Broadband Wrap: Will VCs Return? –

NorthPoint Communications? business headed south long ago, Rhythms NetConnections is silent and the door is just about ready to shut down on Covad Communications.

DSL, at least in its current incarnation, is dead, and venture investment in the sector has trickled to a standstill. VCs who once sank billions into building local-area networks are no longer willing to take the financial risk until competitive providers like NorthPoint or Covad prove willing and able to devise an effective business model that can directly take on the incumbent providers.

?Companies that consume a lot of cash, that are capital-intensive over a long period of time – communications service companies that might ask investors to cough up between $200 million and $300 million before they?re mature enough for a liquidity event – investors don?t like those plays,? said Promod Haque, a partner with Norwest Venture Partners.

A company like Rhythms of Englewood, Col., for example, raised $340.5 million from private equity names like Enterprise Partners and Kleiner, Perkins, Caufield & Byers, and loaded $615 million of high yield debt onto its balance sheet before filing for Chapter 11 protection earlier this month. While investors are cautious, and the DSL industry has all but collapsed, consumer demand for broadband is just beginning to surge.

Since the Telecommunications Act of 1996 opened the floodgates to competition, venture capitalists have sunk more than $3.3 billion just into building local-area networks that might effectively compete with incumbent carriers. Venture investment in the sector reached a peak last year when 42 companies raised $1.7 billion in the market. But, saddled with a heavy debt load, service deficiencies and ineffective pricing models, DSL providers were unable to compete with giants like SBC Communications or AT&T in providing bundled network services at the local level.

Industry advocates, however, insist the demand for broadband has barely reached its peak, and when the industry passes this trough, opportunity will come for investors and entrepreneurs alike to provide broadband at the local level.

“We have not yet gotten anywhere close to delivering the type of services that this country demands – i.e., the Internet: one that’s ubiquitous, that’s always on, that’s multidimensional, reasonably priced, where services are cheap and easy to install from a user perspective,” said Reed Hundt, who sat at the industry?s control tower between 1994 and 1997 as chairman of the Federal Communications Commission under President Clinton. He is also founder and chairman of San Jose, Calif.-based Sigma Networks, a provider of outsourced metro connectivity, and spoke at this week?s Opticon2001 conference in San Jose.

Indeed, according to figures released earlier this month by the FCC, high-speed lines (those transmitting data at speeds over 200 kbps) connecting homes and businesses to the Internet grew at a rate of 158% last year. A total of 7.1 million high-speed lines cross the country – all 50 states, D.C., Puerto Rico and the Virgin Islands. While cable connections grew at a rate of 153% last year, the rate of growth for DSL subscribers hit 435%.

“The broadband revolution is just beginning,? Hundt said. ?People always ask which applications will drive growth, but applications will follow [the networks] because demand is there.”

On the residential front, carriers can expect between 30 million and 35 million broadband subscribers by 2005, according to a still-unpublished report from New York-based consultancy McKinsey & Co., and co-authored by Hundt, who is a senior advisor on information industries to the firm. By 2008, narrow-band access to the Internet will be almost extinct. Still, the top 15 markets will account for 80% of demand and the top four markets will hold 40% of the nation?s total demand for broadband service – which spells promise for investors along the metro fiber networks.

?Metro markets are way, way under-built,” Hundt reports.

Indeed, 20% to 25% of IP traffic is expected to stay in the metro network, and, driven by Web agents and meta-computing, the CAGR for IP is expected to reach 82% through 2005. To sustain the demand, carrier capacity needs to be 6 times to 18 times the demand to deal with the fluctuations in Internet traffic.

Can Anybody Spare A Million Dollars?

Developing the capacity to sustain demand is expensive, and investors know the risk. Still, investment in new technologies is not only a driver for innovation, but also the only model for satiating consumer demand.

“It was never about the money,? Hundt said. ?If you have the idea, if you build the thing, the money will come. This is not the pet rock business. The demand is there, we just need to maintain the confidence.”

To be sure, some investors have kept their fingers steady on the pulse. Thirteen companies tackling local demand for broadband this year have succeeded in raising $208.8 million from venture investors. Paltry as it may be, if this pace can be sustained, a network infrastructure will be in place to drive a new wave of broadband applications.

Contact Carolina Braunschweig at <!–a