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There's light at end of fiber-optic cable
Prospects brighter for telcos in Colorado
By Jeff Smith
Rocky Mountain News
Friday, November 11, 2005

It's nowhere close to the giddy telecom bubble days, but Colorado's three leading publicly held telecommunications companies are enjoying a resurgence.  Qwest Communications, Level 3 Communications and Time Warner Telecom all have experienced stock boosts in recent weeks and perhaps in their business prospects as well.

All of that is good news for the state's battered telecommunications sector, which has been the weak link in an otherwise improving job climate.  The three companies together still employ nearly 13,000 people here, after shedding almost that many since the bubble burst in late 2000 and 2001.

"These companies have shown the investment community that they're not going away, that they're going to remain players," said Jeff Kagan, an independent telecommunications analyst in Atlanta.

Whether they will become among the biggest or best, however, remains uncertain because the U.S. telecommunications industry is in the middle of reshaping itself yet again, Kagan said, as evidenced by regional Bells emerging as mega-merger winners and gearing up to take on the cable companies.

For Denver-based Qwest, whose stock is up more than 15 percent in recent weeks, the company has cleansed itself of most legal and financial issues lingering from former CEO Joe Nacchio's tenure.  Last week, Qwest settled a class-action shareholder lawsuit for $400 million and embarked on a plan to refinance $3 billion of very high-interest debt.

For Broomfield-based Level 3, whose stock this week broke the $3 barrier for the first time since January, the announced purchase of WilTel Communications last week will eliminate a rival in the wholesale fiber-optic network business and extend the company's staying power.

For Douglas County-based Time Warner Telecom, whose stock price has doubled since May, revenues have increased in four consecutive quarters, including 11 percent in the third quarter.

Of course, the stock prices of the companies still are at a fraction of their historic highs.  Earlier this year, Level 3 stock was hovering at all-time lows.

And there's a flip side that arguably makes this a corner-not-yet-turned story:  The three companies still are losing money, with Level 3 especially struggling to generate enough new revenue to offset declines in its older, dial-up Internet access business.

But it is progress.

Time Warner leads way

Time Warner Telecom, which employs 2,000 including nearly 1,000 in Colorado, may be in the best shape right now.  After all, 11 percent revenue growth was nothing to sneeze at even during the telecom boom.

"Their prospects are solid, with good growth in customers," said Donna Jaegers, a telecommunications analyst for Janco Partners in Greenwood Village.

Jaegers recommends and owns the stock personally.  Janco doesn't do any investment business with the company.

Part of Time Warner Telecom's advantage may be related to the telecom space it occupies.

Qwest and Level 3 spent billions building nationwide, long distance fiber-optic backbones.  That market still suffers from overcapacity and price compression.

Prices in some areas of the long-haul network business were still declining by 25 percent to 45 percent last year, according to a regulatory filing by Level 3, although declines are beginning to moderate and traffic is increasing at robust rates.

While it helps for Level 3 to knock out WilTel, the overall impact may not be that great, analysts say, given the number of other competitors:  AT&T, MCI, Sprint, Global Crossing and Broadwing Communications.

"This industry is likely to remain very competitive," Michael Hodel, an analyst with Morningstar, wrote in a research note last week.

Time Warner Telecom, by contrast, has focused its investment in building fiber loops in cities and connecting fiber directly to more than 5,700 buildings in 44 markets across the country.

The company specializes in installing private data networks for businesses and the government, and selling high-speed services to wireline and wireless carriers.

"There's a scarcity in last-mile (connections), and that's where Time Warner Telecom plays," Jaegers said.

Time Warner Telecom Chief Executive Larissa Herda told analysts last week the company is benefiting from low customer churn and industry consolidation such as the mega- mergers of SBC-AT&T and Verizon-MCI.

In the past, Herda said, it was difficult for Time Warner Telecom to gain an audience of larger customers.  But now large customers are inviting Time Warner Telecom to bid because they are concerned about the industry consolidation's impact on pricing and competition "and they're looking for alternatives, diverse networks, disaster recovery (back-up systems)," Herda said.

Still, Kimberly Noland, an analyst for GimmeCredit, a corporate bond research firm, noted this week that Time Warner Telecom's business requires significant investment to run fiber to buildings and will face more competition as the regional Bells increasingly target the large business market.  Time Warner Telecom isn't expected to be profitable until 2007.

Profits foreseen for Qwest

Qwest Chief Executive Dick Notebaert recently indicated money-losing Qwest, which has 10,100 employees in Colorado, might become profitable as early as next year.

Notebaert is basing his optimism on the debt refinancing, which could shave as much as $300 million of annual interest expenses, and modest revenue growth sparked by sales of DSL high-speed Internet access, long distance and new products.

This week, Notebaert told the Rocky Mountain News that Qwest calculated it could generate an additional $500 million of revenue just by catching up with the market penetration figures of its peers.

For example, he noted Qwest was the last of the regional Bells to get permission to offer long-distance telephone service, about a year later than the others.

But Jaegers is skeptical.

"You snooze, you lose," she said. "There's not any God-given right that you should get the same (market) penetration" as others.

Notebaert indicated the potential to grow organically means Qwest isn't under pressure to join the industry consolidation game.  The company tried to do that earlier this year but failed in its bid to acquire MCI.

"We don't need to knee-jerk into some acquisition," Notebaert said this week, saying any deal would have to make strategic sense and be at the right price.

Jaegers agrees there isn't an urgency now that Qwest is building its own momentum.  Still, she wonders if Qwest may be taking one last look at Virginia-based XO Communications, which last week announced a deal to sell to its controlling stockholder Carl Icahn for $700 million.

XO, which provides high-speed communications services to businesses, has said it will consider a superior proposal subject to the acquirer paying Icahn a 1 percent break-up fee.  Qwest has been rumored before as a possible suitor of XO, which two years ago outbid Qwest to buy Texas-based Allegiance Telecom.

A Qwest spokesman declined comment specifically on XO but referred to Notebaert's remarks.

WilTel brings cash to Level 3

In Level 3's case, acquiring WilTel largely buys the company time and revenue.  Level 3 said WilTel will contribute an estimated $125 million to $150 million of additional cash flow after the two networks are integrated in 2007.

"We've been saying for two or three years that the industry needs consolidation," Level 3 President Kevin O'Hara said in an interview Thursday.

Combined with improved pricing trends and a growing Internet telephony business, "we feel pretty bullish about our prospects," O'Hara said.

WilTel, formerly Williams Communications, has a billion-dollar-plus contract to supply communications services to SBC Communications.  But that contract accounts for around two-thirds of WilTel's business and is expected to disappear by 2008 as SBC moves the traffic over to the network of its new merger partner, AT&T.

Level 3's challenge between now and then is to get enough traction on its new products, such as Internet telephony, to prove viable to refinance its debt.  More than half of Level 3's $6 billion of debt comes due in 2008.

But there's another possible silver lining.

Level 3 executives have been talking for years about the power of broadband-intensive applications to drive its business, such as downloading movies or software over the Internet.

This week, Microsoft Chairman Bill Gates urged Microsoft to "act quickly and decisively" to move into such services as online software to thwart emerging competitive threats.

That endorsement, O'Hara said, could be "a very powerful step" in spurring more traffic over fiber-optic backbones.  Microsoft, he noted, "has the kind of market power to likely jump-start a very exciting trend."

But O'Hara also cautioned that the online software business will develop gradually.

Telecommunications rebound

The telecom sector is showing signs of life after five years in the doldrums.

Qwest Communications -  Headquarters:  Denver

POSITIVES  -  Profit margins improving, debt declining, class-action litigation settled.

NEGATIVES  -  Still a lot of debt, and revenues from new services such as DSL high-speed Internet barely offsetting losses in local telephone business.

FINANCIALS  -  Lost $144 million in third quarter on revenues of $3.5 billion.

Level 3 Communications  -  Headquarters:  Broomfield

POSITIVES  -  Buying WilTel Communications eliminates a rival.

NEGATIVES  -  Highly leveraged, and new services such as Internet telephony not growing fast enough to offset losses in traditional business lines such as dial-up Internet access.

FINANCIALS  -  Lost $204 million in third quarter on revenues of $799 million.

Time Warner Telecom  -  Headquarters:  Near Park Meadows mall in Lone Tree

POSITIVES  -  Strong 11 percent revenue growth in third quarter, thanks in part to increase in larger business customers.

NEGATIVES  -  Not yet profitable.

FINANCIALS  -  Lost $23.4 million in third quarter on revenues of $177.8 million.