Qwest comes out fighting

A report by Morgan Stanley criticizing Qwest Communications’ accounting practices surrounding the U S West merger was largely rebuffed by the company and other equity analysts.

The report addresses four areas in which the research analysts believe Qwest’s accounting was faulty: purchase price allocation related to the Qwest-U S West merger; the valuation of Qwest’s stake in KPNQwest; changes in pension assumptions; and incremental software capitalization. Qwest said that it has already responded to inquiries from the Securities and Exchange Commission regarding some of the issues raised and has cleared them to the satisfaction of SEC staff.

For example, according to Morgan Stanley, Qwest’s writedown of $3.1 billion of net assets related to the U S West merger was “unusual” given the apparent lack of disclosure of details concerning the potential impact on reported results. Qwest maintains, however, that the disclosure was made in accordance with Generally Accepted Accounting Principles (GAAP) and will be further detailed in second quarter results.

According to Blake Bath, analyst at Lehman Brothers, the “crux” of the report’s argument is that at the close of the merger, Qwest management should have known what the impairment to Qwest’s asset base was, and adjusted the purchase price allocation at that point. However, under U.S. GAAP the company has 12 months from the merger close to finalize the amount. “The central argument that the report is making is really an academic one…and, according to fundamental valuation parameters, does not impact key value drivers such as cashflow in any way,” Bath said.

According to a report by Dan Reingold, analyst at Credit Suisse First Boston, “Most of these issues only impact [earnings per share], not EBITDA…and are therefore largely irrelevant in valuing Qwest, which has always been a revenue- and EBITDA-driven company.”

Qwest Chief Financial Officer Robin Szeliga responded to the report in detail in a conference call, saying that Morgan Stanley’s accounting analysis was incorrect and nothing said in the report would have any affect on Qwest’s future financial performance. “Nothing they say, except by unsupportable innuendo, casts any doubt on any of our accounting practices,” Szeliga added.

In addition to rebutting the report, Qwest reconfirmed its financial guidance for 2001 and the 2000-2005 timeframe. In the five-year period, the company expects to grow revenue at 15% and EBITDA at 20%, both on an annually compounded basis. In addition, Qwest is trying to cut capital expenditures to between $8.8 billion and $9.0 billion for 2001, down from the projected $9.2 billion. For 2002, Qwest will go even lower, spending about $8.0 billion.