DSL Prime: Qwest for Sale

A recent interview with the firm's CEO, a very careful man, sounded like an announcement that the company's for sale. The company's underinvestment suggests the same.

by Dave Burstein of DSL Prime and Future of TV [June 9, 2006]

Qwest for sale
Notebaert in NY Times, Anschutz off board
Dick Notebaert, Qwest CEO, is a very effective and careful public speaker. He knows exactly what he wants to say, and I read this interview with Ken Belson in the NY Times as an invitation to bid for the company.

Belson: Might you be more of an acquisition target?

Notebaert: If I looked at it as a consultant or an adviser, I would look at Qwest today and say most of the things that made me uncomfortable before are gone. Again, the government at every level we're O.K. The debt load's down, profitability's up. Everything's squared away and there's no threat of bankruptcy, which you might have thought about a few years ago. And the company has solid performance characteristics. And it's throwing off good cash. It's profitable. And it's got a wonderful group of employees. So I don't think we're unattractive.

Phil Anschutz, who controls 16 percent of Qwest, resigned from the board three months ago and so did his aide, Cannon Harvey. Time would give Anschutz credible denial of inside information when he sells. His $1.5 billion sale while Chairman during the midst of the "$44 billion accounting fraud" created talk of an indictment, so he has to be very careful and resigning from the board would cover his ass (cya).

Notebaert's comment I take as confirmation. The logical buyer is Deutsche Telecom, which five years ago was ready to pay over $80 billion for the company. Because they have a mobile network in the U.S., there's a natural synergy. AT&T and Verizon/MCI, on the other hand, duplicate Qwest backbone assets. Sprint is spinning off wireline assets, not adding to them.

Qwest's desperately low capital spending is the third reason I think Anschutz and Notebaert want out. Quest capex is 45 percent lower than depreciation, leaving the network increasingly obsolete and vulnerable to competition. That props up income in the short run, allowing the company to report the first (very modest) profit in several years, fully audited and conforming to GAAP as far as I know.

I am very carefully saying "misleading", not fraudulent, and I'm not suggesting any improper behavior. This DSL Prime story is not a report, like Simon Flannery's a few years ago, hinting at illegal activity. That exposed a major scandal, and I have no reason to believe anything of the sort is going on. What I'm seeing is an investment cutback that legitimately creates earnings but leaves the company extremely vulnerable. A quick getaway makes sense.

A more cynical way to look at it is Notebaert and Anschutz are smart enough to sell before cable VoIP, Seattle and Utah municipal networks, and wireless substitution clobber the company.

One of Qwest's major challenges is the greater capital resources and customer power of SBC/AT&T and Verizon/MCI. Not long ago, Qwest bid more than the company could afford to try to keep MCI away from Verizon. The nearly universal comment was Qwest was dead if they lost the bidding war. Few of those doubters have said anything about Qwest rising to new highs on the stock market.

The effects on Qwest's income of the backbone takeovers may not be so dire. However; AT&T and Verizon now control so much of the backbone and enterprise voice market they may be forming an effective cartel and driving up prices, a story I'm trying to understand.

One enticement to buyers is Qwest's apparent success in winning a large government subsidy through the so-called "universal service fund", most of which is just an incumbent subsidy. D.C. insiders are already calling the new proposals the "Qwest welfare agreement," based on currently leaking details. That money will be shoveled straight to investors, not used to improve the service or prices for rural service.

This item is not based on either Wall Street rumor or an insider leak. I'm going solely on Notebaert's comments and the analysis outlined above. I don't think a deal is in sight very soon, and know things could easily change.

The original title of this piece was "Qwest talking sale." Reviewing the issues, I stuck my neck out and changed the title to "Qwest for sale." I made a printout of this column in case I'm wrong. Unless Qwest drops to half the current price (making a bid unattractive to the owners), if it's not sold in 12 months I'll eat this column. Just as Bob Metcalfe did, I reserve the right to blend it with more wholesome ingredients.

Million reasons to believe Whitacre's "We have 100 percent DSL coverage"
Ciena/Catena million SLC upgrades, Telstra says it's cheap
Ed Whitacre, SBC CEO, startled everyone in 2004, when he answered my question about universal broadband, "We can reach all our customers. It only takes an hour to install." Although I knew that would startle even his own engineers, I reported him verbatim (and accurately) to make the point that the distance limits of DSL could be easily overcome. In fact, SBC virtually froze investment in broadband coverage in 2001 as part of reducing capex to 30 percent less than depreciation to goose the stock price. Dozens of smaller telcos in the U.S., including rural cooperatives, had already proven the technology works fine and the payback is reasonable.

Ciena's Malcolm Loro tells me they are closing in on a million units sold of their solution to the problem of the unserved, the Catena upgrade for existing SLC remote terminals. Six month sales increased over 35 percent to $47 million in Ciena's Broadband Access Group (the old Catena), and it was the most profitable segment of the company. There are millions of U.S. homes behind the old Lucent terminals that can easily and inexpensively serve with Ciena.

Doug Campbell at Telstra told the Australian Financial Review it would cost Telstra a "nominal amount" to fit the Extel equipment to each phone line required. DSL Prime reported in 2004 that the equipment cost would be "under $100" if ordered in quantity by large telcos. Given a charge of $200 to $400 per year for each DSL line, even adding installation makes extenders affordable for nearly all those currently unserved.

Kevin Martin can look Ed Whitacre in the face, say "heck, you said you can do this and make money." That would cut in half the number unserved in a few months. Martin doesn't want to hold up the AT&T-BellSouth merger, but the companies are even more reluctant to have any problem. Martin will probably never again have such a powerful bargaining chip.

Copyright 2006 Dave Burstein.
The DSL Prime Newsletter is reprinted with permission.

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