Vaunted Verizon Needs a Victory

Yes, Qwest looks weak, but its bitter rival has problems too as MCI approaches a verdict.
By Scott Moritz ,

Lest we forget, Qwest (Q) isn't the only telco that has a lot riding on this MCI (MCIP) business.

By now it's well established that Western weakling Qwest would face a grim future without MCI. The company continues to bleed red ink and is burdened with a heavy debt load. Indeed, no less an authority than Verizon chief Ivan Seidenberg has called Qwest a dead-end shop trying to lure MCI by writing a fantasy tale about winning synergies.

But for all its girth and comparative financial security,

Verizon

(VZ) - Get Report

is stuck in a precarious position of its own. It too operates a struggling local-phone business and holds a hefty chunk of debt. Meanwhile, costs keep soaring and the threat of cheap calling looms just over the horizon.

Taken together, Verizon's problems turn out to resemble -- perhaps in milder form -- Qwest's own.

"Verizon needs this as bad as anyone," says Telecom Pragmatics analyst Sam Greenholtz.

MCI could pick its merger partner as soon as Monday. A decision is looming after Qwest again raised its already superior offer and MCI's board got an additional 12 days' worth of deliberation in.

The rival bidders have squared off more than once, with Qwest boasting of the math behind its deal and Seidenberg pointing out that Qwest's revenue fell and its losses increased last year.

Last week, in a follow-up letter, Seidenberg scoffed at Qwest's first-year, postmerger cost-saving projection of $1.7 billion. "We have analyzed Qwest's synergy claims and believe the presentation might be more appropriately considered in the category of Modern Fiction," the literary-minded chief wrote.

But behind all that fiery letter writing is a big old telco with a host of problems strikingly similar to Qwest's.

While Verizon is, unlike Qwest, consistently profitable, it too faces some nasty trends. Last year, Verizon's core, local-phone-business revenue fell 4.8% from a year ago, while local phone lines in service shrank 4.6%. And even though Verizon managed to trim its whopping debt to $39.3 billion from $45.4 billion a year earlier, expenses continue to grow.

For example, over the past four years, Verizon's employee benefit costs have ballooned 50%, hitting $17.9 billion from $11.9 billion.

To be sure, the growth of Verizon Wireless, the joint venture with

Vodafone

(VOD) - Get Report

, has helped keep investors' attention from wandering to the negative stuff. And the company's bold promise to string optical fiber to homes and deliver the triple play of TV, phone and Internet seems to offer an attractive alternative to slowly shutting off the lights.

But don't think Verizon is sitting pretty. Last year, in a bid to rid itself of slow-growth operations, the company put some of its local-phone businesses up for sale. But the move failed when bidders failed to flock to the offering.

And Verizon may soon find that it could use a big pile of cash. One possibility is that wireless partner Vodafone could ask to be bought out of the Verizon Wireless venture. While Verizon has said it would love to own the entire business, it's not clear how the financing would work.

That's because Verizon is already treading on eggshells with credit agencies. Standard & Poor's and Moody's both put Verizon on watch for a downgrade last month, when the company made its bid for MCI. S&P had concerns about Verizon's already weakening core business and the ongoing cash requirements MCI would have.

Still, Verizon sees MCI as the single-best key to unlock the lucrative business services market and another way to offset its slumping consumer phone business.

"Verizon isn't about to let this go" and put together its own network, says analyst Greenholtz. "There's only so much money to go around. And with all their costs, Verizon is looking to make major cuts. I think they see a fully built MCI network as a way to get cost savings."

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