Qwest: Off The Critical List, But...

Cash on hand doesn't help a declining core business and big accounting probes

Just a year ago, Qwest Communications (Q ) International Inc., the Denver-based local phone company, seemed like the epitome of everything that's wrong with telecom. The company, which serves some 25 million customers, most of them in 14 Western states, was reeling under the weight of $25 billion in debt. Federal investigators were looking into its accounting practices, and a fiber network was losing hundreds of millions of dollars. So the company brought in a telecom veteran, Richard C. Notebaert, former chairman of Ameritech Corp. He took over as Qwest's chairman and chief executive in June, 2002.

While Notebaert has Qwest off the critical list, the patient still faces a long and difficult recovery. Notebaert has cut the company's net debt to $16 billion by selling Qwest's Yellow Pages business and buying back bonds at a discount. And on Oct. 16, after more than a year of reviewing its accounting practices, Qwest filed its first audited financial statements since the review began. But Qwest's $16 billion fiber-optic network, built to serve large corporations, is still bleeding red ink. Worse, its core local phone business is crumbling amid intense competition from rivals like AT&T (T ).


To get the company growing again, Notebaert is forging ahead on two fronts. On the business side, he's moving away from targeting large corporations to focus instead on midsize companies where Qwest's telecom knowledge is of greater value. On the consumer side, he has made a flurry of moves that will improve Qwest's ability to offer a complete bundle of services, a marketing strategy where the company has fallen behind. Since Qwest lacked a nationwide wireless presence, Notebaert has partnered with Sprint Corp. (FON ) to resell that company's wireless service. He also signed agreements to market satellite-TV service from DirecTV (GMH ) and EchoStar Communications Corp. (DISH ) and he's spending more than $100 million to improve the company's consumer high-speed Internet access, which should help retain customers. "A year ago, they said we'd be bankrupt. They said we wouldn't survive, that we wouldn't be here. [But] we've done everything we said we would," Notebaert says.

The odds of a full recovery, however, do not look good. Analyst Patrick Brogan of independent investment adviser Precursor Group Inc. in Washington, D.C., calls Notebaert's new wireless and Internet services "Band-Aids with low to no margins." Losses of local lines, he says, will be problematic because rivals are picking away at its most profitable customers in urban markets like Seattle and Phoenix, leaving the company with an even larger percentage of higher-cost rural customers. "There's really no good way out," says Mark Herskovitz, a senior sector manager for telecom at Dreyfus Corp. (DNM ), who got out of Qwest two years ago at prices six times higher than today's $3.50 a share. Qwest stock is down 14% since Notebaert arrived on June 16, 2002, compared with a 5% decline for the Standard & Poor's Telecom Services Index.


Qwest's financial prospects are among the worst in telecom. Solvency is no longer an issue -- the company has $6 billion in cash. But at a time when other big U.S. telecom companies are profitable, Qwest is expected to lose $470 million from continuing operations, on revenues of $14.3 billion this year, according to UBS Securities (UBS ). Losses are expected to continue next year because of weakness in the residential business. It lost 4.9% of its customers during the 12 months ended June 30, the worst performance among its peers.

Notebaert isn't giving up. While he expects the number of phone lines to decline again in 2004, he says that will level off in 2005. That stability and new lines of business are the key to renewed growth. "Yes, we will grow again. I can't say how much -- single digits, maybe. But we'll be a growth company," Notebaert says.

The targeting of midsize business customers may bear fruit. Notebaert is pursuing customers like Porsche Cars North America Inc., which switched its data business to Qwest last February. "Qwest was the low bidder but also the most committed," says Philip Davis, Porsche's chief information officer.

Notebaert is focusing just as hard on cost cuts. In the ailing fiber unit, Notebaert reduced the number of Web-site hosting centers from 14 to 7 and folded the entire unit into local business services, improving efficiency. He also has cut 3,500 jobs and persuaded 27,000 union employees to trade 3% to 4% wage increases for performance-based bonuses.

Notebaert, a master salesman, gets credit for winning favor among customers and employees. He'll need every bit of their support to get Qwest in gear again.

By Christopher Palmeri in Denver

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