The Association of U S West Retirees



Qwest plays it close to the vest
While its competitors bet on acquisitions and risky new projects, Qwest is playing it safe, or is it?
By Andy Vuong, Staff Writer
Denver Post
Sunday, November 12. 2006

Qwest's peers and competitors are betting billions of dollars on acquisitions and lofty initiatives in the high-stakes battle to win phone, Internet and video customers.

Meanwhile, the Denver-based company is playing it close to the vest.  Despite three straight quarterly profits, there is a growing sentiment that Qwest must make a move -- acquire another communications company or launch a broad video play -- to stay in the game.

Verizon Communications, already in the midst of an $18 billion upgrade of its fiber-optic communications network, is reportedly negotiating a deal to allow its customers to view website's video content through the carrier's cellphone and video services.

Comcast, a major Qwest competitor in several markets including Denver, is undertaking its own video content initiatives, such as the recently launched horror channel Fearnet and, a YouTube-like service.

The content moves by Verizon and Comcast are on top of the triple-play bundle of services the companies are already aggressively expanding.  The triple play offers phone, high-speed Internet and television services.

Verizon also has its own wireless business, though it doesn't offer discounts on the service as part of the bundle. Comcast, along with other cable companies, is working on a deal to resell Sprint Nextel cellphone service.

Qwest insists it is satisfied with reselling DirecTV's satellite-TV service as part of its bundle.  The company also resells Sprint's cellphone service.

Over the past several quarters, Qwest has spent much of its capital on broadening its high-speed Internet service.  The company's percentage of capital expenditures to revenue for the first nine months of this year was 12 percent. In comparison, Verizon had a percentage of 18 percent and AT&T 13 percent.

The conservative strategy, while pleasing to investors because the company is generating plenty of cash, could set Qwest up for "slaughter" in the long run, said Pat Comack, an independent telecom analyst with Zachary Investment Research.

"They just ignore this oncoming tsunami and they have no defense," Comack said.  "They're going to have to really start their video initiative immediately."

Qwest, the dominant local phone provider in Colorado and 13 other Western and Midwestern states, said it will make a move when the time is right.

"We're watching the video market very closely," said Bob Toevs, a Qwest spokesman.  "Our strategy is that of a fast follower."

Specifically, Qwest is watching AT&T's video strategy, which is to run fiber to neighborhoods and digital television over Internet lines.  Qwest offers its own video service, but only to a handful of communities in Colorado, Arizona and Nebraska.

To be sure, there are analysts who support Qwest's strategy.

"They're taking the right strategy in terms of holding back on building out a video platform," said Kent Custer, an analyst with A.G. Edwards & Sons.  "They can afford to hold back and let Verizon and AT&T cut through the tall grass."

Verizon and AT&T are both suffering faster rates of wireline losses than Qwest.

Still, analysts say Qwest should make a move soon to offset its own accelerating wireline losses to companies such as Comcast and Vonage, which are offering phone service via Voice over Internet Protocol technology.

In the third quarter, Qwest's primary consumer access lines dropped 5.8 percent year-over year, from 7.92 million to 7.45 million.  The drop was at 4.8 percent in the second quarter.

"We believe Qwest will face increasing pressure in its consumer business as competitive VoIP services begin a more aggressive rollout," Citigroup analyst Michael Rollins wrote in a recent research note.  "Although we witnessed favorable margin improvements in the quarter, the company has not demonstrated any meaningful progress, in our view, to materially improve the potential to grow revenue."

Qwest has achieved much of its earnings and improved margins through cost-cutting and balance-sheet restructuring, said Chris King, an analyst with Stifel Nicolaus.

"We believe Qwest, more than any other RBOC (regional Bell operating company), is at the mercy of broader trends within the sector," King wrote in a research note.

Though unlikely, analysts say Qwest might be a good acquisition for Germany's Deutsche Telekom, which owns T-Mobile.  The merger would pair the nation's fourth-largest wireless provider with the last major independent wireline company.  Deutsche Telekom tried to acquire both Qwest and US West in 2000 for $100 billion.

But Qwest, which acquired US West in June 2000, says it believes it is in a better position to acquire a company rather than be acquired.

Analysts say Qwest couldn't afford to purchase a video provider like DirecTV, which has a market capitalization of about $27 billion.  They also say it's unlikely Qwest would have interest in a company like Vonage.  While Vonage has a growing national brand, Qwest isn't pushing to become a national player with its consumer-business segment.

Instead, companies mentioned as potential targets for Qwest include "metro fiber" firms such as Cogent Communications and AboveNet, which provide high-speed Internet connections to businesses.

Those companies would help boost Qwest's enterprise business, one of its three key business segments.  Qwest believes it can grow its enterprise business market share to help offset wireline losses.

Cogent has "about a thousand buildings hooked up to their fiber, mostly on the East Coast in big cities, so that would make sense," said Donna Jaegers, an analyst with Janco Partners.  "But it's very richly valued right now."

Amid industry consolidation, Cogent's stock price has surged by more than 80 percent over the past three months.

AboveNet could also provide Qwest with "last mile" connections to enterprise customers.

Other companies that Qwest could have its eye on include independent fiber-optic network operators Savvis and XO Communications.

None of those companies are on the scale of MCI, which Qwest tried to acquire before losing out to Verizon last year.  But that doesn't mean Qwest chief executive Dick Notebaert isn't working on a large deal behind the scenes.

After all, Qwest began negotiating its failed bid for MCI seven months before the talks were first reported.

Notebaert has been asked by analysts about mergers and acquisitions consistently over the past several quarters.

"I don't think we're going to change our very disciplined approach to what we are doing," he said during the company's third-quarter conference call.  "For us, we are looking, we're scanning.  There is no shortage of beachfront property left."

The company completed its acquisition of metro-fiber company OnFiber Communications during the quarter.  At least one analyst believes Qwest had interest in independent-network operator Broadwing, which was snatched up recently by Broomfield-based Level 3 Communications for roughly $1.4 billion.

Jonathan Chaplin, an analyst with JP Morgan, said he doesn't think Qwest needs to acquire a company to remain competitive.  "There's a lot of talk because of the consolidation that's happened that Qwest has to do something," Chaplin said.  "I think that's a misconception.  They've got a great business today.  They're generating a ton of free cash flow.  They've got good margins."

"There's not really a clear opinion as to what Qwest is going to do next," said Jeff Kagan, a telecom analyst in Atlanta.  "They've had a remarkable few years.  They took a company that was slipping through their fingers and rebuilt it."

Staff writer Andy Vuong can be reached at 303-954-1209 or

Analyzing the Qwest analysts

Jonathan Chaplin, JP Morgan in New York.

Qwest rating: overweight (outperform)

Disclosure: JP Morgan has received compensation from Qwest for products and services over the past 12 months.

Pat Comack, Zachary Investment Research, Miami Beach.

Qwest rating: sell

Disclosure: Zachary does not have a business relationship with Qwest.

Kent Custer, A.G. Edwards & Sons in St. Louis

Qwest rating: hold

Disclosure: Does not have a business relationship with Qwest.

Donna Jaegers, Janco Partners in Denver

Qwest rating: sell

Disclosure: Does not have a business relationship with Qwest.

Chris King, Stifel Nicolaus & Co. in Baltimore

Qwest rating: sell

Disclosure: Does not have a business relationship with Qwest.

Jeff Kagan, independent telecom analyst in Atlanta

Qwest rating: none

Disclosure: Kagan has done some contract work for Qwest and other telcos in the past 12 months.

Michael Rollins, Citigroup Global Markets in New York

Qwest rating: sell

Disclosure: Citigroup has received compensation from Qwest for products and services over the past 12 months.