On a Qwest for Growth

11/12/2008 11:24 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

George Putnam, editor of The Turnaround Letter, says a regional telephone company has strong cash flow and good growth prospects.

Qwest Communications International’s  (NYSE:Q) initial business was laying fiber-optic cable along railroad rights of way. Following its initial public offering (IPO) in 1995, Qwest expanded via acquisitions and partnerships, and participated in the telecommunications bubble of the late 1990s.

Unlike many high-flying telecoms of that era, however, Qwest realized that you needed customers. So, in 2000, it went out and acquired US West, a Regional Bell Operating Company with millions of local phone customers spread over 14 Western states.

The US West acquisition gave Qwest the revenue base to survive the bursting of the telecom bubble. Although the company survived, shareholders have had a rocky ride during the current decade. The stock peaked around $60 in 2000, dropped to just above $1 in 2002, rebounded to $10 in 2007, and then declined to its present level [of $3.]

Recently investors have been focusing on Qwest’s shortcomings and, to be sure, it has plenty. But it also has very valuable assets and strong cash flow.

One of Qwest’s greatest assets and biggest challenges is its huge traditional landline telephone business. The landline business is in a slow but steady decline as customers move to wireless or Internet telephony. But each landline customer also represents the opportunity to sell new or expanded services, including data, video, and wireless. The company is showing good growth in broadband and video customers. 

In the meantime, the company is cutting costs to boost the bottom line. Over the past five years, management reduced expenses by $2.5 billion. So far in 2008, Qwest has eliminated 2,300 jobs (6.4% of its workforce), and it just announced plans for another 1,200 job cuts.

Cash flow remains very strong. After using the cash inflows to cut debt by nearly one-third since 2001, the company has begun returning cash to shareholders—about $1 billion over the first nine months of 2008—in dividends and share buybacks.

As the stock price has declined, the dividend yield has risen to a very generous 12%. While dividends are never guaranteed, management appears committed to maintaining the high payout. The company also has plans to buy back another $200 million of its stock.

We believe that Qwest will reward shareholders by growing revenues and profits on its own. But it is also a very attractive acquisition candidate. It would fit well with either of the other two, much larger, remaining former Baby Bells, AT&T (NYSE: T) or Verizon (NYSE: VZ). Or it would provide a good beach-head for a foreign telecom company that wanted to expand into the US market.

At about six times this year’s expected earnings and four times cash flow (measured by earnings before interest, taxes, depreciation, and amortization, or EBITDA), Qwest looks very cheap. We recommend buying Qwest up to $4.

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