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Still Standing
How DSL.net dodged the dot.com bullet, the tech bullet and the telecom bullet — so far, so good
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Business New Haven
9/01/2003
By: Mitchell Young
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Racing across the country building a modern version of Route 66 is the analogy this publication employed in "Getting Big By Thinking Small," a January 2000 Business New Haven profile of New Haven’s DSL.net as this publication’s 2000 Innovator of the Year award-winner.
The then-relatively new DSL [digital subscriber line] technology that provided high speed Internet access at lower cost than traditional solutions was just taking off. DSL.net had a late start to the gate, but at least a small leg up on the competition.
Co-founder Paul Sun, an entrepreneur and engineer, was one of the first four employees of Shelton chipmaker TranSwitch. Sun went on to develop his own DSL circuits at a new company, Avidia. He sold Avidia before founding DSL.net with CEO David Struwas and Chief Technology Officer John H. Jaser.
Their plans were to construct a new digital highway across America, with high-speed on-ramps to the "information superhighway" empowering thousands of small and mid-sized businesses along the road.
This broad national network was to grow quickly to include nearly 600 Internet "points of presence" across the county. The company would market by focusing on the small and mid-sized business market in second- and third-tier cities.
It was Struwas’ strategy to stand clear the telecom giants that he believed would concentrate their efforts primarily on consumers in major markets.
Concerns about the Y2K software glitch destroying the U.S. economy ironically helped the tech boom get rolling. And while the January 1, 2000 disaster never materialized the year 2000 will nonetheless be remembered as the beginning of a crash that brought thousands of technology companies to their knees. For upstart New Haven start-up DSL.net, it was an awful roller-coaster rise.
DSL.net’s stock steadily rose to over $32 per share in February 2000 from its $8 initial offering price. But in a few months the real Y2K tech implosion would begin and by the end of 2000 Struwas saw his per share price tumble to a humbling 47 cents.
Struwas strategy collapsed alongside his stock price.
In October 2000, the company added 52 central offices and on November 28, received regulatory approval to sell telecom services in Alaska, which may seem an appropriate venue for a company that would spend the next three years "skating" from one cash call to the next.
But the race that Struwas and company would be running was not the Iditarod.
The company’s original plans to build-out a far-flung national network (including Alaska) and to develop customers with its own sales force required patient capital — and lots of it.
That capital however was now as frozen as the Alaskan wilderness and on December 1, 2000 the company laid off 28 percent of its workforce — 141 employees — barely a year and half after going public.
The company announced it had lost $76 million in the first nine months of 2000, but still had $100 million or so. Things got even frostier, though — another $29 million loss in the final three months of 2000 — and the $8 million annually that the company hoped to save with the cuts would eventually prove far too little to preserve cash.
The company was not the only company trying to perform a harrowing balancing act atop a thin copper wire tightrope.
Northpoint, a far larger and earlier mover than DSL.net, was trying to execute a major buy-in when it saw potential partner Verizon drop out of the race in December 2000. Without fresh fuel, Northpoint went over the edge after filing for bankruptcy.
Rhythms, another DSL high flyer with a national footprint, also disappeared. Still another DSL pioneer, Covad, also cuts its workforce in December 2000. It too soon filed for bankruptcy but reorganized and remains a formidable competitor today.
The problems of failing ISPs [Internet service providers] did, however, provide a potential new strategy for DSL.net as it acquired 2,700 lines in a small acquisition at the end of 2000. That scale of change wasn’t larger enough, however, and DSL.net was only slowly adding new customers via its traditional marketing strategy.
By July 2001, with no tech turnaround in site, the company, announced a follow-up reorganization and cut another 90 jobs.
Things were more serious now, and with cash reserves evaporating DSL.net announced it would continue to lose $4 million per month and would need nearly $40 million in additional capital to become cash-flow profitable.
DSL.net’s board jettisoned the national strategy and announced that, along with the new job cuts, there would be a major reorganization and roll-back to only 250 central offices. "The company shut down every one of those central offices that was not profitable in and of themselves," according to CFO Robert J. DeSantis. "[The remainder] were all profitable at the margin."
Four months and another 86 job cuts later, the company succeeded in attracting $35 million in new investment at the end of 2001, including $20 million from one of its original backers, VantagePoint Capital. VantagePoint had invested prior to the IPO but never sold any of that investment.
Said James Marver, managing partner for Vantagepoint, at the time: "VantagePoint has been an investor in DSL.net since the beginning. We’ve watched this company execute to plan, quarter after quarter. Given DSL.net’s track record, its seasoned management team, and its strong competitive position, we are very excited about its future prospects.’’
Another group, the Virginia-based Columbia Capital, put in another $15 million. Columbia was evaluating the market and its investment in Broadslate, a small DSL company in the Southeast. It dropped its investment there, and DSL.net eventually purchased Broadslate assets and its 750 customers in March of this year.
With the new money in place at the beginning of 2002, the company again had bought more time and the potential to build to a cash-positive position.
"That money came in and we had to make a decision: Do we ramp up our sales force measurably?" recalls DeSantis. "We had 22,000 customers and felt we needed another 18,000 or 20,000 more to bring on the margins now that we had a network that was positive.
"Our other choice was to pursue one of two relatively large acquisitions where we were having discussions with the principals," DeSantis adds. "The objective was to bring on in one fell swoop twice or three times as many lines as we could have sold in that period utilizing our cash."
However, says DeSantis, "The company decided [for 2002] not to try to grow the internal sales force to grow subscriber lines on the remaining network. We decided to pursue strategic acquisitions where we could acquire customer lines on our remaining network, but network components that were complementary geographically to our remaining footprint, which was predominantly East Coast-based. We have a well positioned network and it was all bought and paid for."
As part of that strategy the company identified Network Access Solutions (NAS) of Virginia as a potential acquisition. NAS seemed highly compatible with DSL.net: It had just over 23,000 subscribers and a continuous network with marginal overlapping. The target was identified and DSL.net tried to convince NAS management that a merger would be the best option for both companies, spending nearly six months on that effort. But the merger was apparently stymied when NAS filed for bankruptcy instead in June 2002.
Under DSL.net’s then-structure the company’s monthly cash losses were $1 million, eating into its $35 million cushion and potentially robbing it of acquisition capital. The company did execute some small acquisitions but now found its quest for bigger prey forestalled by the bankruptcy court and its NAS proceedings.
Nevertheless, on the last day of 2002 the court approved DSL.net’s $14 million NAS bid — $9 million in cash and a $5 million note — and the transaction closed.
After combining the two companies’ networks and eliminating 80 overlapping and/or unprofitable offices, the new DSL.net would now have up to 475 central office locations primarily in its core East Coast corridor. The company also acquired some operating efficiencies in personnel, real estate and its Internet backbone.
In addition it moved some 3,500 accounts that were being handled for DSL.net by other providers in the region to the newly acquired central offices. "That was a major economic benefit to us" said DeSantis. "The costs are six times greater [when we outsource a client]."
The company now had 33,000 customers and an annual revenue base of approximately $70 million in a market stretching from Boston to Richmond, Va. Although the acquisition, integration and lead-time costs had eaten a significant amount of the company’s remaining capital, DeSantis claims that DSL.net will get pretty close to cash flow-positive by the end of 2004.
With communication needs evolving, DSL.net was seeing its customers become increasingly fickle. Many would move to companies that could provide all their telecom needs under one umbrella.
New technology was creating new opportunities, however, and Struwas now wanted to provide local, long-distance and high-speed Internet on the same copper wire. New technology would allow him to do it with limited capital investment. Unfortunately the initial $5 million pricetag and the steep learning curve were more than the company could bear.
So Struwas negotiated the purchase — again, out of bankruptcy — of a company called Talkingnets in North Carolina. It brought to DSL.net $5 million-plus worth of technology, trained personnel, some existing customers and the ability to immediately begin offering voice services to some DSL.net customers — all for a cool $725,000.
With this new telecom strategy and a concentrated network area, the company accordingly needed to restock its war chest. So DSL.net set out to raise another $20 million to implement the technology throughout its markets and to develop a broader range of products for its customers.
DSL-net customers will soon be offered a T1 connection to the Internet, 16 local phone lines and somewhere around 2,000 long-distance minutes for a flat rate of approximately $750 per month. The T1 will swap usage with the phone calls, meaning that fewer calls on the line will yield faster service on the data. The real innovation is in the central office. Traditional phone companies have huge, expensive computer switches in each central office throughout their footprint. With this new "soft switch" technology from Cisco, one switch can control calls in all of DSL.net’s multi-state network.
In July, DSL.net closed a $30 million financing round with institutional investors led by Deutsche Bank, which will invest $22 million in the communications company. VantagePoint Venture Partners invested another $8 million in the company. Proceeds will be used to fund company operations and to retire $15 million in debt at a cost of approximately $10 million.
Fresh money, a solid revenue stream, slimmed-down network and a new plan all must seem pretty good to David Struwas.
The money came just in time, too. "The paperwork, legalese took a long time [between] a big bank like Deutsche and us," recalls Struwas. "It kept expanding and I was getting very nervous. We were probably within a week or two of filing bankruptcy."
Struwas has been down this path already. In the summer of 2001 DSL.net was running out of money when the terrorist attacks hit on September 11. "It knocked out our core site [25 Broadway, next to the World Trade Center]. We had to move it to Chicago, there was a Nimba virus, a Code Red virus, there were a lot of things happening all at once," he recalls.
"It just seemed like the world was on your shoulders at that point," he says. "There was tremendous stress on the engineering people here. We had very little money to spend to update the Chicago site. That caused us some customer losses in the next year. If they were with any other carrier they would have had the same problems — but they all didn’t think that."
But says he "knew we had the right track. We were very close to getting cash flow-positive. It was just a matter of getting an investor convinced to invest in the telecom space, which is not easy.
"We had gone to the board before with a voice proposal. The board said, ‘Get more customers first.’ The network we designed on paper was the network that Talkingnets had. When we found them it was like finding a diamond. We tried to merge with them earlier, but they were still trying to get more money and they never did. I can say we stole [Talkingnets]. Just Cisco was owed over $4 million [by Talkingnets at the time of the acquisition]."
And investors have started to take note. In spite of the many remaining questions about the company and its strategy, DSL.net’s stock price remains well under $1, but trading activity has increased substantially.
Says Struwas: "Since the [July] funding the shares have sold three or four million shares in a day up from about 250,000.. Vantage has distributed some of their shares to their limited partners and a lot of that went on the market selling, but whatever has gone on is being absorbed."
Thus we leave our heroes with money in the bank, a solid balance sheet — again — a new strategy, a competitive product, a gradually recovering tech market and an admonition from the Eagles:"We may lose or we may win/But we will never be here again."
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