An immediate cash crunch no longer threatens Qwest ( Q), but the telco's return to good health remains far from certain.

Analysts say that the two-part, $7 billion sale of the Qwest Dex directories business will provide a solid short-term fix. Proceeds from the deal will help the company pay down its debt and give it a boost at the bargaining table as it seeks to amend its $3.4 billion bank credit line. The passing of the immediate threat to the Denver telco sparked a Tuesday rally in the company's beaten-down shares and bonds.

But selling the highly profitable unit exacts a hefty price on Qwest, a longtime cash incinerator that only last quarter reached the black on a limited basis. Some observers wonder what Qwest might do to replace the high-margin revenue it received from Dex. Others, noting how long it took Qwest to strike a deal and the price it finally received, ask whether there are strings attached.

"They are not out of the woods, but at least they have located the tree line and a path," says CreditSights analyst Glenn Reynolds. Qwest jumped 55 cents to $2.79.

Directory Assistance

Fund-raising issues aside, Qwest's latest financial report shows a less-than-inspiring picture of a business still in decline. Local phone revenues fell 6% from year-ago levels as the economy stalls and customers spend less time on their home phones and more on wireless.

And while Qwest boasted of a heroic return to cash flow positive levels in the second quarter, the sale of the yellow pages unit practically ensures the red ink will return, say analysts. The directory business accounted for 8% of second-quarter revenue and was projected to bring in more than $1 billion in sales next year.

Analysts point out that Qwest is a financially weaker company without Dex.

Merrill Lynch analyst Adam Quinton wrote in a report Tuesday that the sale of the directories business will "lower Qwest's free cash flow" by approximately $500 million, putting the company back to negative free cash flow in 2003.

Qwest's stock and bonds had been rising in anticipation of the sale. The bonds, which had been trading in the 30-cent range in recent weeks, rose above 50 cents. But trading at 50 cents to 60 cents on the dollar, the bonds are still at distressed levels, says debt watchdog Reynolds.

Some analysts have cautioned that investors should remain skeptical as they ponder Qwest's prospects. Among the unanswered questions are the ongoing regulatory and criminal investigation into Qwest's accounting practices, its secret deals with rivals to quiet their opposition to long-distance approval and whether a number of network capacity swaps with other distressed telcos were legitimate or fraudulent.

Fingers Walking

Also at issue is whether Qwest will have to keep paying some states a cut of the yellow pages revenue it no longer receives. Qwest has long paid some states a percentage of the money the directory business brings in. Observers now say the company may be obliged to keep paying, even though it has otherwise washed its hands of the yellow pages racket.

Consumer advocates expect Qwest to seek rate hikes, since post-Dex, Qwest's income will be significantly lower. Regulators understandably aren't keen on seeing consumer phone service costs rise as troubled telcos dump assets. The guideline, says a Washington state regulatory agency spokesman, is that there be "no harm to customers" from this sale.

Any annual subsidies due a handful of states aren't likely to break the company. But the added payouts certainly don't stand to help a balance sheet already reeling from the loss of the Dex revenues.