The Association of U S West Retirees



Qwest Beats the Odds, So Far
By Ken Belson
New York Times
Wednesday, September 27, 2006

DENVER — Richard C. Notebaert, the chief executive of Qwest Communications, is not one for conventional wisdom.  Just a year ago, many on Wall Street thought Qwest, the nation’s fourth-largest phone company, was so weak that it was bound to be broken up or sold.

But Mr. Notebaert has quietly and consistently proved them wrong.  He has cut costs, stabilized revenue and built up so much cash that Qwest is actually in a position to buy another industry player — perhaps a wireless carrier or a provider of corporate telecommunications services.

Such a move would go a long way toward arming Qwest with the tools it needs to fend off cable companies, Internet phone providers like Vonage and cellphone carriers like Cingular that are luring away hundreds of thousands of its customers.  It would also help Qwest contend with Verizon Communications and A.T.& T., which account for half of all sales of communications services to companies.

“You can never relax or say I made it,” Mr. Notebaert said recently, sitting in a conference room atop the company’s headquarters with the Rocky Mountains in the distance.  “This is a very competitive sector.  You need some angst.”

The perpetually upbeat Mr. Notebaert, an avid jogger with a firm handshake, may not seem angst-ridden, but he still has reason to be.  Though Qwest is no longer on life support, the company competes with fewer arrows in its quiver than the larger Bell companies, which are spending billions of dollars to build and run cellular and fiber networks.

Given the expense of those networks and Qwest’s considerable debt load, Mr. Notebaert has focused instead on keeping costs down, increasing profit and letting other companies do some of the heavy lifting.

Qwest now resells Sprint's cellphone service, under its own brand, at a modest profit.  Though the business is nowhere near as lucrative as that of Verizon Wireless or Cingular, it is far less expensive to run than Qwest’s old money-losing wireless business, which Mr. Notebaert unloaded two years ago.

Qwest also resells DirecTV;  the alternative was to build its own fiber optic network for carrying television to homes, as Verizon and A.T.& T. are doing.  Those costly projects have unnerved many Wall Street analysts.

By forgoing those ventures, Qwest has increased its profitability and its share price, which is up 136 percent in the last year.  The stock gains have reduced Qwest’s attractiveness as a takeover target.

In the second quarter, Qwest’s profit margin rose to 31.9 percent, from 28.6 percent in the period in 2005 and 24.4 percent at the end of 2003.  Part of that increase is a result of Qwest’s ability to keep its capital spending down to 12 percent of revenue, well below the 19 percent that Verizon spends.

“They have to make sure that over the next 5 to 10 years, they have enough capital to deal with competition,” said John C. Hodulik, an analyst at UBS Securities.  Building a fiber network “would be a major undertaking,” he said, adding that the company “might be sitting back and waiting to see how A.T.& T. is doing” with its new network.

The cost-cutting has left Mr. Notebaert and Qwest’s board with a happy question:  What to do with the roughly $1.8 billion in cash Qwest is expected to accumulate by the end of the year?  They could use some of it, as well as Qwest’s healthier stock, to shop for companies or, as analysts expect, announce a dividend worth about $1 billion and buy back some of stock.

Mr. Notebaert hinted that a dividend could be in the works.  “It’s time to reward our equity holders,” he said.

Qwest’s board is expected to make a decision by late October when the company reports its third-quarter earnings.

Major challenges remain.  Revenue is barely growing as local phone customers continue to defect to cable and other providers.  The pace of cost-cutting is also slowing, which means profits are going to be harder to come by in the next few quarters, analysts said.

“Dick staving off bankruptcy was a feat in and of itself,” said Christopher C. King, an analyst at Stifel Nicolaus, who has a sell rating on Qwest’s shares.  “But where is the growth going to come from with cost-cutting slowing down and revenue flat?”

Qwest lost 263,000 phone lines in the second quarter, leaving it with 14.3 million lines, or 5.3 percent fewer than it had a year earlier.  That decline may pick up speed as cable companies make further inroads into the phone business.

Qwest competes with Comcast, the country’s largest cable company, in five of its largest markets;  it added 306,000 phone customers in the second quarter.  In one of Qwest’s largest markets, Phoenix, the cable provider Cox Communications says it has more than 30 percent of the phone customers and 70 percent of the high-speed-data subscribers.

The success of the company’s wireless business has also been uneven.  Revenue grew 7.6 percent in the second quarter compared with the period the previous year, but the number of subscribers dipped by 7,000 from the first quarter.  Verizon Wireless, by contrast, added 1.8 million customers during the same quarter, and is a major source of growth for its parent, Verizon.

Qwest has been able to prevent these problems from hurting its financial picture by shrinking.  Quarterly revenue per employee, a crucial benchmark, has grown 18.6 percent during the last three years, but that increase came as Qwest eliminated 17 percent of its work force, or more than 8,000 jobs.

The company has also become more efficient, reducing the time it takes to install high-speed Internet lines to three days, from five, and reviewing how it serves customers.  Qwest outfits its trucks with locator devices so managers can instantly track how many miles technicians drive and how many jobs they complete each day.  Using such data, Qwest can redesign routes to eliminate midday trips to the garage, for example.

“We have to take a minute-by-minute look at our business,” said Barry K. Allen, the executive vice president for operations at Qwest.  “We have a lot of learning ahead of us.”

But the gains from cutting costs are starting to slow.  Qwest is expected to trim operating expenses by 3.6 percent this year, down from a 9.1 percent improvement in 2002, according to Jeffrey Halpern, an analyst at Sanford C. Bernstein & Company.

New growth, analysts say, will probably come if Qwest acquires other companies, particularly a wireless carrier that could help it offer packages to draw customers away from cable providers.  The problem is that while Qwest’s market capitalization has risen to $17.1 billion, it is probably not big enough to buy T-Mobile or Alltel, the fourth- and fifth-largest carriers.

U.S. Cellular is the next logical option, but its owners have shown no signs of wanting to sell the company.

Mr. Notebaert said Qwest was “very comfortable” not being “vertically and horizontally integrated in everything we do,” a sign that he does not feel compelled to buy a wireless business.  The company, he suggested, could introduce a hybrid solution instead:  handsets that work on cellular networks outdoors and Wi-Fi connections indoors, so customers can save cellular minutes by using their high-speed data lines at home.

Mr. Notebaert also dismissed talk that Qwest might sell some of its local phone lines to avoid exposure to competitive cable companies.  Investors have approached Qwest looking to buy the company’s lines in Minnesota and New Mexico, but the talks were only preliminary.

“We aren’t in the business of selling our core,” he said, adding that the local-line business, while shrinking, still generates cash.

More likely, Qwest could pursue a company that bolsters its ability to sell to businesses, Mr. Notebaert said.  Qwest recently completed its $107 million purchase of OnFiber Communications, which manages high-speed networks in 23 cities, most of them outside Qwest’s region.  Qwest says it will add nearly $60 million in annual sales and save money by using OnFiber’s networks instead of leasing them from others.

Mr. Notebaert said Qwest would not “get deal heat” and overpay for a company.  It demonstrated this resolve last year when, after raising its bid for MCI three times, it backed out of negotiations, allowing Verizon to buy the company.  The loss to a much bigger rival renewed concerns about Qwest’s weakness and hurt the company’s stock.

Within a couple of months, Qwest’s decision to focus more on cutting debt and improving profit ignited the rally in its stock that continues today.  But how long will the upswing last?

“Dick’s done a tremendous job of attacking a lot of tough problems in the right order,” said Mr. Halpern of Sanford C. Bernstein, who has a hold rating on Qwest’s stock.  “But how long can the game go on?  Cable company competition is looming and your stock is high, so the question is whether it is sustainable.”