April 14 - Desperately Seeking MCI

Has there been a more desperate large-cap acquirer in recent M&A history then Qwest Communications? To this observer, the answer is a resounding no and that is why Qwest will do just about anything permissible to get its hands on MCI. This is no longer about friendly courtship. That game ended weeks ago. Instead,. Qwest CEO Dick Notebart has turned into a stalker who is well aware that his company's immediate future is riding on this deal. And because he is desperate, Notebart keeps sweetening his takeout offer even though the price has reached prohibitive heights.

For Qwest this deal has always been about one thing: the company needs to get its hands on MCI’s pristine balance sheet. This is because Qwest’s own balance sheet is in total disrepair, weighed down by more debt than most Central American countries. With its opening bid, Qwest could have secured MCI’s balance and used it to help solidify its own horrific credit metrics. But that was several billion dollars ago and a deal at current levels makes it much more difficult for Qwest to achieve its original purpose.

Qwest knows this but it hasn’t stopped the company from pursuing MCI with reckless abandon. Qwest executives are probably getting a bit gun shy at this point, but a quick glance at the company’s financials is all that is needed to restore their fighting spirit. I say this because those financials are about as bleak as typical day at the Battle of Verdun. Here is a company that has approximately $16 Billion in debt and other obligations supported by roughly $3 Billion in EBITDA. That is not a pretty equation and the interest coverage metric is perhaps worse since Qwest’s pre-CAP EX EBITDA is only twice its annual interest payments. This is a company that has $16 Billion of debt on the sheets, yet doesn’t generate any meaningful free cash flow. And just to make matters worse, revenue declined three percent in 2004. This patient isn’t just sick – it is terminal and for equity holders, it will be a long slow death.

It has gotten to the point where a deal for MCI at these prices is just a band-aid for Qwest. It buys the company some time, but it is not a cure all. The reason is Qwest’s balance sheet, barring an emergency appropriation from Congress, is perhaps beyond repair. A creative deal and some massive cost cutting could probably help Qwest stabilize its metrics for the moment, but MCI is not a long-term solution. This is because there is simply very little Qwest can do to deleverage this monster. The business is in decline and all valuable assets have already been sold off. In fact, if the business keeps declining, there is no telling how long this company will have sufficient liquidity to operate. That is a recipe for disaster that the acquisition of MCI cannot fix, especially at current deal prices. Qwest executives know this but are desperate to stay in the game and see another card, even though they know deep down that it will take a miracle to keep this company out of bankruptcy. Many MCI holders know full well what it feels like to restructure and that begs the question of why they would want to do it again, this time under that big Q umbrella.