecom downturn offer an example of the impact of the ISP downturn. The company posted subpar quarterly financial results last month--and this week revised those numbers downward--after as many as 14 ISP customers were late in paying the company.

The financial shortfall for several of Covad's high-speed ISP partner companies, such as Flashcom and others, serves as an indication that the capital financing crunch that has so severely affected small, competitive local phone companies is also having an effect elsewhere.

"If you don't have any other revenue streams, it's really hard to make a go of this business," said Yankee Group senior analyst Emily Meehan. "You have to have some other revenue streams coming in, because they fall quickly into the red. I expect to see more consolidation among many of the third-tier companies."

To be sure, the scarcity of investment capital has played a part across the communications and high-tech markets, but particularly for ISPs like Covad, which has paid a high price for attracting customers.

"They've spent see story: Find a broadband providera lot of money on advertising, because there was a sense that capital was available, and they could go after lines and customers at all costs," said Harry Taxin, chief executive of MegaPath Networks, a broadband ISP.

"I think it caught up with them when they went out for more capital. Several of them had filed (for initial public stock offerings). But it didn't happen, and then they had a dilemma about which bills to pay," Taxin said, noting that MegaPath is not among the delinquent ISPs and has never worked with Covad.

Epoch's Langner said many broadband ISPs are likely to lose out to larger, more established competitors. "A lot of smaller ISPs are going to have a hard time competing with larger, more integrated retail players," he said. "A lot of these emerging ISPs just don't have the brand power to compete with the larger companies."