Verizon-NorthPoint Deal Points Toward DSL Consolidation

In a marriage that values convenience over compatibility, Verizon (VZ) Tuesday agreed to bail out digital subscriber-line provider NorthPoint (NPNT), cobbling together an initiative-challenged phone company and a do-or-die-trying, cash-burning start-up.

The $800 million deal marks the clearest sign yet that Verizon wants to get its national DSL business on the fast track. It may also mark the beginning of a long-anticipated consolidation in the high-speed Net-access market, as bigger phone companies seek to avoid the heavy lifting necessary to provide broadband services. (TheStreet.com explored those issues in two recent stories.)

Still, investors weren't exactly wowed by the DSL players' takeout prospects Tuesday: Of the top-three providers, shares in one rose, shares in another dropped and NorthPoint was flat. Verizon, meanwhile, saw its shares get pounded as the company reported an earnings shortfall amid a crippling strike in its core long-distance phone business.

Head-Scratching

"The financials of this deal have us scratching our heads, but the one thing you can take away is that Verizon is buying a time-to-market advantage," says Sanders Morris Harris analyst Dan Ross, who has a strong buy on NorthPoint. Sanders Morris Harris has no banking ties to NorthPoint or Verizon.

Under the deal, NorthPoint shareholders will get a share of the new NorthPoint and around $2.50 a share in cash for each NorthPoint share they now own. The new NorthPoint will include NorthPoint's DSL business as well as Verizon's broadband-network assets. Verizon will also contribute $450 million in cash for NorthPoint's buildout efforts.

The combined entity will be 55% owned by Verizon and will have 282,000 DSL customers in 163 cities. Bear Stearns values the new NorthPoint at $5 billion; the current NorthPoint is valued at $2 billion. Once the two territories are joined, NorthPoint and Verizon will have 600 overlapping facilities, accounting for roughly 17% of the combined footprint. Company officials called the overlap "minor."

Also causing some head-scratching was the stock reaction. NorthPoint shares, after an early rally, were unchanged at 15, just above their 52-week low of 10. Odder still, DSL leader Covad (COVD), seen as an attractive takeout prospect for Verizon rivals such as BellSouth (BLS), saw its shares slide 1 3/32, or 6%, to 17 3/32, while another DSL player, Rhythms Netconnections (RTHM), rallied 1 5/8, or 13%, to 13 7/8. Verizon shares slid 5 5/8, or 12%, to 42 1/4, setting a 52-week low.

Delivery Problems

DSL and cable modems have so far proven to be the only two viable mass-market technologies capable of delivering the words, sounds and images promised by the expansion of the Internet. But that delivery has proven difficult due to technology snags, industry grievances and, in many cases, sheer lethargy, say analysts.

Both Verizon and NorthPoint were quick to characterize Tuesday's deal as a new beginning. And in light of their past pitfalls, that kind of image boost can't hurt.

To many observers, NorthPoint's wholesale-DSL model was unsustainable over the long haul, pushing the company headlong into a potentially fatal cash crunch. And with its shares more than 60% off their high, NorthPoint was in no position to negotiate. Now, the deal gives NorthPoint a necessary infusion of cash to continue its plan, analysts say.

For Verizon, NorthPoint provides a presence outside its combined GTE and Bell Atlantic region and a renewed chance at providing customers high-speed connections in a field of equally inept Baby Bells.

The Challenge

For many observers both inside the company and the industry, the main challenge will be organizational. NorthPoint may be exposed to some of the cultural traits that plague the telcos in their feeble attempts to address this growing DSL market. But company officials tried to squash that notion.

"There are many elements within the traditional [phone company] that, if we organized them properly and focused them properly, they are as entrepreneurial and as competitive as anyone else," says Verizon President Lawrence Babbio, who will become the chairman of the new NorthPoint.

One technique, says Babbio, is to "make sure the management was not absorbed into the company."

Hey, maybe this marriage is off to a good start.

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