If you think about it, it's really two absurd suggestions. First, to even consider buying the stock of a telecommunications service provider. Second, to then consider buying the stock of Qwest Communications, one of the arch practitioners of Internet era flimflammery. Most Wall Street analysts have either a "sell" or a "hold" (also known as the weak-kneed "sell") on the stock. But a few brave souls actually suggest buying it. Really.
Before I get into the details, I should remind you of some of the fun we've had here at Red Herring with Qwest. Contributing editor Christopher Byron beat the stuffing out of the firm for its accounting sleights-of-hand not once, but twice--before everyone else caught on to the company's revenue shell game. Aside from being very entertaining storytelling, Byron's columns exposed an ingrained system of deception that made it difficult to consider ever buying the stock again.
Well, you should never say never. Look what Dubya just did in the mid-term elections, for God's sake. A small group of analysts has been encouraging their clients to buy the stock--and last Thursday, Vik Grover of Kaufman Brothers actually boosted his target price from $5 to $8. The stock had closed at $4.09 on Wednesday evening. Imagine that--Qwest as a double-bagger.
His arguments are straightforward. On the public relations front, Qwest has hired new management and is working on a settlement with regulators. Qwest has also taken $35 billion in impairment charges for goodwill and asset write-downs, cleaning up the balance sheet.
On the operations front, the company has refiled long-distance applications in nine states; Mr. Grover expects a response from the FCC by year-end, maybe even in November. He considers the company's RBOC, US West, the most defensible out there, and the best place to "hide" in the face of the wireless threat, continuing encroachment by CLECs, and the whole unbundled network element platform (UNE-P) services resale controversy.
His valuation methodology? Mr. Grover applies a 6.0 multiple to the company's 2004 estimated EBITDA of $5.5 billion. That gives an enterprise value of $33 billion. Backing out net debt of $20 billion (after the $7.1 billion sale of the QwestDex telephone directory business), you've got public equity value of $13 billion, or $8 per share. Like I said, that's a double from current levels. Stranger things have happened.
The only hitch there, and Mr. Grover readily acknowledges the issue, is that a 6.0 multiple is a premium to the competition, the majority of which lack any taint of scandal and also still own stable, cash-generating directories businesses. That list includes BellSouth, SBC Communications, Sprint, and Verizon. While the sale of QwestDex for $7.1 billion will provide much-needed cash in the short term, it will remove that business's attractive cash flows going forward.
As CIBC World Markets analyst Timothy Horan puts it, "Qwest appears fully valued with no dividends and little free cash flow, and ongoing accounting uncertainty. Qwest also trades at a premium to the RBOCs on an EBITDA and access line basis, despite sharply lower free cash flow and lack of a highly profitable, stable directories business." Clearly, there's room for more than one opinion on this one.
Mr. Grover is not deterred. Citing what he considers superior growth prospects for Qwest over the competition--including using the company's more modern broadband network to compete for enterprise customers--he thinks the stock merits his projected valuation.
Whether he's right or wrong, time will tell. Still, one of the best ways to profit in the stock market is to spy opportunities that others have failed to see, or to which they have turned a blind eye. For its flagrant misbehavior, Qwest deserves the shunning it has received in the market. But maybe its time standing in the corner is coming to an end.