Qwest to sell $1.25 billion of notes in 3-part deal via Merrill, Deutsche

By Paul Deckelman

New York, June 7 - Qwest Communications International Inc. announced plans Tuesday to sell $1.25 billion of new senior notes.

The deal is being led by joint book-running managers Merrill Lynch & Co. and Deutsche Bank Securities, with Banc of America Securities and UBS Investment Bank as co-managers, high-yield market sources said.

It was marketed to potential investors via an afternoon conference call Tuesday, with pricing expected to take place later Wednesday.

The sources said that the size of the three tranches would be determined at the time of pricing. One tranche would consist of 10-year non-callable fixed-rate notes to be issued by the company's Qwest Corp. unit, which would also be the issuer of record for the second tranche, to consist of eight-year non-callable floating-rate notes. The third tranche would be issued by parent Qwest Communications International Inc. itself, as an add-on to its existing 7½% senior notes due Feb. 15, 2014 (Qwest Communications International sold the original $500 million of those notes as part of a $1.775 billion bond deal - also a three-parter - that priced on Jan. 30, 2004).

The two Qwest Corp. tranches will be rated Ba3 by Moody's Investors Service, BB- by Standard & Poor's and BB by Fitch Ratings, and will carry covenants identical to those of Qwest Corp.'s existing 8 7/8% notes due 2012. The parent company tranche will be rated B3 by Moody's, B by S&P and B+ by Fitch, and will carry identical covenants to the existing 7½% 2014 issue. It will be non-callable until Feb. 15, 2009

The three tranches of notes will be sold under Rule 144A, with registration rights.

In its announcement, the Denver-based telecommunications company said that it would use the net proceeds from the big bond sale for general corporate purposes, "including repayment of indebtedness, and funding and refinancing investments in the company and its subsidiaries' telecommunications assets."

Specifically Qwest will use the proceeds to finance tender offers for Qwest Services Corp.'s $504.103 million of 13% senior subordinated secured notes due 2007, for Qwest Corp.'s $150 million of 6 1/8% notes slated to come due on Nov. 15 and for Qwest Corp.'s $250 million of 6 5/8% notes scheduled to mature on Sept. 15. Completion of the $1.25 billion bond sale is one of the conditions that must be satisfied for the tender offer to be consummated.

Besides tendering for those bonds, the company will then redeem unspecified additional indebtedness and use some of the funds for general corporate purposes.

Cutting debt, simplifying structure

On the conference call, Qwest's chief financial officer, Oren G. Shaffer, and company treasurer, Janet Cooper, outlined for potential buyers of the deal Qwest's efforts over the past several years to stabilize its finances, including bringing down its net debt levels and leverage ratios, and to simplify its quite complex capital structure, which currently has debt issued at five separate entities - the parent Qwest Communications international, regulated entity Qwest Corp., and unregulated entities Qwest Services Corp., Qwest Capital Funding Inc. and Qwest Communications Corp. The latter entity has just $314 million of 7¼% notes due 2007 that were originally issued by LCI Communications Inc. and absorbed by Qwest through QCC when it acquired LCI some years ago.

"You have to realize that we have bonds at quite a few entities," Cooper said, with some degree of understatement.

As part of that effort, Qwest is taking out the Qwest Services 13% bonds - and killing two birds with one stone by also eliminating a big chunk of very high cost debt.

"Our long-term goals remain the same," Shaffer said on this score, "we're trying to move the capital structure to a more simplified form and really move debt more to QCII and QC." The CFO added that this will be "a process that takes some time - but that is our direction."

However, Cooper allowed that at some point, even though these would be the two primary issuing entities for Qwest, "that doesn't mean that we couldn't issue debt that is not pari [passu] with the debt that debt that we're issuing today - that [would be] at a lot lower level but still issue it at QCII." She said that the company could issue through Qwest Communications International "debt that is either pari with QSC or pari with,or similar to QCF, which is unsecured." In that case, she said, "the issuer would be Qwest Communications International - but we could look at all sorts of structures at that level."

Cooper noted that since she and Shaffer came aboard in the summer of 2002, the company's net debt level - total debt minus cash and short-term cash equivalent investments - has come down sharply to $14.9 billion as of the end of the recently concluded first quarter, from nearly $26 billion when the debt-cutting effort began. It reduced net debt by $565 million in the first quarter.

As of the end of the quarter, the company had $17.4 billion of total debt, partly offset by a $2.4 billion cash balance, and had an undrawn $750 million of revolving credit facility availability. With consolidated EBDITA of $3.7 billion, Qwest's net debt was about four times adjusted EBITDA.

Cash flow improving

Cooper said the company had also been improving its cash flow, going from negative $400 million at the end of 2002 to positive $400 million - a total swing of $800 million - by year-end 2004.

"We expect to continue our cash generation this year," Cooper said, noting that first-quarter free cash flow was $300 million, after Qwest had made some special payroll payments and employee bonuses of over $190 million.

A key component in the cash flow improvement, the treasurer said, has been the reduction in interest costs, including a reduction of almost $250 million last year, as Qwest continued a busy schedule of debt-related transactions, all aimed at either eliminating debt, lowering the cost of debt or extending maturities. Shaffer said that each transaction had improved the company's overall debt and liquidity picture.

Regulated unit matches A ratios

For the key Qwest Corp. unit - Qwest's regulated entity - total debt at that level of $7.8 billion, versus last 12-month trailing EBITDA of $5.1 billion produced what Cooper called "a fairly impressive" debt/EBITDA ratio of 1.5 times - actually even below the 1.7 times ratio of the average S&P A rated telecom company, and specifically below the ratios for such regional Bell operating company rivals as SBC Communications Inc., BellSouth Corp. and Verizon Communications Inc.

Shaffer noted that even with all of the financial transactions the company had been pursuing, "even moving cash around and financing our growth and our changes and everything like that" as Qwest was managing cash flow across the whole corporation, that low leverage ratio at Qwest Corp has not changed over the last six quarters.

Looking beyond the $904 million of bond debt scheduled to be taken out by the tender offers, Cooper noted that other upcoming maturities include $179 million of 6¼% Qwest Capital Funding bonds coming due in July, $485 million of 2006 maturities at its unregulated entities, and $1.25 billion of Qwest Corp. term loan debt that's maturing in 2007 - but which becomes callable on June 9 "and will give us the opportunity to reduce interest expense as well."

Cooper was asked by one call participant whether the company had any particular preference about what it planned to do with the leftover proceeds once the tender offers had been completed - would it, for instance, lean toward prefunding the Qwest Capital Funding July 15 bonds or prepaying at least a portion of the Qwest Corp. term loan - but she was non-committal.

"I think what we will do is attempt to keep the debt levels consistent with where they are now at both entities," she said, "so for the unregulated side [Qwest Capital Funding] we couldn't materially change the debt and likewise on the regulated side [Qwest Corp.]. So the goal is, after this transaction, to have relatively the same amount of debt at each of the entities."

Looking to consolidate industry

Changing tack and referring to Qwest's failed attempt to acquire MCI Corp., which instead agreed to a nominally lower takeover offer from Verizon, Shaffer said that "finally, we decided that we're never going to convince that fair maiden that we were the prince who could kiss the frog," and declared that now, "we're in a post-MCI period, whether we like it or not."

Although there had been considerable media speculation that Qwest was eyeballing MCI's huge cash stash - more than $5.5 billion - as one way to help bring down its debt, and that this was a key motive behind its pursuit of the Ashburn, Va.-based long-distance operator, Shaffer asserted that "MCI was not a different strategy for us than we had already said," in terms of Qwest looking to be a consolidator picking up value in the fractured telecom industry, "and post-MCI will not be a different strategy for this company than we had already outlined to the market."

He noted that in both the case of MCI and in Qwest's earlier unsuccessful pursuit of Dallas-based Allegiance Telecom Inc. - whose assets ultimately went to XO Communications Inc. via a 2004 bankruptcy auction after XO's $311 million cash bid topped Qwest's $300 million cash offer - Qwest had exercised fiscal discipline, walking away from the bidding when the price became more than it thought the target company was worth.

For the moment, he said, Qwest would concentrate on running its own business and improving it - though "at the same time, if we find a transaction that we believe would be accretive to our debtholders as well as our equity holders, we will certainly have a run at it" - but in "the same disciplined fashion that we've done in the past."

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