Optical/IP Networks

Qwest Sees Light at End of the Tunnel

Qwest Communications International Inc. (NYSE: Q) held the first of a planned series of weekly conference calls with Wall Street analysts today, apparently hoping to keep them up to date during these rocky times. And the news was mixed.

On a positive note, Joseph Nacchio, CEO and chairman of Qwest, said he expects first-quarter cash flow to be between negative $300 million and negative $400 million. On the face of it, that doesn't sound awfully positive, but previous expectations were for a negative $500 million. He expects cash flow to turn positive next quarter.

"Based on national indicators, it looks like the rest of the nation is stabilizing. We tend to lag the rest of the nation. Consumer confidence in our region is up -- I'm feeling somewhat good about that," Nacchio said on the call.

If Nacchio's right, the good news may have broader implications. “Potentially, this could be good news for the equipment guys,” says Rick Schafer, equities analyst with CIBC World Markets. “Getting back to free cash flow where they are generating revenue is definitely a step in the right direction. The faster [Qwest] can clean up their balance sheet and get healthy, the faster the equipment sector recovers.”

A major beneficiary of a Qwest uptick would be Ciena Corp. (Nasdaq: CIEN). Qwest has been one of Ciena’s largest customers over the past several quarters. And in recent months, the company has suffered tremendously as a result of Qwest’s cutbacks (see Qwest Takes Steps). Indeed, Ciena dropped its expectations twice in the past month in response to cuts from Qwest and other customers such as Sprint Corp. (NYSE: FON). (See Ciena: Outlook Dim and More Cuts at Ciena.)

But Schafer warns of a possibly dreary short-term scenario.

“If [Qwest's] debt gets downgraded in the next couple of weeks, that could potentially set off a new round of capital spending cuts,” he says. “And in the near term that would definitely be a bad thing for equipment providers.”

Qwest’s main problem is that it has way too much debt. Earlier this month, it pulled down $4 billion in bank loans, which the company will use to repay $3.2 billion in short-term, commercial-paper loans. The balance will be used for other cash needs.

The fear among investors is that Qwest's debt rating could be downgraded further, hampering its attempts to clean up its balance sheet and get back on track.

Currently, the company’s debt is rated as Triple B, which means that it still has two levels to fall before it becomes non-investment-grade. Compare this to other RBOCs such as SBC Communications Inc. (NYSE: SBC), whose debt is rated a Triple A, or Verizon Communications Inc. (NYSE: VZ), with a Single A rating.

Still, Qwest is much better off than such telecom companies as Williams Communications Group (NYSE: WCG) and Level 3 Communications Inc. (Nasdaq: LVLT), which have debt ratings in the C range (see Williams Winding Down? and Telecom: The Fear Factor).

Some analysts covering the company say they don’t expect a downgrade to occur. Tavis McCourt, senior telecom analyst with Morgan Keegan & Company Inc. says that as long as the company works toward shedding some of its debt by selling some of its assets it should be fine.

“They have control over their destiny,” he says. “They can cut back on capital spending and sell some of their businesses off. If they do get downgraded, it’s because management has taken the stance that it's better not to de-leverage their balance sheet to avoid a debt downgrade. Unless the economy gets much weaker, I don’t see them doing that.”

On the call this morning, CFO Robin Szeliga would not give details about the conversations she has had with the company’s lenders over the past week, but she tried to reassure those on the call that the company is doing everything it can to avoid defaulting on loans and avoiding debt downgrades.

“We are taking steps to make sure that we don’t bump against any of our convenants,” she said during the Q&A portion of the call. “We are working one-on-one with the banks, and we will work through the changes to our facility. I want to leave with the impression that we are working rigorously on all types of cash management that we had alluded to earlier.”

One of the cash management strategies Qwest alluded to is selling off pieces of its business. Nacchio said on the call that he had nothing new to report on that front, but analysts like McCourt speculate that the company could be thinking of selling its directory business, some rural access lines, or its wireless business. But McCourt believes the company will first sell off some of its securities.

Shares of Qwest closed down $0.16 (1.90%) to $8.22 today.

— Marguerite Reardon, Senior Editor, Light Reading

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