Qwest: A New Stink Bomb

Did Phil Anschutz get a sweetheart deal called QDM?

Apr. 1 was filled with bad news for shareholders of Qwest Communications International Inc. (Q ) In a conference call to investors to explain financial documents it filed with the Securities & Exchange Commission that day, officials of the Denver telecom company disclosed it would take a $20 billion to $30 billion charge to write down the value of goodwill on its books. On top of that, Chief Executive Joseph P. Nacchio said the SEC, which already was investigating Qwest's accounting practices, had opened a second inquiry--this time to determine whether the company should have provided investors more financial details following its merger with US West Inc.

In all the commotion, it was easy to overlook one more bit of bad news: Nacchio said the company had closed Qwest Digital Media, a joint venture that specialized in converting video footage into computer files that could be transmitted over the Net. Qwest took charges of $33 million to write down the value of QDM in 2001 and shuttered the business in February, 2002. "Obviously, this market did not grow in the way we and many others thought it would," Nacchio said at the time.

To some Qwest shareholders, QDM represents more than just another bad investment. It raises questions about whether Qwest's founder and chairman, Philip F. Anschutz, has put his personal interests ahead of Qwest's. QDM was created in 1999 as a 50-50 joint venture between Qwest and Anschutz, who was acting on his own behalf. Qwest contributed $85 million to the venture, payable over nine years, while Anschutz chipped in TV production assets whose value was not disclosed in public documents. Then, in 2000, Anschutz received $48 million from Qwest for selling the company an additional 25% of the equity in QDM. Some shareholders are outraged that Qwest lost its entire investment, while paying Anschutz tens of millions of dollars that reduced his losses in the venture.

Experts say it's unusual, though not unheard of, for a top exec to do business with a company to which he has a fiduciary duty. The potential problem is that Anschutz' interests as Qwest's chairman may conflict with his interests as an individual investor. "This is corporate governance 101--you try to avoid conflicts," says Steven N. Kaplan, a professor at the University of Chicago's Graduate School of Business. "The concern is that the largest shareholder or chairman takes from the other shareholders."

A spokesman for Qwest denies there was any conflict of interest. He says Anschutz paid $85 million for the assets he contributed to QDM for his 50% stake, and Qwest bought the additional 25% stake from Anschutz because, in 2000, Qwest thought video over the Internet had a bright future. He added that in both cases Qwest's independent board members signed off on the transactions and an investment bank provided objective appraisals. A spokesman for Anschutz declined to comment.

The QDM venture is just one example of what appears to be a pattern of cozy financial dealings between Qwest and its chairman. According to the company's Apr. 8 proxy statement, Qwest paid $4.5 million to rent space in an Anschutz-owned skyscraper in downtown Denver last year. An additional $146,000 went to lease a suite in Anschutz' Staples Center arena in Los Angeles. Anschutz-related entities have collected $478,000 in insurance, legal, marketing, and other fees from Qwest in 2001. And in 1999, Qwest paid Anschutz $34 million for a telecom company called Precision Systems Inc., which was later sold at a loss. Qwest says the rental fees are at market rates, the $478,000 in fees just covered Anschutz' costs, and Anschutz sold Precision to Qwest for $22 million less than he paid for it.

These transactions, coupled with the company's plummeting stock price and Nacchio's escalating compensation, have shareholders hopping mad. The nation's largest pension fund, the California Public Employees' Retirement System (CalPERS), named Qwest to its annual list of companies that fail to meet its standards for good corporate governance. "These decisions demonstrate blatant disregard for shareholders," said CalPERS Chief Investment Officer Mark J. Anson. "We have lost complete confidence in Qwest's management and board." Adds Nelson B. Phelps, president of the 45,000-member Association of US West Retirees: "It just reeks of cronyism--`you take care of me, and I'll take care of you.' We've got to get people on the board who want to do the best thing for shareholders and not for themselves." Qwest's spokesman says the board is acting in the best interests of shareholders.

The outcry has focused attention on the relationship between Anschutz and Nacchio. Anschutz, a low-profile 62-year-old billionaire who made his fortune in railroads and oil before turning to telecom, hired Nacchio from AT&T to run the little-known Qwest in 1996. Over the next five years, the brash, Brooklyn-raised Nacchio built the company into a legitimate player in the telecom industry. But during the past year, Nacchio has lost credibility with some investors by overpromising on Qwest's financial performance and by the company's use of aggressive accounting practices that have sparked the SEC inquiries.

Still, Anschutz and the board have given no public indication that their support for Nacchio is waning. Nacchio received a four-year employment contract in October. It included a 25% hike in his base salary, to $1.5 million, a boost in his target bonus to 250% of his base salary, and options on 7.2 million shares that vest through 2005.

The QDM deal certainly wasn't that lucrative. The Qwest spokesman says the company invested $94 million in the company. Since Qwest expects to recover $11 million from selling off QDM's assets, Qwest figures its loss from the venture will total about $83 million. Qwest says Anschutz lost $48 million in QDM, although his losses were mitigated by Qwest's payment to him.

Qwest has much larger problems than the closing of QDM. This year, Qwest is expected to lose $379 million as revenues decline 9%, to $18 billion, according to Merrill Lynch & Co. Its stock is trading at $5 a share, near its all-time low. And with bankruptcies racking the telecom industry, some investors are concerned that Qwest may not be able to pay off its $25 billion in debt.

Perhaps, then, it's not surprising that Qwest decided to hold its annual meeting far from the spotlight. Rather than Denver, where the company is headquartered, Qwest is holding the June 4 event in Dublin, Ohio. The company says that's because a large number of its employees are based there. Shareholders are still expected to attend and complain about Qwest's performance and Nacchio's pay. Perhaps someone will ask for more explanation about QDM, too.

By Christopher Palmeri in Los Angeles

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