Qwest v. 2.0: Starting All Over Again With U S West

Maybe, just maybe, Joe Nacchio does know what he's doing after all.
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And now, Mr. Nacchio, to work.

With the

Qwest

(QWST)

-

U S West

(USW)

deal settling out Sunday afternoon pretty much on schedule, and pretty much per expectations, the big task now is for Qwest management to show the rest of us that we were wrong, that this deal really does offer rich opportunities for synergies. And I'm not talking about saving money by eliminating duplicate jobs.

Either Joe Nacchio shows he's an ops guy

par excellence

, and makes 2 + 2 equal about 7, or he turns out just to be another deal-maker.

As skeptical and pessimistic as I have been about this mess, I have over the last week or so forced myself onto the hopeful and maybe even positive side, and I can construct a thesis under which this marriage between Bill Nye and

The Beverly Hillbillies'

Ellie Mae starts to make business sense.

First, the gory details: The two companies joined as a merger of equals; Qwest will pay U S West shareholders $34.7 billion, or $69 a share, in QWST stock. The deal was structured as a tax-free event for USW shareholders.

Solomon Trujillo

, USW chairman, CEO and president, becomes one leg of a three-way Office of the Chairman at the combined company, which will be called Qwest; he will also become president of the new Qwest's Internet, local-service and wireless-service operations. Present Qwest CEO Nacchio will be part of that three-man Chairman's office, as will Qwest's current chairman and dominant shareholder

Philip Anschutz

, who emerges as the new overall but nonexecutive chairman of the combined companies. (Three chairmen? Yep, so they say. Can you say "unwieldy governance"?)

With about 64,000 employees -- for now -- the combined company forecasts revenue of $18.5 billion next year, with EBITDA of $7.4 billion. Nacchio forecasts savings from the combined operations (read: mainly, staff reductions) of about $12 billion over the next five and a half years. But remember that figures like that are always highly speculative. Remember, too, that USW's labor unions are highly restive about the deal, which, unsurprisingly, they think will lead to -- gasp! -- layoffs.

On the other side of the original offer, Qwest backed away from its offer for

Frontier

(FRO) - Get Report

.

Global Crossing

(GBLX)

will acquire Frontier, paying $10.7 billion, or $63 a share, in stock. GBLX agreed to cut the breakup fee USW had promised to pay to back out of its deal to be acquired by GBLX from $850 million to $280 million.

So what are my new-found positive thoughts? What are the new Qwest's real strengths?

  • A demonstration site. First and most importantly, Nacchio & Co. gain a high-profile in-house demonstration site to show where the gee-whizzy high-speed value-add services Qwest has been preaching about for so long can go in the near-term future. One example is movies-on-demand, which I discussed last week. As the smallest of the RBOCs, with 25 million customers scattered -- sometimes thinly -- over 14 Western states, U S West offers both a perfect test lab and also a nearly ideal live "demo suite" for Qwest to show off the value-add services it's been touting as the real advantage of its nationwide high-speed fiber network. Trujillo had been backing all sorts of on-demand-services tests, and to USW's credit, it has been better than most RBOCs about rolling out DSL service. USW's residential customers in many of its service areas can get 256-kilobits-per-second ADSL service for just $19.95 in a noncontinuous-connection option, $29.95 for continuous connections. And service up to the full 7-megabits-per-second capacity of ADSL is available, though at a heck of a price premium. So USW has at least been laying the groundwork for the wide-scale delivery of multimegabit deliveries of home entertainment. I think we'll see Qwest start filling that pipeline through deals with "content providers" -- in other words, movie studios. Qwest's new USW-installed-base test lab also has rich potential for demonstrating the value of high-speed commercial service. To take the health-care industry as a handy example, physicians all over the country are screaming for high-bandwidth connections for transferring the output of all their fancy new medical-imaging devices from one place to another. Most new health-care facilities get high-speed on-site fiber connections pulled through their walls ... but the speed stops right there. There is no high-speed link for them to the larger world, for those multisite, real-time-imaging consults they want so badly. The new Qwest could do a lot worse than to adopt the health-care industry as its poster child for the benefits of very high-speed connections. Especially in the mountain West, where facilities and experts are often far apart, and "collaborative medicine" becomes especially important, Qwest could develop an impressive portfolio of case studies on how what it provides can change U.S. medicine for the better.
  • A stabilized income stream. In the first quarter of 1999, USW had revenue of $3.18 billion and net income of $397 million. For the same period, QWST had $878 million in revenue, and net income of ... $4.8 million. 'Nuff said? While there are profound differences in the finances, bookkeeping and reporting of a hot growth company like Qwest and a heavily regulated public utility such as U S West, the fact remains that the merger now gives Qwest a large, steady earnings stream. After repeated trips to the debt and equity markets, Qwest will now own relatively stable revenue streams from U S West's basic and value-added communications services, in addition to its own income from selling and leasing capacity on its buried-fiber network.
  • The BellSouth connection. Remember that not long before Nacchio set out on his quest for U S West, he sold a tenth of Qwest to BellSouth (BLS) . With his own in-house RBOC, and another, highly visible RBOC present at his table as an equity partner, he and his execs are in a position to start pushing the value-added services he's so eager to demonstrate out into the wider marketplace, learning how to sell them to real customers.
  • The long-distance card. Qwest, already the nation's fourth-largest long-distance company, can be expected to move fast to expand its LD sales through the other RBOCs and CLECs.

In short, those who rode through this rough period for Qwest shares may well be rewarded over the next few months (or prove to have bought in at what they thought was an enticing bottom) as the market starts to respond to the synergies Nacchio and Trujillo will be claiming -- not without some basis in fact -- for the new Qwest. Climbing back from a 25-point plunge is going to take a lot of rallying, but the Qwest-U S West engine may have the pull needed.

Former U S West shareholders make out well, getting $69 a share for an issue selling at $53 in early May. My guess is that most will hold their new QWST shares, rather than bailing. Many of the 40% of U S West's 508 million shares held by individuals are owned by current and retired U S West employees, who won't be eager to cut the cord. That Qwest, based like U S West in Denver, is a hometown company, not an outlander, won't hurt.

We should acknowledge that there will be regulatory approvals, regulatory accommodations and regulatory delays galore in the days ahead. Indeed, Qwest execs said privately Sunday that they think this deal will take at least a year to zip up. The deal will be approved, but there will be some interesting times ahead for Qwest's lawyers.

One of the biggest hurdles, of course, is the ban in the

Federal Communications Act of 1996

against sale of long-distance services by the RBOCs. Qwest -- "old Qwest" -- is going to have to wait until that barrier falls (probably as a result of a court decision, not from legislative or administrative action) before it can offer its 25 million new ex-USW customers its LD service.

So ... the deed is done. A deal that Qwest probably should never have begun has played out the end game, with a one-time high-growth highflier now married to a plodding regulated utility. Perhaps "old Qwest's" shareholders will over time do as well as U S West holders have here.

The longtime rap on Qwest -- that it was really, in style and prospects, a hot Silicon Valley company that wound up somehow misplaced in Denver -- is dead.

Two final thoughts: First, despite the huge task ahead in melding the two corporate cultures, solving regulatory-review problems and cutting costs, Nacchio's not through acquiring. Look for another big offer, perhaps even more bodacious than this one, before the end of the year. Casting the next acquisition as a merger of equals -- just like this one; sure, Joe -- may make it seem less aggressive. But it's coming.

And second, if Nacchio pulls this off, what we're going to see over the next decade is a two-horse race in U.S. telecom, with

AT&T

(T) - Get Report

, which I am long, and Qwest battling it out for the leadership. Big T has pledged its troth to the notion of a fusion between traditional telephony and the national cable-TV infrastructure; Qwest has placed its bet on a more traditional telephone-industry-like future. And yes, I know the usual pairing in this coming battle for the hearts and minds (as well as other anatomical features...) of the domestic telecom market is T vs.

MCI WorldCom

(WCOM)

.

Don't count WCOM out by a long shot -- I'm long WCOM and expect to stay so -- but it's possible, just possible, that this U S West deal, followed by some sensational management and marketing, may leverage Qwest into that kind of two-horse race with T.

And if that happens, those, like me, who pooh-poohed this deal are gonna have a lot of egg on our faces. Because even the loser in a two-horse race for U.S. telecom leadership in the 21st century is going to become fabulously wealthy.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Seymour was long Qwest, MCI WorldCom and AT&T, although positions can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.