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Challenges loom for Qwest
Analysts weigh telco's solid profits vs. ongoing loss of phone lines
By Jeff Smith
Rocky Mountain News
November 4, 2006

Qwest Communications has earned a profit in three consecutive quarters, generating hundreds of millions of dollars of cash in the process.  Its stock has nearly doubled in price from $4.50 a share in the past year.  But the profits and cash flow have come mainly from cost cutting and frugal spending.  Revenues remain flat and under pressure, with the company's traditional phone line business declining 6 percent annually because of increasing competition from cable TV companies.

All of that makes some analysts wonder if this is the best the Denver telco can do unless it gets more aggressive in making acquisitions or building its own cable TV networks.

"I think (the stock) is overvalued and they'll probably make an acquisition in the next six months," said Donna Jaegers, telecommunications analyst for Janco Partners in Greenwood Village.  "(Chief Executive Dick) Notebaert has been patient on acquisitions.  But I think his window is closing as Comcast continues to erode market share."

One problem is that Broomfield rival Level 3 Communications already has snatched up some of the best candidates, with seven acquisitions announced since the spring of 2005.

Tom Friedberg, a longtime Denver telecommunications analyst who now is a consultant, gives Notebaert credit in showing things weren't as bad as people thought in early 2005 by pursuing MCI.

But while things weren't as bad then, Friedberg also said he doesn't believe things are good enough now to justify Qwest stock being at the $9 level.

Qwest finds itself in a "strategic pickle" today, Friedberg said.  "What can they do for an encore?"

Investors seemed to agree somewhat this week.  They bid Qwest shares past $9 on Monday in anticipation of a good quarterly earnings report the next day.  But when Qwest narrowly missed revenue projections and reported bigger phone-line losses, investors took their profits, and shares slid below $8.50.

Jaegers, who has a sell rating, and Friedberg are pretty tough on Qwest.  But overall, seven analysts have sell ratings and 10 have hold ratings, while only five recommend buying the stock, according to Bloomberg.  The average target price is $8.14, slightly below current levels.

Showing the variety of opinions, Frank Louthan of Raymond James boosted Qwest to a buy this week.  But Bears Stearns reiterated its hold rating and noted "competitive pressures with wireless and cable are only increasing."

To maintain investor momentum, Qwest needed to show better numbers this week or a higher cash-flow forecast and didn't do either, Jaegers said.  "They were cryptic on their guidance, and they certainly weren't raising the bar."

Qwest recently acquired OnFiber, a small communications provider that serves 23 metro markets, for $107 million.  But many think Qwest needs to do a whole lot more to avoid being a small Bell orphan.

Neither Jaegers nor Friedberg criticize Qwest for being less aggressive on acquisitions than Level 3.  They note Qwest has a different stockholder base, including phone company retirees and other longtime investors who don't want to see their stock values diluted by a big acquisition that involves stock or debt.

But Qwest doesn't have its own wireless network to offset the loss of phone lines, Friedberg noted, and the company has yet to prove that growth in high-speed Internet and data services will do anything more than barely offset phone-line losses.

And Jaegers and Friedberg said Qwest inevitably will lose more land lines to Comcast and Cox.

Some Qwest shareholders may be waiting optimistically for the company to be acquired at a premium by another telecommunications company or private equity firm.  But the current stock price, phone line losses and lingering litigation from the Joe Nacchio accounting scandal days make that unlikely, many analysts believe.

"Until Qwest can show how much share it will lose to Comcast and what it can hold onto, I don't think anyone will touch it," Jaegers said.  "There is a (local-phone) franchise that Qwest will continue to have, but do they lose 30 percent?"

Qwest is capturing a portion of Comcast's cable TV market by reselling DirecTV as part of communications "bundles."  But reselling somebody else's services generally isn't as profitable as operating one's own, and Qwest has yet to spend the money to aggressively expand its cable-TV infrastructure to compete with Comcast head on.

For now, "Qwest is playing a game of chicken, and Comcast increasingly is hogging the road," Jaegers said.

Qwest going ahead

  Likely needs to buy more revenue, such as companies that help drive more communications traffic onto its nationwide fiber-optic network.

  Without acquisitions it may be difficult to offset growing phone-line losses with revenue from high-speed Internet and data services.

  Will try to continue to cut costs, but opportunities to do so may be decreasing.

smithje@RockyMountainNews.com or 303-954-5155

http://www.rockymountainnews.com/drmn/tech/article/0,2777,DRMN_23910_5117593,00.html