A Telecom Con-Qwest for Private Equity?

Richard Notebaert's plan to move on—along with two other chief officers—could leave an opening for a buyer

by Bruce Meyerson

Richard Notebaert has done such a good job rescuing Qwest from near financial ruin that his plan to retire could leave a tasty cash-generating treat for private equity investors, who have shown an appetite for telecom plays of late. On June 11, Qwest (Q) announced that Notebaert, who turns 60 this summer, will be retiring as chairman and CEO once a replacement is found.

It's likely that a successor will come from outside Qwest's managerial ranks, as two of Notebaert's top deputies have also announced their departures in the past few months. Notebaert was recently elected chair of the board of trustees at Notre Dame University, a position he may want to turn his full energies to after five years of leading Qwest's revival from the telecom market's collapse and a financial scandal in which his predecessor, Joe Nacchio, has been found guilty of insider trading (see BusinessWeek.com, 4/19/07, "Nacchio's Defense-Lite Strategy Backfires"). The departures of the CEO, Chief Financial Officer Oren Shaffer, and Operations Chief Barry Allen suggest that Qwest's board may be hoping to move in a new direction now that the turnaround has returned the company to stability and profitability.

Still, investors appear to worry that Notebaert is leaving while the going's still good in a hugely difficult industry where Qwest, the dominant local phone company in the Rocky Mountain and Pacific Northwest regions, is hardly the strongest player despite the impressive turnaround he has led. Qwest's shares, which recently notched a five-year high of $10.45, slid 8% on the news.

A Good Buy

Despite those jitters, analysts have been upbeat about Qwest's prospects of late. Last week, Standard & Poor's raised its rating on Qwest's unsecured debt. And a month ago, Bank of America analyst David Barden raised his rating on Qwest to buy, arguing that the company has transformed itself into a reliable cash-flow machine despite abundant market threats. At the end of March, Qwest had nearly $900 million in cash on hand with long-term borrowings of $13.2 billion—only slightly more than half the $25.6 billion debt hangover from the telecom boom that Notebaert inherited when he joined the company in June, 2002.

Meanwhile, free cash flow is expected to reach about $2 billion next year, according to estimates from both Barden and UBS industry analyst John Hodulik. That cash stream could prove tempting for private equity, which has shown a sudden interest in telecom investments in the past month with deals to acquire Alltel (AT) and Avaya (AV). The difficulty in trying to buy Qwest, however, is that the wireline telephone industry remains highly regulated by the government. While the Federal Communications Commission has tried to scale back its regulatory intrusions, state agencies remain bent on ensuring and improving local phone and Internet service for consumers.

"We believe senior level departures represent a 'changing of the guard' rather than 'abandoning ship' as Qwest has regained both operational and financial footing in the aftermath of its post-bubble woes," Barden said in an update to investors. "We believe private equity or strategic buyers could be attracted to Qwest by the ability to place senior leadership and set the tone of the company."