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Advanced Corporate Finance University of Colorado-Boulder Leeds School of Business October 7, 2009. Joseph J. Euteneuer Executive Vice President & CFO Qwest Communications. Agenda. Background / The Business Environment The “Street’s” Perspective Creating Shareholder Value
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Advanced Corporate Finance University of Colorado-Boulder Leeds School of Business October 7, 2009 Joseph J. Euteneuer Executive Vice President & CFO Qwest Communications
Agenda • Background / The Business Environment • The “Street’s” Perspective • Creating Shareholder Value • Balanced Approach to Capital and Investing • September 2009 Bond Offering • Asset Strategic Review
September 15, 2008 Crisis on Wall Street as Lehman Totters, Merrill Is Sold, AIG Seeks to Raise Cash —Fed Will Expand Its Lending Arsenal in a Bid to Calm Markets; Moves Cap a Momentous Weekend for American Finance By Carrick Mollenkamp, Susanne Craig, Serena Ng and Aaron Lucchetti A1 The American financial system was shaken to its core on Sunday. Lehman Brothers Holdings Inc. faced the prospect of liquidation, and Merrill Lynch & Co. agreed to be sold to Bank of America Corp…. Euteneuer to Lead Qwest’s Finances By Roger Cheng B5 Qwest Communications International Inc. hired former XM Satellite Radio and Comcast Corp. executive Joseph Euteneuer to serve as chief financial officer…
The Business Environment Post 9/15 Source: the Conference Board and NIPA; Moody’s Economy.com Source: Bureau of Labor Statistics: Current Population Survey; Moody's Economy.com U.S. Business Bankruptcy Filings: 3Q06 – 2010E Source: Bureau of Census: Form C-404; Moody's Economy.com Source: Office of US District Courts; Moody’s Economy.com
2009 Total Qwest Guidance Qwest is on track to meet Guidance and Analyst Consensus in 2009 7 7
Bank of America, David Barden – Key Points Buy/$5.00 Positive view of Qwest is based on several factors: • Management focus on extracting value is a positive • Potential for enhanced returns to shareholders • Increased the probability of Qwest fully pre-funding the potential put of its convertible senior notes in 2010 • Expect another wave of consolidation to emerge in 12 to 18 months • Valuation is attractive • Qwest’s EBITDA multiple is the lowest in the sector while its ‘09E FCF yield of 21% is among the highest 8
Morgan Stanley, Simon Flannery – Key Points Hold/No Price Target Investment Conclusion • Successfully tapped the credit markets, partially addressing its short-term maturity profile, easing concerns over its dividend sustainability • The company has the ability to sustain its dividend: • Substantial cash on hand • Strong cash generation • A ~$945M undrawn credit facility (as of July 29) • Capital budget flexibility • Revenue Generating Unit (RGU) growth, and its impact on revenue growth, is the bigger obstacle for the stock • Without the stabilization in RGU trends, it may be harder to attract longer-term investors 9
Goldman Sachs, Jason Armstrong – Key Points Sell/$2.75 • Revenue pressure making margin gains difficult to hold • The glimmer of hope in AT&T/Verizon results around a consumer wireline inflection was not present at Qwest • We still expect 2010 revenues to decline another 3.4% • This will lead to 150 bp in 2010 margin pressure, with an EBITDA decline of 7.4% to $4.0 bn • Tough balancing act ahead • Peers have invested in video, which appears to be stabilizing line loss, Qwest line loss stepped up another 50 bp QoQ • Comparisons versus AT&T and Verizon in consumer are likely to become even more unfavorable given the current trajectory • Attempts at structural value creation through monetizing certain assets seems unlikely as shown through the recent unsuccessful auction of the company’s backbone business 10
Creating Shareholder Value Sustainable Free Cash Flow “Growth” 11
Shareholder Value Theoretically how share price is determined: Revenue – OpEx = EBITDA EBITDA – Capex – Interest – Working Capital = FCF FCF *Perception Value = Total Value Total Value – Net Debt (Debt-Cash) = Equity Value Equity Value/Shares Outstanding = Share Price Increasing Shareholder Value Return on Investment Capital Weighted Average Cost of Capital Sustainable Free Cash Flow Growth The value of a company is determined by its expected discounted Free Cash Flow *Perception Value - Shorthand metric to reflect the expected Discounted cash flows of a business, discount rate (including risk) and expectedcash flows growth. 12
Perception Value Models • David Barden’s Perception of Q: • Confident that Q will resolve debt towers through refinancing • Meaningful results in business markets • Consumer access line loss should continue to slow as FTTN matures • Views IXC auction as a positive indication that Q is exploring value • Jason Armstrong’s Perception of Q: • Intense revenue pressure • - Large wholesale disconnects • - Mass markets pressure intensified • Unfavorable FTTN trajectory • Unsuccessful IXC auction 14
Shareholder Value Theoretically how share price is determined: Revenue – OpEx = EBITDA EBITDA – Capex – Interest – Working Capital = FCF FCF *Perception Value = Total Value Total Value – Net Debt (Debt-Cash) = Equity Value Equity Value/Shares Outstanding = Share Price Increasing Shareholder Value Return on Investment Capital Weighted Average Cost of Capital Sustainable Free Cash Flow Growth The value of a company is determined by its expected discounted Free Cash Flow *Perception Value - Shorthand metric to reflect the expected Discounted cash flows of a business, discount rate (including risk) and expectedcash flows growth. 21
Shareholder Value Expectations Revenue Capital Administrative / Operating Expense Capital Spending New Customers Acquisition Cost Shared Support PP&E Efficiency Existing Customers Service Cost 3rd Party Payments Working Capital Efficiency ARPU – Wallet Share Facility Cost Simplify our Focus to Drive Shareholder Value Execution Perfecting the Customer Experience
Comparative Balance Sheet QWEST COMMUNICATIONS INTERNATIONAL INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, December 31, 2009 2008 (Dollars in millions) ASSETS Current assets: Cash and cash equivalents................................................................. $ 1,796 $ 565 Other................................................................................................. 2,252 2,405 Total current assets............................................................................... 4,048 2,970 Property, plant and equipment—net and other..................................... 16,178 17,171 Total assets........................................................................................... $ 20,226 $ 20,141 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term borrowings ......................................... $ 1,085 $ 820 Accounts payable and other.............................................................. 2,703 3,033 Total current liabilities......................................................................... 3,788 3,853 Long-term borrowings—net................................................................. 13,038 12,735 Other..................................................................................................... 4,451 4,939 Total liabilities..................................................................................... 21,277 21,527 Stockholders' equity ............................................................................ (1,051) (1,386) Total liabilities and stockholders' equity.............................................. $ 20,226 $ 20,141 24
Balance Investment in Growth with Returns to the Shareholder • We started paying dividends in February 2008 • The first dividend paid since 2001 • We announced a $2B stock buy back program in October 2006 • Repurchased $1.8B through December 2008 • Still have authorization to buy $.2B • We spent $1.8B in 2008 on CAPEX • Estimated CAPEX is $1.7B or less in 2009 25
Qwest Debt Maturity Schedule $ in Millions 3,389 Unregulated QCIIandQCF(pay down)RegulatedQC(re-finance) 2,168 2,151 1,900 950 Notes: • Convertible notes shown as a maturity in 2010 given investors’ put rights • $945 million un-drawn revolver matures in October 2010 • Paid down $562M QCF notes due August 3, 2009 • Information above excludes any potential pension funding starting in 2011 26
2009 – 2011 Quarterly Debt Maturity Schedule $2.6B in Debt maturities within 90 days –“The Elephant” Unregulated QCIIandQCF(pay down)RegulatedQC(re-finance) 27
So – How Do You Eat an Elephant? In the 90 day period between Nov. 2010 and Feb. 2011, Qwest has $2.6 Billion Debt Maturing (The “Elephant”) = $2.6 Billion $.8 Billion Combined with cash on hand and expected cash flow generation, we need to finance approximately $800 Million to finish the meal. … One Piece at a Time 28 28
Capital Markets Seize Up High Yield Bonds ($ in billions) Investment Grade Corporate (Non-Financial) Bonds ($ in billions) Upcoming Annual Maturities Upcoming Annual Maturities Annual New Issuance Annual New Issuance Source: Citi Syndicate Source: Citi 30
Qwest Yields and High Yield Market Issuance • Heightened LBO Activity • “Cheap Money” – unlikely to return to these levels • Heavy issuance volume 9/16/08 Lehman files for bankruptcy 3/9/09S&P 500 2009 low • Current yields are comparable to 2008 (pre-Lehman) levels ($ in bn) 8/18/09
September 14th – Why did Qwest launch a bond offering? Financing Transaction • On September 14th, Qwest launched and priced a $550m high yield bond offering • Price of 98.244%, coupon of 8.0% and yield of 8.375% Pay rate as of 9-14 (8.375%)1 Rates increase Now Rates decrease Opportunity cost - could have paid lower rate Re-finance decision Pay higher rate (could be 20%+) Rates increase Later Rates decrease Pay lower rate1 1 Best rate issued since 2002 is in the low 7% range 32
September 14th – Why did Qwest launch a bond offering? • Funding need • Debt maturities in 2010/2011 that exceed FCF less dividends • Improved market environment • Equity and bond market were greatly improved • S&P 500 up 54% from low of 676 on March 9, 2009 to 1,043 as of Sept. 11, 2009 • High yield market has also rallied (bond prices up and yields down) • Qwest’s 7.5% note due 2014 trading yield improved to 8.2% (Sept. 11) down from a high of approximately 20% in December 2008 • Decision • Raise capital now or at a later date in 2009 or 2010 • Waiting = taking a position that interest rates will fall or remain flat • Not waiting = protection against rising interest rates • Chance to opportunistically re-finance a portion of funding requirement (dollar cost average) • Cost is negative carry (the interest cost on new debt raised prior to the maturity of the old debt) 33
Qwest Corporation 14-state Local Service Area Qwest POPs VoIP Deployed Cities Qwest Central Offices Introduction – Opportunity • Qwest Communications International Inc. (“QCII”) • Unregulated parent company traded on the NYSE “Q” • with a state-of-the-art nationwide fiber optic network • and advanced product offerings • Regulated Regional Bell Operating Company (RBOC) telecom provider in 14 western states with a significant customer base: • Third largest local telephone company • 10.9 million access lines • 2.9 million high-speed Internet subscribers • 853K video subscribers • Potential Opportunity • Qwest received an unsolicited inquiry from a company that was interested in purchasing assets (property plant & equipment, customers, revenue and employees) • The assets in question were not a separate stand-alone business unit with financial statements 1) As of Q2 2009
Unsolicited Offer for Assets - Summary • Company receives an unsolicited offer from a buyer • Corporate governance issues • Board has a fiduciary duty to the shareholders to evaluate an acquisition proposal • Internal and external counsel consulted • Meetings with management, the board of directors and consultants / advisors • Comprehensive review of the assets and operations undertaken • Decision to run competitive bidding process • Outside advisors engaged to manage process • Evolution of offers concluded the asset was more valuable to Qwest shareholders • No disclosure requirement until an actual agreement is reached
Identify the Specific Assets – Due Diligence Process Physical Assets Customer Assets Human Capital • Detailed process to identify specifically what physical assets the buyer was interested in • For example: fiber in the ground from city A to city B, etc. • Detailed process to identify what customer contracts and revenues would be included in the sale • Many lawyers reviewing contracts • Audited financial statements needed to be created • Detailed process to identify the employees that would be included in the sale of assets • Separation of related assets (e.g., real estate, PCs, e-mail networks, etc.) Goal is to determine what assets would be sold and, therefore, the cash flow stream that would be leaving the company in exchange for a purchase price
Asset Purchase Valuation – Value to a Buyer of Assets Considerations • Buyer will estimate future cash flows • Identification of synergies is typically a significant value driver • For example, elimination of duplicative overhead Not actual numbers / For illustrative purposes only NPV (net present value) of the cash flows discounted at the company’s WACC (weighted average cost of capital) is the value of purchasing the assets inclusive of synergy value
Asset Sale Valuation – Value of Retaining Assets Considerations • Review of assets and operations • Sale of assets may involve dis-synergies • For example, corporate overhead allocated over a smaller revenue base • Separation of assets involves transaction costs Not actual numbers / For illustrative purposes only NPV (net present value) of the cash flows discounted at the company’s WACC (weighted average cost of cost of capital) is the value of retaining the assets plus the avoided transaction costs and dis-synergies
Evaluation of the Purchase Offer Consideration Execution Risk Financial Markets Risk • Currency utilized could be: • Cash • Stock • Debt • Commercial agreements • Combination of the above • Terms & conditions of contract • Time to close • Impact to the business between announcement and closing • Regulatory risk – sale may be delayed or blocked by the government • Time and cost to extract the assets (e.g., billing systems) • Evaluation of the buyer’s ability to raise financing • Shareholder perception of the offer • Exposure on debt pricing A purchase proposal can be very simple or extremely complex
Conclusion • Value of retaining the assets was greater than purchase price proposed by the buyer
Conclusion Qwest Completes Strategic Review of Long Distance Network Asset Company Reaffirms Full Year 2009 Guidance DENVER, June 8, 2009 — Qwest Communications International Inc. (NYSE: Q) and its Board of Directors today announced the outcome of its strategic review of its long distance network asset. After receiving unsolicited indications of interest from potential purchasers of Qwest's long distance network asset, the company and its Board of Directors undertook a comprehensive review of this asset and its operations. Following this review, the company commenced a competitive bidding process. Although there was significant interest in this process from prospective buyers, the company and its Board of Directors have determined that the long distance network asset holds far more value to Qwest shareholders and is more strategically important to Qwest and its customers than is the alternative of pursuing a transaction. Qwest reaffirms its guidance for the full year 2009, expecting adjusted free cash flow to be $1.4 to $1.5 billion, full year adjusted EBITDA of $4.2 to $4.4 billion, inclusive of an expected increase in non-cash pension and OPEB expense of $200 million, and capital expenditures of $1.8 billion or lower. “Qwest remains confident in its outlook for 2009 and the ability of its business to continue to perform,” said Edward A. Mueller, chairman and chief executive officer of Qwest. “At the same time, we are committed to taking steps that will benefit our shareholders, customers and employees in every decision we make. We have always taken a disciplined, prudent approach to assessing our business in this ever changing industry. The review we conducted confirmed that our nationwide network is a tremendous asset and delivers best-in-class telecommunications services to businesses and government agencies throughout the country. We are committed to serving those valued customers and remain focused on increasing shareholder value and perfecting the customer experience." Second Quarter 2009 Earnings Call The Company will announce its second quarter 2009 financial and operational highlights on Wednesday, July 29, 2009, at 7 a.m. EDT. Qwest management will host a conference call at 9 a.m. EDT on the same day to discuss the company’s perspective on the results and answer questions.
