Qwest being seen as likely takeover target

The Denver Post

By Andy Vuong
February 7, 2010

Qwest Communications appears to be on the block, with a growing number of Wall Street analysts speculating that the company is a prime acquisition target and senior management speaking more freely about consolidation.

The mergers-and-acquisitions tailwind is not new, just stronger. A drumbeat of analyst upgrades over the past few weeks cites the potential for the Denver-based company to be swallowed.

"In recent years, we have seen numerous (rural phone company) mergers and acquisitions, and we expect further consolidation," Piper Jaffray analyst Chris Larsen wrote last week in upgrading Qwest shares.

UBS analyst John Hodulik was more direct, stating that he believes "the final leg to the (Qwest) story comes in the form of M&A."

Both UBS and Piper Jaffray seek investment-banking business from Qwest and buy and sell shares of the company.

Qwest's key assets are worth nearly $20 billion, according to an analysis by The Denver Post.

What company could, or would, cough up that kind of cash for a firm whose most valuable asset — phone landlines — is a dying business?

Smaller rural phone operators CenturyLink and Windstream have been mentioned as potential suitors. A leveraged buyout is not out of the question, as Qwest's cash reserves increased to $2 billion at the end of the third quarter, up from $590 million a year earlier, making it more attractive to private-equity firms.

Qwest spokeswoman Diane Reberger declined to comment.

With a massive debt load and varying assets, Qwest could be carved up for a sale, experts say.

The company has 10.5 million access lines in its 14-state local service territory — essentially the business Qwest bought from U S West in 2000 for $45 billion.

Last year, Frontier Communications purchased 4.8 million rural access lines from Verizon for $8.6 billion, paying roughly $1,800 per line.

Qwest's lines are worth less because they stretch across large swaths of isolated countryside — making them more expensive to serve — whereas Verizon's rural lines are more condensed. If Qwest can fetch $1,500 per line, the phone business, including broadband customers, could be sold for nearly $16 billion.

The company's 16 data centers could be worth about $1.5 billion, based on an average size of 50,000 square feet per location and construction costs of up to $2,000 per square foot.

Qwest's nationwide fiber-optic communications network also could have a price tag of $1.5 billion, based on 22,000 route miles and industry construction costs of about $70,000 per mile. The company tried unsuccessfully to sell the network last year, reportedly seeking $2 billion to $3 billion. Broomfield's Level 3 Communications had been mentioned as a potential buyer for that asset.

Finally, Qwest has fiber-optic connections in more than 40 U.S. metro areas, valued at about $200 million. In 2006, Qwest paid $107 million to acquire about half of those connections.

Rural phone operator CenturyTel merged with Embarq last year to form CenturyLink, a firm analysts say could have interest in Qwest. Monroe, La.-based CenturyLink operates 7.5 million access lines in 33 states.

"(CenturyTel's) model really has been acquired growth as opposed to organic growth, and this has been going on for at least 15 years," said Dave Novosel, an analyst with Gimme Credit in Chicago.

Novosel added that "right now, Qwest is probably too big of a chunk to bite off."

In December, Qwest chief financial officer Joe Euteneuer said industry consolidation would continue, but the company's low stock price prevents it from being the acquirer. Qwest shares have not been above $5 since 2008. The shares hovered around $4.30 last week, which fairly values the company at about $20 billion when factoring in debt and cash.

As of Sept. 30, Qwest had $13 billion in long-term debt and $2 billion in cash and equivalents.

"Management is talking a lot more about it (consolidation)," said Donna Jaegers, an analyst with D.A. Davidson & Co. in Denver. "But the fact that they still have all that debt and 14 state regulated bodies looking over their shoulders, I don't see them as being a real attractive target."

Qwest may opt to continue doing what it's done in recent years — cut costs to offset revenue declines. That formula has helped the company, which employs 31,000, including 8,000 in Colorado, generate cash from operations and post profits.

"It gets harder and harder to keep cutting costs," Jaegers said. "As (former WorldCom chief executive) Bernie Ebbers used to say, 'There's no more lemon juice left in that lemon.' "

Andy Vuong: 303-954-1209 or avuong@denverpost.com