Qwest Bondholders Only the First to Feel Squeeze

Analysts expect the troubled telco to try to rework deals with other partners in a cost-saving effort.
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Qwest's

(Q)

debt swap is making bondholders squirm, but it appears only a matter of time till others feel the squeeze as well.

Moving down its list of capital priorities, Qwest may soon turn its hardball tactics on its business partners, observers say. With bondholders

outraged by the prospect of a $2.5 billion haircut, suppliers, phone company peers and landlords appear certain to take a hit.

A not-so-subtle pattern is emerging at Qwest, where the new management is attempting to steer the company out from under its crippling debts and toward a path of lower costs. Unable to re-energize sales in a down economy, and having already cut deeply into staff and network gear spending, the scandal-plagued Denver telco is now likely to go after some pricey contracts that are out of sync with today's less bubbly times. Qwest, which has some $4 billion worth of lease and purchase agreements, rose 28 cents in early trading Monday to $4.90.

"Expense reduction is just a code word for getting rid of some of these contracts like their minimum purchase agreements," says Moody's debt analyst Jim Veneau. "I'd say, based on the size of the remaining contracts, that cutting their obligations by $1 billion is reasonable."

Breaking the Locks

Like any business, Qwest has numerous contracts like real estate leases for equipment and office space, supplier agreements and purchase commitments with phone companies like the other regional Bells. Some of these purchase agreements, for example, represent attempts to lock in prices Qwest must pay other phone companies that carry its traffic.

Qwest's purchase obligations jump to $1.4 billion in 2003 from $1 billion this year, in part because those agreements were built on assumptions about robust demand for data communications and stable pricing. But as we've seen in the telecom recession, data traffic levels dashed expectations and prices fell through the floor.

While declining to offer specifics, a Qwest spokesman said: "We are looking at all our obligations and a way to reduce operating expenses, but we haven't broken out how much or where."

Given the collapse of the telecom market and the legal, regulatory and financial uncertainty Qwest has been party to, it is likely that some of the big telcos like

SBC

(SBC)

,

Verizon

(VZ) - Get Report

and

BellSouth

(BLS)

have been bracing for quake from Qwest's direction.

BellSouth said it could not comment on contracts it has with its customers. SBC and Verizon were unable to comment.

Recourse

"Bondholders and stockholders have all taken a haircut on the company," says Veneau. "Why should the counterparties to these contracts be any different?"

Speaking of stakeholders, bondholders were searching for some collective recourse to Qwest's bond swap offer late last week. But observers say their resistance may wane in the face of limited alternatives.

"The reality is that they know they have to end up doing it, but they want a higher price on the front end or equity incentives as well," says CreditSights analyst Glenn Reynolds. "They want to milk this cow, but not send it to the slaughterhouse."