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Qwest refocuses effort on its land-line garden
Without wireless, firm has tough row to hoe, experts say
By Jeff Smith
Rocky Mountain News
Saturday, March 11, 2006

Qwest Communications is sticking to its game plan after failing in its bid last year to buy MCI Inc.  Improve revenue.  Reduce costs.  Cut debt.  And hunt for a deal to boost its size and value.

But questions about the Denver telco's future viability are being asked again in the wake of AT&T's grab of Atlanta-based BellSouth.  Reflecting renewed takeover speculation, Qwest's stock was wobbly this week, rising suddenly from $6.59 to $7.02, dropping to $6.38, and settling at $6.48 on Friday.

"Qwest without a wireless network is a little bit like the kid who never gets picked for a team in high school," said Bruce Allen, owner of Bruce G. Allen Investments in Denver.  "I'm not sure what the attraction is at this point."

Citigroup's Michael Rollins downgraded Qwest's stock to a "sell" this week, saying Qwest was unlikely to be bought by a larger telecom company and would struggle in its efforts to grow revenue on its own.

The telecommunications analyst also estimated Qwest, which is carrying some BellSouth communications traffic, stands to lose about $200 million to $300 million in revenue in 2007 when that traffic is transferred to the AT&T network.

That works out to 1.5 percent to 2.2 percent of Qwest's $14 billion of annual revenue.

There's no sign of panic at Qwest, at least outwardly, that it might be left a Bell orphan.  In fact, Chief Financial Officer Oren Shaffer indicated this week the telco relishes the fact that main competitors such as Verizon and AT&T are preoccupied with absorbing large mergers.

"It's good for us," he said at an analyst conference in Florida.

Shaffer said the 40,000-employee company is trying to adopt the best strategy for its shareholders:  be "very protective" of its 14-state Western local phone region and invest in new products and services.

"I think if one were trying to position themselves to make sure they were still in the game, if you will, as the industry consolidates," Shaffer said, "you would do just that, you would try and make yourself as valuable as you can and . . . I think we have done that."

Jerry Paul, chief executive officer of Quixote Capital Management in Greenwood Village, which focuses in part on merger arbitrage, said he likes what Qwest has done.

"Debt load remains an obstacle, although I love their (financial) restructuring.  It's been good for the stock."

Qwest stock was trading below $4 as recently as last fall.

But continued improvement will be difficult, according to Rollins and others.

Qwest has no wireless operation;  it resells Sprint/Nextel service.  It has a shrinking local-phone business, and its dominant markets -- Denver, Portland, Ore., Seattle, Salt Lake City and Minneapolis -- are under increasing attack by cable companies.  In some cases, municipalities themselves are thinking about going into the broadband business.

"They have to be willing to prepare for life alone," said Ray Gifford, former chairman of the Colorado Public Utilities Commission and president of the Progress & Freedom Foundation, a Washington think tank.

"That means figuring out a way to balance (cost and debt reduction) with having capital budgets significant enough to meet the competitive onslaught from cable. . . . They really do need to have the capital to invest or they'll die a slow death."

One can never say never, but an acquisition of Qwest appears unlikely, at least in the short term.

Verizon is capable of buying Qwest if it thinks AT&T would make a run at the company.  But Verizon has been clear that it has a higher priority:  trying to buy out Vodaphone's 45 percent stake in Verizon Wireless.

And AT&T, which would benefit from creating a coast-to-coast network by buying Qwest, would seem to have enough on its plate, with the recent merger of SBC and AT&T and now the acquisition of BellSouth.

Sprint, which used to be mentioned as a merger partner, has been focusing on the high-growth wireless business, recently acquiring Nextel.

Private equity firms also have been mentioned as takeover possibilities.  Many have the resources, but, analysts ask, do any want the hassle of running a complicated, regulated business that has high overhead expenses?

The most compelling reason companies are making acquisitions, Allen noted, is to expand their wireless operations, as in Sprint, as in AT&T buying BellSouth for its 50 percent stake in Cingular Wireless.

"That's the golden goose, or at least it's considered the golden goose at this juncture," Allen said.  His firm has holdings in most of the large telecommunications companies and a small position in Qwest.

Another hurdle is that many, including Citigroup's Rollins, view Qwest as overpriced.  Its current market value is more than $12 billion.  A buyer presumably would have to pay a premium and be willing to take on $15 billion in debt.

A couple of possible deals in the next six months or so might change the telecommunications landscape, Allen believes.

Both Alltel and Sprint/Nextel will possibly separate their wireless and land-line phone businesses.

"At that point, it may be interesting to see who is interested in acquiring their wireless businesses," Allen said.

Or land-line businesses, for that matter.

Qwest proved it could surprise when it was competitive in the bidding for MCI.

But Donna Jaegers, a telecommunications analyst at Janco Partners in Greenwood Village, believes Alltel's wireless assets, for example, would be out of Qwest's reach.  Alltel's market value is $25 billion, pre-spin-off.

And she doesn't buy speculation Qwest could do a deal with a satellite-TV provider.  Qwest already offers video services through DirecTV as part of a communications package.

"I don't see DirecTV, which also has alliances with Verizon and BellSouth, as wanting to be exclusive with Qwest, and I don't think Qwest could pony up the money to buy DirecTV or Dish (Colorado-based EchoStar). . . . I don't sense anything big is going on."

Instead, Jaegers believes Qwest's best options are to continue hunting for smaller acquisitions that can gradually build its business.

One area that could really help Qwest's finances, she said, is buying a company that would put more traffic on the company's long-distance fiber-optic network.

In the past, Jaegers has said she believes Douglas County-based Time Warner Telecom could fit the bill.

But Time Warner Telecom, which provides high-speed services to businesses, has posted double-digit revenue growth its past two quarters, and its stock has doubled since last fall to nearly $15 a share.  That's put the company's market value at $1.7 billion.

"I think they've run past Qwest's budget now," Jaegers said, adding Time Warner Telecom possibly is looking for an acquisition of its own.

Jaegers does think there's a possibility of an acquisition outside the traditional telecom space, something Qwest Chief Executive Dick Notebaert said recently the company would consider.

"Maybe they'll buy somebody like a Savvis," said Jaegers, referring to the St. Louis-based information technology services firm that has Internet-hosting centers and 5,000 business customers.  "That kind of operation makes sense -- they have enterprise customers that (Qwest) could put on its own network and improve its scale."

Savvis has been losing money and was rocked by controversy after its former chief executive allegedly spent $241,000 at a New York strip club.  But the dispute over the bill has been settled, and Savvis has stemmed its losses.  But because its stock has been hammered, its market value is less than $200 million.

Jaegers noted the company's largest shareholder is Welsh Carson Anderson Stowe, the same leveraged buyout firm that bought the Dex telephone directory business from Qwest in 2002 and 2003.

Gifford of the Progress & Freedom Foundation said this week he thinks the next big wave of consolidation will involve communications carriers and content or application providers.  That's because, he said, communications transport essentially has become a commodity, while the profit is in the content.

That also brings up intriguing possibilities for Qwest, which already has a partnership with Microsoft's MSN in providing high-speed Internet services.

But it's unclear which small, medium or large content provider would be a merger or partnership prospect.  Google, which wants to surpass Microsoft as a technology giant, has been the most tantalizing name to come up in parlor-room talk.

"It might be interested in buying Qwest's network," Jaegers said, "but I don't think they would be interested in the rest of Qwest.  It's just too regulated."

But as Qwest's run for MCI proved, what happens next and when might be something few expected.

"In the near term, it's not clear to me that they've got to be bought by anyone," Paul of Quixote Capital Management, said of Qwest.  "But longer term, I believe that's got to happen if they don't get scaled up."

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