The first step to rebuilding

Qwest

(Q)

will be to tally up the damage done. It now appears that doing so will be no mean feat.

Qwest shares dropped 9% Monday as the Denver telco detailed a massive restatement of earnings reaching back several years. Signaling its willingness to work with regulators and shed the stigma of classic Qwest's widely cited arrogance, the company turned the spotlight on itself.

Getting big play were some bookkeeping practices analysts had long questioned, regarding so-called capacity swaps, as well as some areas that hadn't been seen as problematic, regarding its directory business.

But CEO Richard Notebaert didn't indulge listeners' desire for juicy details Monday following Sunday's throw-out-the-record-books press release. In fact, instead of receiving the usual assurances, analysts and investors came away with a rather grim view of a company limping toward bankruptcy protection.

Considering Qwest's massive debt load and eroding business, it now seems likely that the company will become the first Baby Bell to seek Chapter 11 protection, analysts say -- a development that only a year ago would have been shocking but now, in the wake of

WorldCom's

collapse, appears simply a matter of time.

Qwest stock, off more than 90% from last summer's 52-week high, dropped 13 cents to $1.37.

WorldCom Redux?

Observers say Notebaert is working to identify the misdeeds of his predecessor Joe Nacchio so he can reboot the company. But the industry's fundamentals have gone into such free fall that even Baby Bells free of the classic Qwest's cash-burning network operations have come under sharp pressure in recent weeks. As a result, the executive may have to find that fresh start somewhere in Chapter 11 restructuring.

"It certainly wouldn't be a bad thing for Qwest's new management," says PaineWebber analyst John Hodulik, who has a hold rating on the stock. "It would give them a chance to wipe the slate clean."

The evidence is piling up. Restatements, a missed financial filing deadline, questions about misbooked costs and a possible snag in its sale of the QwestDex directory business have investors and observers seeing the WorldCom collapse all over again.

Citing bookkeeping mistakes, including booking as revenue hundreds of millions of dollars worth of potentially worthless swaps of optical capacity, Qwest says it is likely to restate $1.16 billion in sales recorded over the past three years. Notebaert said that figure was a preliminary total and that it "will take months, rather than days," to complete the restatement process.

Covenants

Thanks to the aggressive dealmaking by Nacchio, it may prove impossible to untangle Qwest from its web of questionable transactions without triggering a negative reaction from the company's creditors and suppliers, say analysts.

Chief among the concerns is the probable violation of the company's loan covenants. Qwest must maintain a minimum cash flow to debt ratio to stay in compliance with its loan agreements. Analysts have noted that if Qwest had to subtract as much as $800 million from its earnings before interest, taxes, depreciation and amortization or EBITDA levels last year, it probably will have to admit it was in violation of its debt guidelines.

"If they are in violation of their covenants, the creditors could accelerate payments and force them into bankruptcy," says Hodulik.

Qwest may not find much sympathy with its creditors. In February, finding that it was shut out of the commercial paper market, Qwest suddenly drew down its entire $4 billion credit line, putting its bankers on the hook for a company that has increasingly proven to be far more of a credit risk than lenders may have bargained for.

Midnight Runners

To further complicate the company's cash supply, Qwest also said Monday that it's reviewing some of its QwestDex directory revenue. Though the executives downplayed the move as merely an issue of timing rather than quality of those sales, analysts say the review could ultimately cause delays in the sale of the directory business. Qwest put the yellow pages units on the block to raise cash and pay down debts in order to avoid the covenant violation by year-end.

Notably, Sunday's press release was the first official acknowledgement by Qwest that perhaps some of the controversial network capacity swaps the company threw together with outfits like

Global Crossing

and

Enron

may not have had any actual value.

Tit-for-tat swaps like the

11th-hour deal between Qwest and Enron last fall have caught the attention of

Securities and Exchange Commission

investigators. These deals went well beyond the line of credibility, say industry observers.

"The cinders are still burning," says Friedman Billings Ramsey analyst Susan Kalla. "Notebaert should have at least waited until the fire was out before he took on the job."