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Rhythms NetConnections Connects on Sand Hill Road
A telecom startup raised $180 million in venture money and high-yield debt

For a 20-month-old company, Rhythms NetConnections already moves with a swagger.

While most startups struggle to scrape together a few thousand dollars, Rhythms CEO Catherine M. Hapka and venture capitalist Bill Stensrud rounded up $180 million for the new venture in record time. Last year, they successfully toured Sand Hill Road in Menlo Park, Calif., the epicenter of Silicon Valley's venture-capital world.

"I put together a handful of slides, went to Sand Hill Road, and within a few days, had lots of savvy investors onboard," says an offhanded Hapka, 44, who formerly headed business and consumer telecommunications at U S West Communications Inc.

The cash pile is funding digital subscriber lines (DSL) -- high-speed voice and data links aimed at small and midsize business and the growing legions of "teleworkers" who need the communications technology to let them do the same things at home as in the office. An estimated $5 billion market now, the high-speed data delivery market is expected to grow to $35 billion by 2001, according to San Francisco investment bank Hambrecht & Quist.

Even with backing from venture-capital firms such as Kleiner Perkins Caufield & Byers and Brentwood Partners and utility giant Enron Corp. -- outsiders control about 80% of the company and employees 20% -- telecom won't be an easy market to crack. Baby Bells, cable companies, and dozens of other telecom upstarts are all swarming to lay data "pipes" into homes and businesses.

So why were all these high-powered companies in such a hurry to bankroll Rhythms? First was the management team's experience building data networks, says Kevin Compton, general partner at Kleiner Perkins. (Hapka has recruited other managers from Sprint, CompuServe, and U S West.) Second, he says, is "the public's insatiable demand for bandwidth." Rhythms' network will be relatively inexpensive to build, because it's simply upgrading leased copper wires to handle data as well as voice.

MAKING CONNECTIONS. The company's close ties to venture capitalists were no handicap, either. Stensrud, a long-time telecom backer at Enterprise Partners in La Jolla, Calif., conceived the idea. He then got wind that Hapka had similar plans and persuaded her to join his venture. With Stensrud's entrée into the venture-capital community, the two were well received when they passed the hat. "We had a lot more interest than we had slots," says Stensrud. The company managed to raise $30 million in equity from venture capitalists and sold $150 million of junk bonds last spring in a private placement. Enterprise Partners is also an investor (see chart).

Rhythms has a mere $500,000 in revenue at this point, though Merrill Lynch, one of its debt underwriters, projects the company's sales at $126 million by 2000. That assumes that the telecom is doing business in 50 U.S. cities by then. By yearend, Rhythms will be in 12 cities -- mostly on the East and West Coasts. Customers already include Cisco Systems, Wells Fargo, and Silicon Graphics.

Rhythms is betting that small companies and corporate teleworkers will want its service, which combines local and long-distance voice, data, video, and network maintenance. "This takes away all the hassle," boasts Hapka. "We take the copper that runs inside your phone system and put it on steroids."

One of Rhythms' offerings turns a telecommuter's home phone into an extension of his company's elaborate phone system -- all the while surfing the Net on the same line. One Rhythms user at Qualcomm, for instance, now fields customers' toll-free calls at home, rather than at the company call center. "It's exactly like being part of the corporate dialing plan," says Ray Buccat, the Qualcomm staff engineer who oversees the Rhythms account.

Rhythms' fast start owes much to Hapka. The Minnesota native started her business career as a supervisor in a Schlitz brewery. After stints at McKinsey Consulting, General Electric, and Control Data, she rose quickly at U S West, where she honed her expertise building specialized data lines for giant companies. Within four years, she turned her division into a $400 million powerhouse. At age 38, she was named one of Business Week's Top 50 Women in Business.

In less than two years, Rhythms has grown to 170 employees. Hapka has come to appreciate its small size after toiling in the confines of a regulated monopoly. "I feel like I'm in a Ferrari," she says of Rhythms. Working at U S West, "was like being in a Model T."

For all her good fortune, Hapka has had some taste of entrepreneurial frustration. She left U S West in early 1997 to become president of Nets Inc., a Web-based business-to-business transaction service headed by former McKinsey colleague and Lotus Development Corp. founder Jim Manzi. Even with such an illustrious founder, Nets went bust two months later. Hapka downplays the experience, saying Manzi asked her "as a personal friend" to assess the company's prospects. "The day I left Nets, I was out raising money to do my own," Hapka says.

She'll need that confidence. Hambrecht & Quist analyst Mark Langner estimates that there will be hundreds of DSL providers like Rhythms in the next five years.

Hapka isn't fazed. "This is an opportunity too big to pass up," she says. Of course, having $180 million to back up that dream doesn't hurt. Nor does it hurt to have secured that money before the stock market's late-summer crash, which dried up bond markets for telecom companies.

Clearly, the company's fast start isn't all luck. But Hapka will need all she can get as Rhythms swaggers into what promises to be one rough business.

By Dennis Berman in New York

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