Copyright 2002 The Deal L.L.C.

The Daily Deal…06/18/2002

From LexisNexis

Even without Joseph Nacchio as a lightning rod for allegations of misleading accounting and excessive capital spending, the many problems at Qwest Communications International Inc. make the company an unlikely takeover target, industry observers say.

With $26.6 billion in debt, a money-losing fiber-optic business and weakness at its local telephone unit USWest Corp., Qwest will be hard pressed to attract one of the country's three other former Baby Bells to acquire it.

"Getting Joe and his substantial ego out of the way will certainly help out, but the fact is that Qwest's businesses are still losing money," said Drake Johnstone, telecom analyst at Davenport & Co. in Richmond, Va. "The only way Qwest would be a potential merger candidate is if it can successfully generate enough money from capital sales to lower debt."

Even then, added Johnstone, it is questionable whether Verizon Communications Inc., SBC Communications Inc. or BellSouth Corp., Qwest's most logical acquirers, would want to buy the company's broadband network along with its 14-state Western local telephone service business.

At present, all three Baby Bells are concentrating on offering high-speed telecommunications services to businesses within their home regions. When a corporate customer needs to make connections outside its region, the telecom can lease or buy capacity on existing fiber-optic lines for less than it costs to own the lines.

Those low wholesale broadband prices are a direct result of the over-building of fiber-optic lines that companies such as Qwest laid at a furious pace in the late-1990s. At the time, credit was easy, and executives such as Nacchio were especially good at obtaining it. But the high demand for fiber-optic capacity has yet to materialize, leaving Qwest deeply in debt.

"Being sold is not the main focus, and won't be anytime soon," said Tim Horan, telecom analyst at CIBC World Markets. "They've got to figure out a strategy to increase liquidity and win back investor confidence."

Like Bernard Ebbers at WorldCom Inc., Nacchio and his large personality had become as much of an issue in the opinion of investors at Qwest Communications International Inc. as the weakness of the company's business units.

Denver-based Qwest announced Nacchio's resignation Monday, June 17, a move that excited investors but can hardly be expected to make the company any more attractive to potential buyers - providing that any telecommunications company is interested in making an acquisitions. The company's stock price gained nearly 20.5 percent Monday, ending the day at $5 a share.

When Ebbers left WorldCom in April, some observers surmised that the absence of the company's strong-willed founder and chief executive would make it easier for management to sell off its unprofitable parts to ready the long-distance provider for a sale. Even though the company carries $30 billion in debt, its fiber-optic network operations remain profitable.

Qwest, conversely, has been steadily losing money. Revenues for the three-month period ending March 31 were down 4 percent compared to the previous year. More concerning was the revelation that revenues at USWest Corp., the local telephone operator Nacchio pushed to acquire in 2000 for $78 billion, fell by 3 percent.

To avoid violating an existing $4 billion bank facility, Qwest's incoming chief executive Richard Notebaert must lower the company's debt by year's end to less than four times cash flow. To do so, Notebaert is betting that Qwest can sell its directories business for $7 billion to $8 billion. But that figure many be overly optimistic, Johnstone said.

McLeodUSA Inc., a fiber-optic provider based in Cedar Rapids, Iowa, sold its directories business to Yell Group in April for $600 million, or about two times its 2001 revenue and four times its cash flow. At those ratios, Qwest is only likely to bring in about $3.2 billion for its comparable unit. Even after lowering its debt following such a sale, the decreased revenues from its directories unit would put Qwest in violation of its bank facility.

"With Qwest on the ropes, why would anyone pay a premium for the directories business?" Johnston asked. "Then again, why would anyone pay a lot of money for a company that has so much debt?"