The Association of U S West Retirees



12-step program aids Qwest's recovery
By Bob Mook
Denver Business Journal
Friday, August 11, 2006

With quarterly earnings reports showing a profit for two consecutive quarters and its stock gaining traction on Wall Street, the questions about Denver-based Qwest Communications International Inc. have swung from "will it survive?" to "how'd they do it?" in the past five years.

"The recovery is behind us," said Oren Shaffer, chief financial officer of Qwest. "Now, we're building on the recovery."

But true recovery, as they say in various 12-step programs, is an ongoing process.

While few would dispute that Qwest's turn from the brink of bankruptcy has been impressive, observers differ on how -- or if -- the telecommunications company can keep the momentum going.

As one of the area's few big flagship companies, Qwest's vitality remains critical to the Denver economy.

Qwest employs 40,000 people -- including 10,000 in Colorado.  Many local businesses -- from vendors who deal directly with Qwest to restaurants that serve the company's employees -- also rely on the company's financial health.

In talking to analysts and Shaffer about Qwest's recovery, the Denver Business Journal identified 12 steps Qwest took -- and must continue to take -- to ensure its relevance in the rapidly consolidating telecommunications universe:

Step 1:  Admit there's a problem -- Joe Nacchio's "voluntary" resignation in mid-2002 set the stage for Qwest's recovery.

Indeed, Qwest's then-plummetting stock actually rose more than 20 percent to $5 a share on the day Nacchio resigned.

He left Qwest under a pall of scandal that's still playing out in court.

The former Qwest CEO is awaiting a trial for 42 counts of insider trading for allegedly selling $101 million in stock based on inside information that the Baby Bell wouldn't be able to meet revenue targets.

But Nacchio's Qwest also earned a reputation for poor service, low morale and dismal market performance that managed to disenchant customers, shareholders, debtholders, vendors and employees.

"Qwest was just one step away from becoming WorldCom," said Eric Paulak, a Boulder-based analyst for Gartner Inc., referring to the troubled long-distance telecommunications company that eventually emerged from bankruptcy, changed its name back to MCI and sold to Verizon in 2005.

Step 2:  Recruit new executive leadership to restore sanity -- Immediately after Nacchio's resignation, Qwest's board unanimously elected Dick Notebaert its chairman and CEO.

A stark contrast to the brash Nacchio, Notebaert guided Ameritech's purchase by SBC Communications (now AT&T) in 1999.

Upon getting the Qwest job, Notebaert declared he would focus on repairing the company's balance sheet and damaged reputation.

Some, including Scott Cleland, president of the Precursor Group, a telecom research firm based in McLean, Va., doubted that even an executive with Notebaert's skills could fix Qwest's dire situation.

"I didn't believe he could turn it around, but I was dead wrong," Cleland said.  "The fact that they did is a testament to Notebaert and Shaffer's leadership."

A self-described "raging fan" of Notebaert, Cleland said the CEO solved Qwest's financial problems "the old-fashioned way."

"He did it with smart, ethical performance," Cleland said.  "Clearly, he had a long-term vision."

To repair Qwest's fractured balance sheet, Notebaert tapped Shaffer, a trusted colleague from his Ameritech days, as Qwest's chief financial officer.

Shaffer replaced Robin Szeliga, who recently was sentenced to two years probation, six months of home detention and a $250,000 fine for her role in Qwest's accounting scandal.  Szeliga is expected to be a key witness in the government's insider-trading case against Nacchio.

Step 3:  Make amends with employees -- Qwest workers, particularly those from the US West era, were completely demoralized by the time Notebaert came on board.

Cleland said Notebaert was wise in tackling concerns from Qwest employees early on.

"The first thing he did was to calm down all the irate constituencies and buy himself time," he said.  "After that, he rallied the employees and company around his new 'Spirit of Service' vision.  He basically rallied the company around the new idea and ideal."

Step 4:  Make amends with customers -- Given the magnitude of Qwest's problems, Shaffer said it would have been easy for Notebaert to focus on the company's internal trappings.  But that wouldn't have improved the company's public image.

The company set out to improve its customer service scores, which Shaffer claims are now "higher than they've ever been."

Qwest also established online feedback forums, giving employees ways to determine what customer service glitches need to be fixed.

"We believe it's much more economical to hold on to the customers," Shaffer said.

Step 5:  Make amends with shareholders and debtholders -- Notebaert credits Qwest's financial team with being "very creative" in restructuring its debt.

On Shaffer's watch, Qwest's debt has shrunk to $14 billion from a high of $19 billion. The company expects to lower that number even more as its finances improve.

"We're on a tremendous run now," Shaffer said.  "We've demonstrated value in our organization and expanded profitability."

But Brian Hamilton, CEO of Profitcents, a market research firm based in Raleigh, N.C., said while Qwest has good cash-flow management, he's concerned about the company's static liquidity, which he called "kind of soft."

"If operations fell off, that could create some problems," he said.

Step 6:  Make a fearless and searching inventory of the organization -- In Notebaert's time, Qwest has eliminated 11,000 positions (largely through attrition) and dramatically reduced the company's operating expenses.

Qwest also got out of the publishing business in November 2002 by selling its Yellow Pages division to two private equity firms for $7.1 billion.

Cleland credited Notebaert and Shaffer for taking an across-the-board, "penny-pinching" approach to running Qwest -- not out of design but out of necessity.

"All local telephone companies have a history of bloated cost structures," Cleland said.  "Qwest is involved in a two-decade transition from a former monopoly to a competitive convergence player.  They had to transform from a caterpillar to a butterfly.  It's not an easy trick to pull, especially when you're transforming from a narrow-band base into a broadband future."

Hamilton also applauded Qwest's cost-cutting measures.

"What's neat about [Qwest] is they've become profitable while their revenue has declined, which can only mean they've managed their costs better."

Step 7:  Recognize weaknesses and build on strengths -- As demand for traditional phone services, which remains Qwest's main revenue source, slowly declines, the Baby Bell continues to build its broadband customer base.

Qwest added 120,000 new DSL customers in the second quarter -- up 51 percent from the previous year -- as more people converted from dial up.

While revenue from DSL didn't grow proportionally, Shaffer said the growth of broadband is critical for Qwest to lock in customers as the company expands its offerings -- including its planned expansion of TV service.

Paulak said Qwest is well-advised to build on DSL because of its low customer churn rate of only 4 percent a year.

"Once they get the customers, they don't go away," he said.

Step 8:  Build partnerships -- Because Qwest sold its wireless business and doesn't have a strong presence in TV yet, the company provides cellular and satellite TV services through resale agreements with Sprint Nextel Corp. and DirecTV.

"We were losing a lot of money [on wireless] while our customers were telling us they wanted a national footprint," Notebaert told the DBJ on Aug. 1.  "Our goal is not to be T-Mobile.  Now we offer wireless in the bundle, [which] you can include on the same bill as your wireline and DSL service."

Step 9:  Build on other markets -- Paulak fears Qwest may be missing an opportunity to provide voice and data services for business -- particularly in the area of managed hosting services.

"Qwest has not done well in adding incremental revenue in managed service," Paulak said.  "AT&T gets a third of its revenue from leasing out managed services;  Qwest only gets 12 percent."

He claimed Qwest has pursued the business market only in "half steps," while conceding that building the market means beefing up its sales force to sell the services.  But making the investment may pay off in the long run.

"Now is the perfect time to do this kind of thing," Paulak said.  "There won't be another major technology migration for four or five years.  Qwest could end up waiting until 2012 for the next transition."

Shaffer said revenue for Qwest data and Internet services for businesses grew 8 percent in the second quarter to $1.1 billion, but he also said the success of its enterprise business has been "overshadowed" by its success in DSL.

Step 10:  Find new efficiencies -- Qwest cut its total operating expenses to $3 billion in the second quarter of 2006 from $3.2 billion the same time last year (a 6 percent reduction) -- part of an ongoing effort to reduce costs.

But the company's initial efforts to cut costs by outsourcing customer service operations hurt the company's customer satisfaction, forcing it to retreat on offshoring.

"There's only so much you can do in squeezing margins in consumer service," he said.

Shaffer said Qwest invested more money on technology and software to help customer service representatives and technicians do their jobs more effectively and efficiently.

"To drive our broadband abilities, we needed to invest in customer service," Shaffer said.

Qwest beefed up its online presence, giving customers more opportunities (and discount incentives) to order or upgrade service on the Internet -- eliminating a go-between while improving convenience for customers.

Step 11:  Put the past behind -- Though Qwest's new leadership has distanced itself from the Nacchio era with a proposed $400 million class-action settlement for shareholders and $250 million settlement with the Securities and Exchange Commission (SEC), Paulak said the company's stock will continue to be weighed down by bad publicity until the trial concludes.

"Until the business with Nacchio is done, there's still a dark cloud hanging over the company through no fault of its own," he said.

Step 12:  Surrender to a higher power (or become the higher power) -- Depending on who's talking, Qwest's failed bidding war for MCI either made investors take Qwest seriously or undermined the company's recovery.

The fact that Qwest lined up backing for the proposed $9.7 billion deal illustrated the confidence financial institutions had in the company, analysts said at the time.

But Paulak said little good came out of the incident.

"Qwest's attempt to buy MCI was a fiasco," he said, adding the effort actually hurt Qwest's creditability with business customers.

In May, Qwest announced it would buy OnFiber Communications Inc. of Austin, Texas, a competitor for Time Warner Telecom Inc. of Littleton, for $107 million.

Analysts note there's no shortage of second-tier telecom companies available for consolidation, but Shaffer said Qwest will consider only those that add shareholder value.

Most analysts agree it's unlikely that Qwest will be acquired by the two other remaining Baby Bells -- Verizon and AT&T -- since both companies have their hands full with recent acquisitions, and Qwest's debt and sparsely populated coverage area is still considered too much baggage.

"I'd question whether Verizon really wants the state of Montana," Cleland said.

Cleland said Qwest more likely will "stay on course" and pursue "opportunistic" acquisitions.