Analysts: Upside in Qwest credit a chance to exit, convertible holders should stay cautious

By Ronda Fears

Nashville, Tenn., Sept. 5 - Qwest's amended bank facility should give its bonds a lift, which some analysts say is a chance for holders to take the money and run. Convertible holders are urged to continue to be cautious.

Qwest's bank lenders have agreed to extend its $3.4 billion credit facility by two years to May 2005 and ease debt covenants. Previously, Qwest (B2/B-) was expected to trip a debt/EBITDA covenant by the end of the third quarter, but the new amendment raises that covenant to 6 times.

Also, in a two-part deal, Qwest sold its QwestDex yellow pages business for $7 billion. Only $2.75 billion is expected to close near term, subject to approval from and payment to the states involved. The same thing is required of the remaining properties, which are expected to close next year.

"This is good news for Qwest, but we do not believe investors should come away with confidence that this gets the company completely out of the woods yet," according to a report Thursday by convertible analysts Jeanine Oburchay and Brian Park at Wachovia Securities.

"Any delays on these transactions could, in our opinion, squeeze Qwest again, but for now, the company has bought time. Look for the equity and the credits to trade up here, but convert investors should continue to be cautious."

Unsecured bondholders should have mixed feelings about the news, said Carol Levenson, director of research at Gimme Credit.

The QwestDex sale, if it goes through, will remove a relatively stable business line and bring in less cash than originally anticipated, she said.

As for the new loan terms, she added, if bondholders were ever in doubt about their place in the food chain, it's now abundantly clear they stand well behind Qwest's bank lenders.

"Two pieces of what could be construed as good news in the space of a month should provide non-gambling bondholders the opportunity to exit this name in a less painful manner," Levenson said.

Currently, the entire $3.4 billion is drawn off Qwest's credit facility and the company ended the June quarter with just under $700 million in cash. Qwest is required to use proceeds from the first tranche of the sale of QwestDex to pay down the credit facility to $2.0 billion.

"Because we have yet to see what any restatements or new guidance for the company look like, there is still some question about the company's funding position," Wachovia analysts Oburchay and Park said.

The analysts noted that QwestDex obtained a $750 million term loan due in 2004, secured by a lien on QwestDex stock and certain assets of Dex. Qwest must pay down the term loan with the proceeds of the second tranche of the QwestDex sale.

"It could be argued that there's sufficient value in Qwest to cover much more than $4.25 billion in secured bank loans, so bondholders haven't been harmed all that much by this maneuver," Levenson said.

"However, the additional requirement that banks be paid off first with the QwestDex proceeds explains why the banks were willing to be lenient on covenants and maturity - they won't be on the hook for much.

"This leaves bondholders shouldering virtually all the remaining risk of a company with questionable accounting, SEC and criminal investigations, a dismal business outlook and not much more in the way of saleable assets."

Under the new bank facility amendments, allowable leverage has been increased to 6x debt/EBITDA from over 4x, but even that may prove to be a challenge to meet.

Even assuming the best case for debt reduction where free cash flow continues to be positive and all of the QwestDex sale price is realized in net proceeds and used to pay down debt, Levenson said annual EBITDA excluding QwestDex could fall some 30% below current guidance with a corresponding EBITDA coverage of interest at a meager 2x.

"Remember, the bankers will get their money first, so they shouldn't care all that much about Qwest's ongoing debt protection measures and thus could afford to set the EBITDA bar fairly low," Levenson said.

"Amazingly, they also don't seem to care about Qwest's inability to produce audited financials, or potential significant restatements, shareholder suits and impending goodwill and asset impairment charges. But bondholders should care about these things."

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