NEW YORK (CNN/Money) -
Is Qwest, the forgotten Baby Bell, a takeover candidate?
Now, don't get me wrong. I'm not recommending that investors rush out and buy the stock. There are still numerous reasons to "qwestion" Qwest. (Sorry, but what's up with that hokey spelling? I thought "w" was a vowel only in Welsh.)
The company has a terrible balance sheet and there's also the not-so-trivial matter of an ongoing SEC accounting investigation. But, lately, investors don't seem to mind.
The stock is up more than 50 percent since March 11 and was slightly higher Thursday after Qwest finally reported preliminary first quarter results. The full results still aren't ready because of the company's continued audit of prior years' accounting.
Qwest posted a profit of $150 million, or 9 cents a share, compared with a loss of $23.9 billion (not a misprint), or $14.23 a share, a year ago. The majority of that earlier loss was due to a writedown in goodwill related to its merger with U.S. West in 2000.
After a closer look, Qwest's operating numbers aren't as bad as those of other Baby Bells like Verizon, SBC Communications and BellSouth. That could mean that down the road, Qwest would make sense as an acquisition target.
The case for consolidation
Qwest, through its merger with U.S. West, is the regional Bell operating company (RBOC) for 14 states, including North Dakota, South Dakota, Idaho, Montana, Wyoming and Nebraska. But it also operates in markets such as Arizona, Minnesota and Colorado, where the company is based.
In the first quarter, Qwest lost 130,000 retail consumer access lines (that's jargon for the number of phone lines used by customers). But the performance was an improvement over the 157,000 lines it lost in the fourth quarter of 2002.
David Mantell, a research associate with independent research firm Loop Capital Markets, said Qwest has done a better job of stemming customer defections than the other Bells.
"Access line loss, relative to other Baby Bells, continues to be minimal because there aren't as many competitive pressures," Mantell said. The main reason for this is that Qwest has more of a focus on rural areas that AT&T, Sprint and MCI have not aggressively targeted.
Simply put, there is a glut of U.S. carriers offering similar services to Qwest's. The Baby Bells are getting into long-distance and long-distance companies are hawking local service.
Late last year, Qwest itself received approval to offer long-distance service in nine of its states, and signed up 530,000 customers in the first quarter. Last month, Qwest received approval to sell long-distance in three more states.
Before his ouster last year, Qwest CEO Joe Nacchio was often quoted as saying that there was no need for four Baby Bells. Nacchio's successor, Richard Notebaert, has also said that he expects more consolidation in the telecom industry.
So why wouldn't there be more mergers at some point? We've already gone from seven Baby Bells following AT&T's government forced breakup in 1984 to four.
BellSouth publicly said in 1999 that it was considering an acquisition of Qwest, but that was before Qwest bought U.S. West. Still, rumors resurfaced about BellSouth-Qwest nuptials in late 2001. At the same time, there was market chatter about Sprint being interested in Qwest, as well.
But nothing is imminent
Even though Qwest has lost more than 85 percent of its value in the past three years there won't be any serious interest in the company until it can get rid of the scarlet letter D (for "debt") pinned on its chest. Qwest trimmed $333 million off its debt in the first quarter but that's puny relative to its $27.3 billion in aggregate short-term and long-term borrowings.
"The stock price may have come down but Qwest still carries a heavy debt burden and that is not very attractive to potential acquirers," says Pat Brogan, assistant director of research for Precursor Group, an independent research firm focusing on telecom.
This is a particular problem because the possible takeover candidates (i.e. the Bells, Sprint or AT&T) are themselves highly leveraged. A deal for Qwest right now by any of them would likely lead to investor revolt and possible credit downgrades.
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Fear of more earnings restatements also should keep prospective buyers away as the SEC investigation continues. "There are a lot of accounting issues that have taken place under prior management that haven't gone away and don't appear to be dissipating," said Todd Rosenbluth, an equity analyst with Standard & Poor's.
In fact, Qwest said Tuesday that the SEC probe is widening but declined to give more specifics.
Bottom line: Consolidation in telecom is desperately needed, but it's not going to happen overnight. Once it does, however, Qwest is a logical takeover target as long as it continues to add long-distance customers and slow the rate of local access losses.
That might be one reason why the stock has surged so much lately. But since nothing is imminent, that's all the more reason for investors to not chase Qwest at these levels.
Analysts quoted in this story do not own Qwest and their firms do not have investment banking relationships with the company.
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