Credit analyst: Qwest balance sheet enhancement plan looks iffy

By Ronda Fears

Nashville, Tenn., Feb 6 - Qwest Communications' balance sheet strengthening plan via some $1.25 billion of new convertibles looks questionable as to whether it will improve the company's debt protection measures, said Carol Levenson, director of research at Gimme Credit, in a report Wednesday. Thus, Levenson recommended avoiding the name.

"Last week, Qwest again reduced its projections for sales and EBITDA for this year, a projection that had been lowered less than two months earlier. The company announced (Tuesday) its intention to issue as much as $1.25 billion in equity or equity-linked convertibles, thus joining the balance sheet enhancement brigade," Levenson said.

The current 2002 EBITDA projection represents a drop of only 4% from 2001, while EBITDA in the fourth quarter fell by nearly 20%. If 2002 EBITDA drops by 10%, Qwest's debt protection measures don't improve one whit, despite a $2 billion reduction in debt. If it falls by 20%, we estimate the company could violate the only financial covenant in its debt agreements. The whole plan looks pretty iffy to us, and we would not buy."

Levenson noted that recently Moody's placed the company's long-term ratings under review for a downgrade, and S&P changed its outlook on the company to negative. The analyst also noted that Qwest faces $1.2 billion in maturities this year and has $3.3 billion in outstanding commercial paper, which management says it's having no trouble rolling over. The company's $4 billion backup bank line matures in May, but can be extended for a year.

She also noted that Qwest shares are 20% lower than December levels.

"Apparently the equity markets believe strengthening Qwest's balance sheet is more important than any potential dilution, since the stock was up slightly on the day," Levenson said in the report.

"Not that this move alone will make a tremendous impact on Qwest's credit measures, but it should demonstrate capital market access, which these days is an impressive feat."

Some sensitivity analysis on Qwest's debt protection measures shows how important its EBITDA projections - notoriously flawed - have become, the analyst said. Assuming Qwest reduces debt by the high end of its target range, or $2 billion, by an equity-like issue, that proceeds from any asset sales wouldn't diminish cash flow, that free cash flow positivism occurs on schedule in the second quarter and that management's EBITDA projections come true, Levenson said Qwest's debt/EBITDA would fall to a more reasonable 3.25 times with EBITDA coverage recovering to nearly 5 times.

"Even if these positive trends were sustained and nothing untoward occurred with KPNQwest obligations," Levenson said, "Qwest would still look considerably weaker than it did in 2000."

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