More Bad News from Qwest, WorldCom

The bad news in telecom just keeps on coming.

Bankrupt telephone company WorldCom Inc. has discovered about $2 billion in additional accounting discrepancies, CNBC is reporting. Buckling under stiff competition, slack broadband demand and a steep debt load, Clinton, Miss.-based WorldCom stunned the world June 25 when it disclosed inaccurately posting $3.85 billion in earnings over five quarters by booking expenses as capital expenditures. In July WorldCom filed the largest bankruptcy petition in U.S. history.

Meanwhile, Qwest Communications International Inc., which is under investigation by the Securities and Exchange Commission and the Justice Department, posted a $1.14 billion net loss in the second quarter and could be forced to file for Chapter 11 bankruptcy protection by the end of the year, analysts said Thursday.

Denver-based Qwest faces a cash crunch as $5.6 billion of debt is maturing over the next year.

Qwest is in talks to reach a new agreement with its lenders. Qwest disclosed Thursday it reached an agreement with Banc of America Securities LLC to arrange a $500 million bank facility through QwestDex, adding that a Banc of America affiliate had made a $200 million commitment.

The company also noted Thursday it was in late-stage negotiations with bidders to sell all or part QwestDex, a phone directory business analysts have speculated could fetch up to $10 billion.

The Denver-based carrier posted free cash flow of $320 million in the second quarter, but Qwest must rely solely on the money it generates through sales to pay its huge debt load, analysts said. The company was cut off this year from access to short-term loans.

“I think [bankruptcy] is likely before year end,” says Davenport & Co. analyst Drake Johnstone, who rates the stock as a sell.

The local telephone and Internet giant, which derives 90 percent of its EBITDA from business with US West’s original 14-state region, had $25.6 billion in debt and $699 million in available cash at the end of the second quarter.

Qwest must hope its suppliers do not become unnerved and require the carrier to pay cash up front, a circumstance that can force a company to file for bankruptcy protection.

“As long as the various vendors are not demanding cash up front, Qwest can go for months without any payment defaults – the primary factor in a path to bankruptcy,” says Jim Veneau, a senior analyst at Moody’s Investors Service.

Qwest attributed most of its second quarter loss to its failed joint venture, pan European operator KPNQwest. Qwest wrote down $926 million of its investment in KPNQwest.

WorldCom Inc., the bankrupt telecom giant, also hurt Qwest. Qwest attributed a $119 million loss to bad debt reserves stemming from the WorldCom bankruptcy.

Revising its financial guidance for the year, Qwest anticipates total revenue of between $17.1 billion and $17.4 billion and adjusted EBITDA of $5.4 billion to $5.6 billion. The company expects to be cash flow positive for the year.

Credit Suisse First Boston analysts, which downgraded Qwest’s stock to a sell from a hold Thursday, said the company posted “disappointing” second quarter results. Qwest’s second quarter EBITDA of $1.26 billion was 14 percent below the analysts’ forecast.

Qwest attributed the earnings decline to “the absence of optical capacity sales and certain IP equipment sale, the company’s continued investment in product platforms for dial Internet access and managed wavelength services and certain unanticipated expenses recognized within the quarter for increased litigation risk and write-downs of certain inventory and assets.”

The shares of Qwest plummeted to a record low in late July following the latest accounting scandal to contaminate the telecommunications sector. Qwest shares were trading Thursday afternoon at $1.20 on the New York Stock Exchange.

On July 28 Qwest announced it had improperly accounted for up to $1.16 billion in optical sales revenue over three years. Sales of optical capacity in 2000 and 2001, including swaps, represented 2.8 percent and 5.1 percent of total reported revenue in those periods, or $468 million and $1.013 billion respectively.

Qwest also withdrew its annual forecast and noted it would restate financial results for the last few years - a move analysts said could result in lower earnings and bank covenant violations. The company said it is continuing to analyze its accounting policies and practices in consultation with its new auditor, KPMG LLP.

Qwest's former CEO Joe Nacchio helped build a 190,000-mile global network. But with broadband demand failing to materialize at the rate carriers anticipated, hundreds of providers have found themselves sitting on assets that have generated significantly less cash flow than the debt required to fund them.

Once the darling of Wall Street, the beleaguered telecommunications industry has lost an estimated $2 trillion in equity over the last few years and 500,000 jobs.

The rubble continues to mount. The country’s largest – and at one time most venerable - telecommunications providers are under federal investigation for unscrupulous accounting practices.

Meanwhile, telecom companies have an estimated $1 trillion in debt, FCC Chairman Michael K. Powell said last week. “Until firms substantially pay down this debt, much-needed capital will continue to sit on the sidelines and the recovery will be stalled,” he said.

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