By Jeffry Bartash

WASHINGTON (CBS.MW) -- Allegiance Telecom Chief Executive Royce Holland has seen it all.

The industry pioneer witnessed up close the explosive growth of the competitive local exchange carrier industry -- small rivals of the Baby Bells -- and its ensuing disintegration.

Well before the inelegantly named Clec sector burst into full public view, Holland was slugging it out quietly in the trenches. In 1988, he co-founded an original Clec, MFS Communications, and helped turn the company into a $1 billion enterprise. WorldCom eventually bought MFS for $14 billion.

Holland started Allegiance shortly after passage of the historic 1996 Telecom Act -- a far- reaching and increasingly controversial effort to open the phone industry to competition. For a while the act seemed to work, spawning dozens of Clecs. Yet since the industry slump began in early 2000, many small local phone companies have folded. Even the best-run carriers, such as Allegiance, have sustained heavy damage. Since peaking at a stratospheric (and unrealistic) $110 a share in February 2000, the stock has fallen back to earth with a thud. It now trades at $1.39.

Still, Allegiance Telecom looks like one of the survivors -- thanks to Holland and his management team. CBS.MarketWatch.com caught up with Holland this week.

CBS.MW: Some analysts argue that Congress played a key role in the rise and fall of the publicly traded Clec industry by encouraging, via a fatally flawed 1996 Telecom Act, too many new companies to enter the market. Wall Street gets an assist for financing too many start-ups that lacked solid business plans or experienced management. Royce Holland: I do not think Congress should be blamed for encouraging too much competition. Certainly the 1996 Act was one of the most significant pieces of commercial legislation enacted in the post-World War II period. Indeed, it produced what it intended to produce. It set forth the fervor in the technology and telecom spaces and encouraged a lot of investment. Like any gold rush, there will be a shakeout. It happened to personal computers 20 years ago, and you can go all the way back to the automobile, railroads, even the telegraph in the last century.

What happened was you had the convergence of two things: opening monopoly markets to competition, and the emergence of a new phenomenon that changes the way people work and live: the Internet. This convergence really was sparking venture capital firms that were used to raising $200 million to raising $2 billion funds. For a while, anyone with a pulse and a minimum of brain waves was going to get financed. Well, the weaker players fell to the wayside. What I think you will see emerge from what I call a nuclear winter in the capital markets are a few, much more fit survivors. Much as we have seen in the PC industry and others.

CBS.MW: Compared to most other Clecs, Allegiance avoided many of the same mistakes, or erred to a lesser degree. How come?

Holland: First, we have a very experienced management team. Quite a few of our executives lived through what I call the pioneer days of telecom competition before the 1996 Act. Indeed, a lot of what we did at MFS helped to shape the act. I always said we'd make plenty of mistakes, but that they would be new and original ones. Second, we got to start with a clean sheet of paper. We got to put in the most modern and cost effective network in the land and we got to start from scratch on our back-office systems. That's really the big headache for anyone trying to get into a mass-market environment.

CBS.MW: Yet even now, Allegiance has to walk a tightrope. You have to add more stable and lucrative customers, but at the same time curb expenses and capital spending without hurting future growth.

Holland: You're absolutely right. With capital markets being essentially closed for the last 12-18 months, it puts a real premium on growing your business, but doing so very profitably. I think we are accomplishing these goals. We're still targeting growing at 50 percent this year, compared to most other players that are flat to negative. At the same time, we plan to hit cash-flow positive by the second half of this year.

CBS.MW: What's going to make investors come back to the stock? It's been severely punished like every other local carrier.

Holland: There's three things. One, we do intend to demonstrate we can build a profitable competitive telecom business. Two, we have to stay in compliance with our bank covenants, which were set in January 2000 in a higher-growth environment. We plan to do that, as well. The third stool of that leg is being fully funded. We have about a $150 million cushion.

Right now, it's like performing an off-Broadway play when everyone has gone home. We think if we perform the audience will come back to the telecom sector. I think the irrationality on the downside is just as bad or worse than the irrationality to the upside in 1999 and early 2000. I feel there is a huge amount of money to be made for those who can pick the winners.

CBS.MW: Allegiance and Time Warner Telecom look like they'll be among a handful of publicly traded Clecs to survive the slump. Is there still a vibrant future for a Clec industry, at least in public markets?

Holland: What we have seen many times in American business is a gold rush-shakeout phenomenon. The industry will consist of much fewer but much healthier and stronger players. It won't be 40 of them. It will just be a handful.

What we see is capitalism performing its normal function: providing an opportunity and then weeding out the weaker players. There's a famous economist, Joseph Schumpeter, who created the term "creative destruction." The capital markets create and then destroy much of what it creates. It does lend itself to producing a very hardy and battle tested band of survivors. Those of us going through it may find it painful, but we are a lot tougher than we were.

CBS.MW: The U.S. Supreme Court ruled this week in favor of the Federal Communications Commission's policy for determining how much the Baby Bells can charge companies like Allegiance for leasing access to portions of their networks? How does this help?

Holland: This was a very big decision. It accomplished a couple of things. It took away this cloud of uncertainty. The Bell companies have been screaming that they are losing money and they are leasing pieces of their network at below cost, which just plain isn't true. The court put the lie to that.

The second thing is that by upholding the FCC's pricing methodology, which was set in August 1996, it allows the states to continue this process that began recently of lowering the cost that the Bells can charge competitors. New York and New Jersey have already done this and California is in the process. That will certainly help to improve our margins. And it will expand our ability to compete.

CBS.MW: Is this the end of the matter?

Holland: As long as the Baby Bells are run by lawyers, which it appears they are, I think they will continue to try to compete in the courts and in the Congress rather than in the marketplace. When the Supreme Court rules, it certainly reduces their potential for mischief. They lost big. They lost on every point.

CBS.MW: What does Congress have to do to boost competition and do you realistically see any chance of that happening in the next few years?

Holland: I don't think Congress is going to do anything. The House passed a real Bell- friendly bill (Tauzin-Dingell), but we don't think that will gain any traction in the Senate. Some of the senators would like to pass legislation that would promote competition even further. In my opinion, we don't need more legislation. All we need is enforcement of what we've got.

CBS.MW: What about the FCC? Chairman Michael Powell appears to favor loosening, not tightening, regulations on the Baby Bells, in part to speed up deployment of broadband service.

Holland: I am not sure the intention is to allow the Bells to re-monopolize the market. I think the FCC is looking at some type of regulatory parity, which we don't agree with. We'll see how it plays out. I think the Supreme Court decision today was very helpful because it basically said the Telecom Act was deregulatory.

CBS.MW: You've been in this industry a long time. This is a time of tremendous change and uncertainty -- just look at WorldCom. How do you see it shaking out over the next five years, and where does Allegiance fit in?

Holland: The next five years are going to be marked, first, by the end of the shakeout period. We will have survivors emerge. Capital markets tend to run in cycles. There might be another round of new entrants and some of the survivors will grow. At some point we will see that long anticipated process of consolidation reappear. WorldCom, for example, may be a seller this time instead of a buyer.

Where does Allegiance fit in? We have the broadest operation serving the medium and small business market serving the U.S. Our 36 markets address 57 percent of the U.S. communications market. We have the opportunity to become the premier provider of combined access, voice and data products to that market.

Jeffry Bartash is a reporter for CBS.MarketWatch.com in Washington.