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MAY 8, 2002 STREET WISE By Jane Black Tricky Math for Qwest Investors What's the stock worth? Maybe twice its current $6 or so -- if the bulls are right in their valuing of the assets it could sell off
Qwest officials promised to take aggressive steps to cut debt. But just two weeks later, Qwest reported that its first-quarter revenues fell 13.5%, to $4.37 billion, down from $5.05 billion for year-earlier period. The decline, which it blamed on tough economic conditions and a $462 million write-down of investments in European data communications company KPNQwest, resulted in a net loss of $698 million (42 cents a share), compared to a $46 million loss (3 cents a share) in the year-ago period. Yet there's talk -- among even some of the most bearish analysts -- that Qwest shares are undervalued. The stock was trading below $5 -- down 78% from its 52-week high of $39 -- earlier this month and is now around $6. Since the beginning of April alone, Qwest has lost some 37.5% of its market value. But analysts say based on the value of Qwest's assets and its strong local-phone business, it should be trading at anywhere from $9 to $12. "It's simple math. There's a significant spread between what a Baby Bell's business is worth and what Qwest is trading for," says Susan Kalla, a telcom analyst with Friedman, Billings & Ramsey in Arlington, Va. OLD ASSUMPTIONS. Just what Qwest's shares are worth depends on how you value telecommunications in one of the worst years in the industry's history. The bulls say a traditional sum-of-the-parts valuation -- a method in which each division is valued as if it were going to be spun off or sold -- finds Qwest's assets worth around $47 billion. Subtract $25 billion in debt and divide that by Qwest's 1.7 billion shares outstanding, and the stock should trade as high as $13. However, the bears argue that such measures don't apply in today's telecom environment, since investors can no longer assume steady revenue streams. They point out that Qwest has missed its earnings projections for the last three quarters. Still, the bulls do seem to make a reasonable case. Qwest, after all, isn't just another startup telecom gone haywire. Its $58 billion purchase in 2000 of Baby Bell U S West transformed the long-distance provider and fiber-optic network operator into one of today's four regional Bells. It has a virtual monopoly of 25 million local-service customers across 14 Western states. By yearend, Qwest could gain permission to sell long-distance service throughout its region. That would be a boon for the beleaguered "classic Qwest" -- the original, pre-U S West fiber business -- and would allow it to finally make good on the billions of dollars it invested in the long-distance business. It would also lower the barriers for a merger with another Baby Bell -- Verizon (VZ ), SBC (SBC ), or BellSouth (BLS ). So even if one factors out Qwest's heavy debt load and assigns zero value to classic Qwest because of the overcapacity in that business, the stock should still worth upward of $8 a share. Qwest also has a telephone directory business, network facilities including wireless towers, and a heavy concentration of rural access lines. Any or all of these could be put on the block. "The market is too heavily discounting a number of businesses that Qwest can sell for hard cash," points out Sanford Bernstein's telecom analyst Jeffrey Halpern. PRICE PER HEAD. Take its Yellow Pages business, a division that brings in revenues of $1.6 billion each quarter and grosses 60% margins. Qwest is seeking as much as $8 billion for the unit, and some analysts think the company might get that much. It's talking to multiple potential buyers and has set a May 8 deadline for bids, which could include offers from an array of private equity firms. Phone lines that serve rural consumers also have value since competition outside metropolitan areas is limited. Alltel, for example, bought 600,000 rural customer accounts from Verizon for $1.9 billion in October, 2001, for an average price of $3,167 per customer. Since then, the value of these accounts has fallen. But even with the declining market, the price for each of Qwest's several million customer acounts would be between $2,000 and $2,400, says Halpern. "This company is not going to have any trouble paying back its debt," he asserts. So far, though, investors aren't buying -- literally. "Saying what the company is worth is different than deciding whether I'd buy the stock," says David Bank, an analyst at RBC Capital Markets. Bank has a hold rating on Qwest, even though he admits it's worth from $7 to $9 a share. He's among those who argue that the telecom sector, with its numerous bankruptcies, weak demand, and capacity glut, is just too risky overall. "A FALLING KNIFE." Given those factors, potential acquirers of Qwest's assets may not want to pay top dollar. "If you're a buyer, you have to ask, 'why buy now?'" says Soundview Technology's Michael Bowen, one of the Street's most bearish analysts on Qwest. "You could miss out on a good asset. But the risk of waiting is not as great as the risk of a falling knife." Bowen believes that Qwest's directory business is worth only from $3.2 billion to $4 billion -- about half of what Qwest wants. Extracting the right price depends on Qwest Chairman and CEO Joe Nacchio. The outspoken -- some would say loose-lipped -- executive has lost credibility with Qwest investors who are furious about the plunging stock price and the ongoing SEC scrutiny of Qwest's accounting. But that's only half the story. Nacchio is still considered a savvy negotiator. "Joe's credibility with shareholders is one thing. His skills as a dealmaker are another," says Sanford Bernstein's Halpern. Qwest declined to comment on Nacchio's standing with shareholders. Instead it pointed to his recent moves to reduce debt. On Apr. 23, Qwest finished issuing $1.5 billion of debt securities, which gave it the cash to pay off syndicated credit lines. Qwest now also has the leverage to renegotiate a debt covenant, giving it more time to bargain with potential buyers. STILL RISKY. "Of course, there's no assurance at this time regarding prices or timing of sales of any specific assets," Nacchio said in a recent conference call, giving a more subdued assessment of Qwest's status. And that's a pretty accurate description. If Qwest can sell assets for the right price, the stock may be pretty cheap right now but no less risky. For investors looking for a stake in telecom, Qwest may be a buy. For everyone else, its buyer beware.  Black covers technology for BusinessWeek Online in New York Edited by Beth Belton Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. 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