NERVOUS CAPITAL MARKET DRIVES AWAY INVESTORS

Feb 18, 2002 12:00 PM, Toby Weber

Fears of aggressive accounting force Qwest to draw on bank facility

Qwest Communication's decision last week to fully draw down its $4 billion bank facility to pay off all its commercial paper may be telecom's first tangible fallout from the accounting jitters plaguing Wall Street.

Last week's news is emblematic of the communications sector. Now fears of aggressive accounting are driving valuations to all-time lows and affecting telecom companies' ability to raise capital (see table).

Some analysts say investors could abandon the sector completely. "They've taken losses in so many telecom stocks," said Patrick Comack, telecom analyst for Guzman & Co. "They've taken enough pain, and they don't want to risk any more."

Fitch Ratings, which lowered Qwest's senior unsecured rating one notch to two levels above junk status, said the carrier has had difficulty rolling over commercial paper at maturities beyond seven days, causing these balances to increase. But Qwest said its plummeting stock price--dipping below $7 per share late last week--was caused by irrational fear in the markets.

"What's going on today is a series of rumors, innuendos and old news," Qwest Chairman and CEO Joe Nacchio told analysts. "It's a nervous capital market."

Indeed, some analysts and service providers say many of the accounting stories are minor when viewed simply as accounting irregularities. The real problem with such reports is that they create a climate of doubt about the sector.

"It's headline news--who can break what," said John Diercksen, senior vice president of investor relations for Verizon Communications, which has not had its accounting questioned. "With the size of some of these companies, [these reports] are not meaningful unless you get significant issues like Enron has."

But investors trade on perception, not on dispassionate fact.

Qwest's situation provides a perfect example. Investor confidence waned on fears of aggressive accounting. These fears contributed to Qwest losing access to commercial paper. The carrier, in turn, used bank debtloans with a higher interest ratemaking it more difficult for the company to meet its earnings targets for the quarter.

More revelations about questionable transactions from previous quarters likely will be revealed in the near term, said Michael Bowen, principal for SoundView Technology Group. If this proves to be true, more telecom companies could be forced to draw on funding other than commercial.

Companies can muffle reaction to questionable deals by presenting it to investors before the media does, Bowen said. The perceived lack of disclosure by Qwest about selling equipment to KMC Telecom and then purchasing services from the company is what raised the ire of investors and analysts alike, more so than the actual accounting ramifications of the deal.

Given that Qwest's accounting has been criticized in past months, Bowen said he is surprised by the latest news. "I'm in a little bit of disbelief that Qwest didn't realize they had this KMC Telecom issue out there and that somebody was going to find out," he said. "Fortunately, most management teams and auditors now fully understand the gravity of less-than-arms-length transactions, so I would be surprised to see a spate of these deals going forward."

With additional reporting by Glenn Bischoff in Chicago.