XO Communications filed for bankruptcy protection last week, a move that could help it emerge as a humbled-but-stronger provider of telephone, data, and Internet services to small and midsize businesses. Despite debt problems, the Reston, Va., company's sales continue to grow--its first-quarter revenue soared 25% from a year earlier.

XO filed for bankruptcy protection after months of negotiations with creditors and its main investor--Theodore Forstmann--failed to produce a refinancing deal. Financier and XO bondholder Carl Icahn offered to step in, but lenders nixed his plan.

In January, Forstmann agreed to a restructuring plan. But now, his investment firm, Forstmann Little & Co., is challenging the plan, which requires the buyout firm and Telefonos de Mexico SA, Mexico's largest carrier, to invest $400 million each in XO. Should that deal falter,

XO has a fallback plan to exchange $1 billion in debt for $500 million in new debt plus a sizeable equity stake for lenders.

XO is relatively large and established, with 2001 revenue of nearly $1.3 billion. "They had global ambitions," says IDC research manager Steve Harris, "but probably will emerge where they were before--a solid provider for the small enterprise market."