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Qwest Is Again Put in a Funk Amid Deal Talk
By Shawn Young and Sara Silver
The Wall Street Journal
Wednesday, March 8, 2006

AT&T Inc.'s proposed acquisition of BellSouth Corp. sent shares of Qwest Communications International Inc. on a roller coaster.

Following Sunday's announcement of the planned $67 billion deal, Qwest's shares were up 3.7% amid speculation that the telephone company -- with a market value of only $12 billion -- might become the next target in an industry that is consolidating faster than expected.  But the excitement fizzled fast as two analysts slapped "sell" ratings on the stock yesterday.  The stock was down 46 cents, or 6.7%, to $6.38 in 4 p.m. trading on the New York Stock Exchange.

This isn't Qwest's first bout of Wall Street whiplash.  Qwest's stock, which was a Wall Street darling during the telecom and Internet craze of the late 1990s, plunged into the low single digits a few years later as an industry meltdown, an accounting scandal and a huge debt load raised the specter of a bankruptcy-court filing.  The stock rallied more than 60% in the past 12 months as the company reduced and refinanced debt, paid settlements in shareholder lawsuits and promised a return to profits this year.  At less than $7 a share, it is hard for some investors not to think of it as cheap.

But AT&T's plan to buy BellSouth highlighted a relative lack of strategic or deal-making options for Qwest, which looks weak compared with its peers, some say.

"They're in kind of a hazy situation," says Steve Paspal, a senior analyst at Sovereign Asset Management.  "They were a lot worse off financially a couple of years ago and they've improved a lot, but that doesn't mean the future is really any brighter."

In reports downgrading the shares, Michael Rollins of Citigroup and Christopher King of Stifel Nicolaus, a brokerage and investment-banking firm, both said a merger is unlikely and noted that Qwest shares are significantly more expensive than those of its stronger siblings when prices are contrasted with expected earnings before interest, taxes, depreciation and amortization.  Mr. Rollins said Qwest trades at 6.1 times his Ebitda estimate for this year, compared with a multiple of 5.4 for Verizon Communications Inc. and AT&T, which are larger, have smaller debt burdens and are better positioned for growth.

Citigroup Global Markets and its affiliates own Qwest securities and have provided investment-banking and other services to Qwest.  Stifel Nicolaus doesn't have a position in Qwest stock and doesn't do investment-banking work for the company.

In addition, Mr. Rollins said, Qwest could lose more than $200 million in revenue in 2007 as BellSouth moves its long-distance traffic from Qwest's network to AT&T's. Qwest declined to discuss specific customers.

In 2005, Qwest posted a loss of $779 million on revenue of $13.9 billion.  After the close of the BellSouth acquisition, AT&T is expected to have roughly $120 billion in annual revenue.

Any potential buyer for Qwest would be confronted with a company that still has $15.5 billion in debt, owns no wireless assets and serves a heavily rural territory in 14 Western and mountain states.

Verizon, which may feel pressured to match AT&T's move, isn't likely to be a buyer because it has been selling rural phone lines like Qwest's by the millions. Verizon picked up long-distance assets with its acquisition of the former MCI Inc. AT&T eventually may focus its acquisition machine on Qwest, but it isn't likely to be a priority after the rapid-fire series of gigantic takeovers that culminated in the BellSouth deal.

Qwest Chief Executive Richard Notebaert has suggested that Qwest might be a buyer of smaller companies, possibly outside telecom, but the company declined to elaborate yesterday.  A partnership or deal with a satellite company would make sense, says Maribel Lopez, an analyst at Forrester Research.  But analysts say it is unlikely that any acquisition small enough to be affordable for Qwest would be significant enough to really change its outlook.

Still, after years of losses, the company expects to become profitable again this year.  Revenue has edged up for the past three quarters, high-speed Internet sales are growing and the company is having some success in selling Sprint Nextel Corp.'s wireless service under the Qwest name.  Qwest retired $3 billion in high-cost debt in the fourth quarter and expects a $300 million reduction in interest expenses this year.

All that might pique the interest of private-equity investors attracted by Qwest's sluggish but cash-rich local-phone operation.  So far, though, there is little to suggest that a deal is in the works.

Qwest's chief financial officer, Oren Schaeffer, said the company's priority is to return value to shareholders out of its cash flow, but he didn't rule out a sale.

"What we've tried to do is probably the best strategy for our shareholders, which is to create in Qwest the most valuable set of assets that we can," he said Monday at a Raymond James Financial Inc. investor conference in Orlando, Fla.  "And I think if one were trying to position themselves to make sure they were still in the game ... you would try to make yourself as valuable as you can and keep your territory and your franchises as valuable as you could."

Write to Shawn Young at shawn.young@wsj.com and Sara Silver at sara.silver@wsj.com

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