Covad To Dissolve BlueStar Subsidiary

A year after acquiring BlueStar Communications Group in part to deliver digital-subscriber-line services to second- and third-tier markets, Covad Communications Group is shutting down the subsidiary as part of its effort to reach profitability. Of some 400 BlueStar employees being laid off, 70 will immediately become Covad employees charged with helping the troubled DSL provider further develop its direct sales channels.

That direct connection with consumers was part of the reason Covad acquired BlueStar last June, but given the sluggish adoption of DSL in smaller markets, the costs of maintaining a network to deliver an unprofitable service forced Covad to pull the plug on BlueStar. Rather than file for bankruptcy, Covad has chosen to execute "an assignment for the benefit of creditors," in which a neutral asset manager takes over control of BlueStar's assets and ensures that its creditors are paid in reasonably short order and with minimum pain to Covad. Chairman Chuck McMann says the move is a recognition that last year's mandate from the financial markets to grow at all costs has shifted and is now a call for profitability. Shutting down BlueStar is expected to save Covad about $75 million over the next year, thus hastening its efforts to get into the black.

McMann also says the integration of BlueStar into the Covad infrastructure was taking longer than was originally hoped, and the revenue realized wasn't justifying the necessary investment. In the most recent quarter, BlueStar brought Covad $5.6 million in revenue but posted an operating loss of $26.7 million. Through its so-called safety net program, which has been a refuge for DSL users left without service as other providers have gone belly-up, Covad will assume delivery of DSL services to BlueStar customers located in markets currently served by Covad.

TeleChoice analyst Pat Hurley says he's not surprised that Covad was forced to cut its losses when it comes to serving second- and third-tier markets. "Nobody's figured out how to make money in those markets," Hurley says. But Hurley says he would have been disappointed had Covad not said it was staying committed to building its direct sales channnels. He says developing a direct connection with consumers and thus minimizing dependence on telcos is crucial to Covad's future. Says Hurley, "The wholesale market has proven to not work very well."