Qwest Analysis – 11/5/05
Summary
The 5 year CDS for the convertible issue was quoted at 325/350. I believe that the spread could tighten by 50bps to 275/300 within the next 12 months. Qwest generates strong and steady cash flows of about $1.1B per year and management is committed to continue to reduce debt and return the operating company to investment grade. Maturities of debt in the next 5 years are manageable at $5.5B.
Business
Qwest Communications consists of a regulated local telephone business (US West) and unregulated wireless and long distance businesses (Classic Qwest). The local business operates in the 14 state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming.
The local business generated 75% of the company’s revenues and over 100% of the cash flow. The unregulated businesses derive 25% of total revenues and consumes about $300M of cash per year although it is expected to be breakeven in 2006.
Positives
- The local business is a solid and steady cash flow generator.
- Qwest has been conservative with its local fiber network build-out and using excess cash to reduce debt.
- The local business operates in mostly rural areas of the US that face less competition from CLECs and Cable companies.
- Qwest finally settled its shareholders lawsuits. The settlement gave Qwest visibility of its cash needs and thus allowed Qwest to reduce its cash balance from $2.8B to $800M to repay debt.
Negatives
- The unregulated businesses continue to be a drag on cash flow.
- The local business continues to lose access lines to wireless and cable.
- Qwest may need to accelerate its capex spending for new technologies including a local fiber network build-out.
- Unlike other RBOCs, the company does not have its own wireless assets (hurts growth) or directory business (hurts cash flow)
Capital Structure
There are four entities in the Qwest Capital Structure.
1) Qwest Regulated Operating Company (Old US West) – OpCo
2) Qwest Holding Company – HoldCo
3) Qwest Financing Company – FinCo
OpCo (QUS) debt ($7.8B) has the best credit because it is closest to the operating assets. Holdco is next with has two classes of debt: $2.6B that is secured by OpCo and $1.2B that is unsecured (includes converts). FinCo debt totals $3.7 and is pari passu with the Holdco unsecured notes.
CDS levels 11/04/05
Debt/EDITDA | rating | 3 yr | 5 yr | 7 yr | 10 yr | |
OpCo (QUS Corp) | 1.6x | Ba2/BB | 80/110 | 150/170 | 163/193 | 170/200 |
HoldCo – Guarantee (QCII) | 2.6x | B1/BB- | 197/227 | 250/275 | 257/287 | 265/300 |
HoldCo (QCIIcb) | 4.3x | B3/B | 300/325 | 325/350 | 345/370 | 370/396 |
FinCo (QUScfg) | 4.3x | B3/B | 328/348 | 344/369 | 356/381 | |
Maturity Schedule
HoldCo(NG) | ||||
Total | OpCo | HoldCo(G) | FinCo | |
2005 |
21 |
21 |
– |
– |
2006 |
486 |
– |
– |
486 |
2007 |
1,037 |
660 |
– |
377 |
2008 |
583 |
320 |
69 |
193 |
2009 |
1,312 |
– |
750 |
562 |
2010 |
2,053 |
500 |
– |
1,553 |
After 2010 |
10,247 | 6,307 | 1,825 | 2,115 |
Total | 15,737 | 7,808 | 2,644 | 5,285 |
Cash and Cash flow
Cash = $850M
FCF4Q2005E = $125M
FCF2006E = $1,300M
FCF2007E = $1,100M
FCF2008E = $1,100M
Debt = $15,737M
Equity = $8,300M
Debt details
Qwest Operating Company | ||
coupon | maturity | amount |
6.13% |
11/15/2005 |
21 |
6.25% |
1/1/2007 |
90 |
L+475 |
6/30/2007 |
500 |
6% |
8/1/2007 |
70 |
5.63% |
11/15/2008 |
320 |
6.95% |
6/30/2010 |
500 |
7.88% |
9/1/2011 |
825 |
8.88% |
3/15/2012 |
1,500 |
L+325 |
6/15/2013 |
750 |
7.63% |
6/15/2015 |
400 |
7.50% |
6/15/2023 |
484 |
7.25% |
9/15/2025 |
250 |
7.20% |
11/10/2026 |
250 |
7.38% |
5/1/2030 |
55 |
7.75% |
5/1/2030 |
43 |
8.88% |
6/1/2031 |
250 |
6.88% |
9/15/2033 |
1,000 |
7.25% |
10/15/2035 |
250 |
7.13% |
11/15/2043 |
250 |
Qwest Holding Company (Guaranteed by Operating Company) | ||
coupon | maturity | amount |
7.25% |
11/1/2008 |
8 |
7.50% |
11/1/2008 |
62 |
L+350 |
2/15/2009 |
750 |
7.25% |
2/15/2011 |
525 |
7.50% |
2/15/2014 |
1,300 |
Qwest Holding Company & Qwest Finance Company | ||
coupon | maturity | amount |
7.75% |
8/15/2006 |
486 |
7.25% |
6/15/2007 |
314 |
9.47% |
10/15/2007 |
11 |
13% |
12/15/2007 |
52 |
8.29% |
2/1/2008 |
22 |
6.38% |
7/15/2008 |
171 |
7% |
8/3/2009 |
562 |
7.90% |
8/15/2010 |
403 |
3.25% |
11/15/2010 |
1,150 |
7.25% |
2/15/2011 |
801 |
14% |
12/15/2014 |
177 |
6.50% |
11/15/2018 |
187 |
7.63% |
8/3/2021 |
111 |
6.88% |
7/15/2028 |
541 |
7.75% |
2/15/2031 |
299 |
More thoughts on Qwest – 11/29/05
I continue to like Qwest credit for the convertible bonds (5 yr). Earlier, I looked at Qwest’s cash generation and determined that it was strong enough for the company to continue to de-lever and retire maturing debt. Here, I look at the asset value of Qwest based on the value of access lines and concluded that access line valuation provides strong debt coverage.
Qwest has two businesses: 1) Local telephone access lines (Old US West) and 2) Long distance assets (Classic Qwest).
The local telephone business has 15,000 access lines in the Pacific Northwest and Rockies section of the U.S. consisting of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming.
Over the last few years, access lines have been mostly sold by RBOCs and bought by independents and private equity groups. Last week, Alltel said that there were 3 bidders (Citizens, CenturyTel, Valor) that would pay up to $3,425 per line ($10B total). Other deals valued access lines at between $2,334 and $3,500 per line.
The value of access lines depend on many factors including location, customer base, technology (DSL ready or not), physical condition. By all accounts, Alltel lines are at the top of the list since they serve non-competitive regions, are in top condition, and have good technology. The lowest valued deal in recent years was Carlyle Group’s acquisition of Verizon’s Hawaii operations of 790k lines for $1.65B ($2,334 per line) mainly because those lines were geographically isolated and were not in good condition.
Given Qwest’s total debt of $17B and 15,000 access lines, even a very conservative $2,000 per line estimate ($30B) would cover its entire debt. The risk is that access lines are declining at between 5%-10% per year due to cable telephony and wireless substitution. The goal for management is to offer enough new services such as DSL or Video to offset lost revenues.
The market value for Qwest access lines are probably in the $2,700-$2,800 range. In general, Qwest has the benefit of operating in many rural areas that have limited competition from cable and CLECs. However, Qwest has not invested enough to deliver DSL to its customers. Its penetration of 9% is the lowest among the RBOCs.
Given this valuation cushion, the 5 year credit for Qwest is very safe. It is the longer term debt (20-30 years) that carry the most risk.
The equity is assigning a negative value to Classic Qwest. At $5.20, Qwest has an Enterprise value (Equity + debt – cash) of $24B. At $2,000 per line, the market is assigning -$6B to Classic Qwest. While this was justifiable when Classic Qwest was losing billions per year, the cash drain is down to $150M per year. THis implies there is upside to the equity to $6.80 should Classic Qwest be valued at zero.
Additionally, Classic Qwest should see experience a better pricing environment in 2006 following SBC acquisition of AT&T and Verizon’s purchase of MCI. All indications are that SBC and VZ will manage the business for profits rather than market share, which should put a pricing umbrella over other players such as Qwest, Sprint, Level 3, and others.