Online Extra: Qwest: Sitting in Telecom's Sweet Spot

Though it's an expensive stock in a beaten-down sector, analysts say its combination of businesses may be worth the premium

A pricey telecom stock might sound like an oxymoron these days. But Qwest Communications fits the bill. At around $37.60 per share, the company trades at a heady price-to-earnings ratio of 70. That price is well off Qwest's 52-week high of $59.88. But it still soars above the rest of the pack, from market laggards WorldCom and AT&T to darlings such as SBC Communications and Verizon. None of them trade at a p-to-e over 20. So what could justify such a high bounty?

Qwest combines the best of both worlds. Through it's ownership of Baby Bell U S West, Qwest has 25 million local-phone customers and steady cash flow. The acquisition of U S West last year pushed revenues from $3.9 billion in 1999 to $16.6 billion in 2000. At the same time, respected CEO Joseph Nacchio has built a modern long-haul fiber-optic network spanning 150 U.S. cities and reaching into Mexico. He has also partnered with Dutch company KPN to build a European fiber network.

All of these facors will come in handy as the company tries to capitalize on growth markets in data transport, streaming media, and Web hosting, as well as bundled service packages that include everything from local tone to long-distance to residential broadband service. With its local-phone service in 14 states to fund the buildout of an advanced fiber network and its data infrastructure, Qwest looks like a formidable contender. "Qwest is growing substantially faster than any of the other regional Bell holding companies," says Alan Harris, senior portfolio manager of the Munder NetNet Fund.

GREAT NEWS. According to a recent study conducted by JP Morgan Chase and consultants McKinsey & Co., transportation, storage, management, and protection of data are the brass rings of the telecom business. Revenue from data services will grow to $150.7 billion in 2005, up from $68.7 billion in 2001. Revenues from local data services, including digital subscriber lines (DSL) and high-speed T1 lines for businesses, are expected to rise 25% by 2005. Revenues from managing long-distance data transmission for corporations will rise 14% in the same period. Internet services, which includes Web hosting and housing of Internet infrastructure and equipment, are expected to rise 34%.

Booming demand for data services is great news for Qwest, which has a data-handling backbone superior to its Baby Bell siblings and even to long-distance providers such as WorldCom. Of Qwest's $5.05 billion in first-quarter revenues, Internet and data services accounted for 25%. That's up from a 23% share in the previous quarter. Analysts expect this segment to generate one-third of the company's revenues by yearend, further decreasing Qwest's exposure to voice services.

The combination of data and local dial tone helped Qwest meet analysts' first-quarter earnings expectations of $0.13 per share, a 12% increase compared to the same quarter a year ago. That number should pick up as the company has forecasted year-over-year revenue growth of 15% to 17% as it builds its data-services business and gets deeper into the still lucrative but rapidly weakening long-distance game.

FAST MOVER. While this business is killing AT&T, Qwest can keep operational costs low due to its more technologically advanced systems. And it has shown that once it receives long-distance clearance in a particular state, Qwest is able to steal 15% to 20% of that area's long-distance market within a year. For Nacchio & Co., that means about $2 billion in annual revenues at the current sales rate, the company says.

In the meantime, Qwest continues to invest in developing data capabilities. Total spending on capital projects is slated at around $9 billion this year. The company is on track to have 24 key data centers for its network up and running by yearend. "Their nationwide network goes across the board," says Stephen Shook, an analyst at Wachovia Securities. "For big companies who need global presence, Qwest can meet those needs for them."

On the residential side, the company recently announced that it will expand its high-speed DSL coverage severalfold over the next two years, in part through its provision of high-speed service to Microsoft Network subscribers. Though broadband capacity isn't a huge piece of the business now, "the importance will increase over time," says Morningstar stock analyst Mike Hodel.

HANDICAPPED. Qwest is not without some questions marks. It's still digesting last year's U S West acquisition, a process that could take several more quarters. So far, analysts give the company high marks for managing the deal well. But merger problems often don't come to light until late in the game. Furthermore, Qwest is not allowed to offer long-distance voice or data services in the 14 sates where it provides local service. That has handicapped efforts to bundle services to consumers and small businesses.

Qwest could get regulatory relief pronto. Despite resistance from small operators, long-distance deregulation is expected to pass Congress this year. Even without loosened regulatory requirements, Baby Bells have already started reentering the long-distance business on a state-by-state basis. Qwest is now in the process of filing for permission to sell long-distance. Munder's Harris expects the company will have approvals for more than 7 of its 14 states by early 2002.

And Qwest has an ace in the hole with helmsman Nacchio, a well regarded manager. "His motivational skills are pretty impressive," says Derek Scarth, assistant fund manager at Berger Mid-Cap Growth Fund. The former AT&T executive "is an important factor when you're looking at what they're able to do," says Scarth. While Qwest's is an ambitious plan in a fast-changing business, if analysts are right about the upcoming demand for its services, it should be well-positioned. That's why most analysts think its stock is probably worth the premium.

By Amy Tsao in New York

Edited by Alex Salkever

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