Investors eager to know what's next for Qwest
With MCI bid off table, telco to size up options during annual meeting
By Jeff Smith, Rocky Mountain News

Saturday, May 21, 2005

Has Qwest completely given up on MCI, and, if so, what's next?

That's likely to be a central question in stockholders' minds when the Denver telco hosts its annual meeting Tuesday in downtown Denver.

"I'm concerned where the company goes from here," said Mimi Hull, president of the Association of U S West Retirees.  "Are we really in or out of MCI?  If that's a dead deal, what happens next?  Going as a stand-alone doesn't look like a viable alternative."

Qwest bowed out of the running for MCI two weeks ago but left the door open a crack for a possible renewed bid.

Most analysts consider Qwest to be in a vulnerable spot because of its $17 billion in debt and flat revenues, and because the mergers of Verizon-MCI and SBC-AT&T will create two huge competitors.

Qwest Chief Executive Dick Notebaert has declined to get too specific about Plan B but has said recently one opportunity could be scooping up assets divested by Verizon and SBC because of antitrust issues.

"There's a number of strong options before us," Notebaert said.

Qwest, which operates a local phone business in 14 states and a nationwide fiber-optic network, has experienced some improvement to its cash flow, in large part by cutting costs and jobs.

But the 40,000-employee company is struggling to offset continuing losses in its traditional home land-line business with newer products such as DSL high-speed Internet.  And the company's long-distance fiber-optic network continues to bleed - though now at a slower rate of around $100 million a year vs. more than $500 million annually in prior years.

Analysts say Qwest's strategic options are limited because its massive debt restricts its ability to invest significant money in an outside deal.  The beauty of MCI was that Qwest in effect could use MCI's cash to do the deal, get additional high-profile customers on its long-distance network and eliminate a duplicate network.

But Qwest might be able to do smaller acquisitions with the goal of increasing customers over its long-haul network, said Donna Jaegers, a telecommunications analyst for Janco Partners in Greenwood Village.

Lehman Bros. analyst Blake Bath wrote that smaller acquisitions seems to be Plan B.

But Bath said Qwest also might be able to cut its debt by gradually increasing cash flow and by issuing additional equity.  While an equity offering likely would dilute current shareholder value, Bath sees Qwest as possibly resuming a stockholders dividend.

Here are some of Qwest's possible options:

On the acquisition front

  Assets SBC-AT&T and Verizon- MCI will be forced to sell for antitrust reasons.  Network assets may become available in such geographic areas as New York/New Jersey, Chicago and California, but it could be months before they're up for sale.  The assets could strengthen Qwest's long-distance network operations, but customers may or may not come with them.

  Time Warner Telecom, a Douglas County-based company that provides communications and data services to businesses in 44 metro markets in the United States.  The company's network connects to more than 5,000 buildings, with a strong presence in California, the Carolinas, New York, Texas and the upper Midwest.  This would help drive more traffic onto Qwest's nationwide fiber-optic network.

Time Warner Telecom also has some high-profile customers such as the HealthOne system in the Denver metro area.  But the company is small, with revenue of just $653 million and losses of $133 million in 2004.

  XO Communications Inc., a Virginia-based company that also provides high-speed communications services to businesses in 45 markets, with a heavy concentration in California, Texas, along the Atlantic seaboard and in the Pacific Northwest.

XO is bigger than Time Warner Telecom, with $1.3 billion of revenues in 2004.  But the company, which went through bankruptcy reorganization, is bleeding, having lost $410 million last year.  XO also connects to fewer buildings than Time Warner Telecom and has a larger percentage of smaller customers and lower profit margins, Jaegers said.

  TelCove, formerly part of Adelphia business systems that hedge funds took out of bankruptcy last year.  The Pennsylvania-based company provides high-speed communications services to almost 3,200 buildings in 52 smaller markets in the Eastern U.S.  TelCove will reach 70 markets later this year upon the completion of an acquisition from KMC Telecom.  Revenue is only about $300 million a year, Jaegers said, "but they have decent margins and good local fiber networks."

  Level 3 Communications, WilTel, Broadwing:  All three spent billions of dollars building long-haul fiber-optic networks during the telecom frenzy, and all three have struggled since paying off their debt.

How tantalizing would be a merger between Qwest and Broomfield-based Level 3?  It wasn't long ago that former Qwest CEO Joe Nacchio bristled to be mentioned in the same story as Level 3 CEO James Crowe.  Nacchio felt betrayed when Crowe left Qwest's board and started a rival company.

Notebaert already has shown his ability to surprise with his pursuit of MCI.  But many analysts question the sense of Qwest merging with any of the above three companies, since all have similar problems: modern networks with not enough customer traffic.

To be or not to be acquired

  BellSouth, an Atlanta-based regional Bell that also owns 40 percent of Cingular Wireless.  BellSouth bought 10 percent of Qwest in 1999 when it was considering buying the company.  But BellSouth started selling soon after Qwest merged with U S West in 2000.

Under a 2002 pact, BellSouth agreed to purchase $350 million in services from Qwest over a four-year period minus a $71 million credit to cancel a previous contract.

BellSouth hasn't made a move yet to buy a long-distance company.

"They haven't been very inquisitive," Jaegers noted.  "I don't get the feeling that they really feel they need to make an acquisition."  Plus, Jaegers said, BellSouth could probably buy Broadwing or WilTel cheaper than Qwest.

Perhaps reflecting BellSouth's philosophy, Jaegers said BellSouth Chief Executive Duane Ackerman once told her he plays tennis by letting others make the mistakes.

  Sprint, the Kansas-based telecommunications giant with $27.4 billion of revenues in 2004.  Sprint has been rumored before as a possible merger partner.  But it has its hands full with the $35 billion Nextel merger, reflecting its focus on its prospering wireless business.

Some analysts say Qwest may have an opportunity to buy Sprint's local-phone properties in Las Vegas, the Southeast and the Ohio Valley.  Others think Sprint might eventually spin off its long-distance business.

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