Confident Qwest Pooh-Poohs Pending Probe

Anyone who thought that news of a federal probe would cow the Qwest (Q) bulls has obviously never run with this herd.

At a Monday morning speech at New York's Merrill Lynch Global Communications Investor Conference, CEO Joe Nacchio insisted that the Securities and Exchange Commission's questions about Qwest's books are "nothing new" and that if it weren't for the media, regulators would never have bothered to seek the information.

The company also stuck to its guns in saying that it didn't believe that worries stemming from the SEC probe would keep it from closing the sale of $1.5 billion of bonds Tuesday. Meanwhile, the cash-short Denver telco said it would seek to renegotiate cash-flow covenants on its bank credit line, and that it wouldn't be forced into asset sales simply to keep its investment-grade bond rating. For the moment, Qwest investors were mostly buying Nacchio's stay-the-course message; the stock fell 4% Monday, dropping 38 cents, to $9.33.

Early Bird

Qwest disclosed in a 3:30 a.m. EST press release Monday that the SEC had informally asked for information on how Qwest accounted for a number of capacity-swap transactions over the last two years. TheStreet.com has explored Qwest's use of these deals, which telecom-industry critics contend boosted revenue and earnings without serving any legitimate business purpose. Qwest has said its accounting was proper and that it didn't enter any swaps solely for financial purposes.

Indeed, Nacchio saved his most ringing defenses yet of the company for his Monday morning comments, in which he claimed that Qwest was a victim of a creeping "Enronitis" that has opened a new era of "corporate McCarthyism." Of regulators who want to look at the company's books, Nacchio said, "If these things weren't in the press, they wouldn't have asked."

The SEC's questions center on sales of network capacity that aren't illegal but have drawn criticism from investors regarding accounting and disclosure. Typically, an IRU is a long-term lease of capacity. But instead of spreading the revenue from that lease over the length of the contract, many companies booked it all at once as a one-time sale. Likewise, companies that purchased capacity typically characterized the deal as an investment in property and assets, not as a traditional expense. So in these tit-for-tat deals, a company could use IRUs to enhance both the top line and the bottom line of their financial statement.

Nacchio did provide a few details Monday on the deals the SEC is looking at. The exec said the transactions being examined amount to about half of the IRU business Qwest has done. Those deals include six to eight swaps with Global Crossing that were valued at a total of $430 million. Regulators have previously said they would look into the swap deals at Global Crossing, a huge new network provider that collapsed in January amid talk of accounting improprieties.

Best in Church

But with Qwest running short of cash and considering asset sales to shore up its balance sheet, the question of whether regulators could force a financial restatement is key to Qwest's health. Qwest last month drew down a $4 billion bank credit line after it was essentially shut out of the commercial paper market, the short-term low-cost funding many big companies use for day-to-day cash. Furthermore, the company is talking with lenders about the covenants on its loans; Qwest would like to relax the covenants that specify how much cash flow it must bring in to carry a certain amount of debt.

"Liquidity is going to be an issue for Qwest for a long time," says a New York hedge fund manager with no position in the stock. Still, assuming the company can avoid a sharp deterioration, he says, "They can sell assets and lower their capex until their business can work itself out."

Nacchio contended Monday that Qwest's continued health isn't dependent on any immediate asset sales. Moody's downgraded Qwest's debt to a step above junk status last week as cash worries continued to mount at the company. Regarding the question of whether the company would proceed with a course that would lead to its debt being downgraded by the credit agencies, Nacchio said Monday, "I'd bring that up with the board."

Nacchio also said selling receivables could bring in $1 billion in six to eight weeks, a course Sprint(FON) recently said it would take in seeking to raise cash to fight off its own short-term cash woes.

Qwest investors chose to believe Nacchio's contention Monday that the company will indeed weather this storm. The reaction underscores the deep divisions among the various camps of Qwest watchers; market observers say there are small but vociferous camps of Qwest believers and opponents, and a larger but largely silent camp of investors who are watching the company with some interest from the sidelines.

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