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Qwest: The Issues go beyond Accounting

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DQI Bureau
New Update

A case of Enronitis may now be spreading to Qwest Communications

International Inc. Last year, the Denver telecom giant saw its stock slide 64%,

to $14.13, after it came under fire for its accounting practices. This year,

Qwest’s shares slid an additional 31%, to $9.71 on Mar. 8, amid growing

liquidity concerns and downgrades from the major credit-rating firms. Then, on

Mar. 11, Qwest disclosed that the Securities and Exchange Commission had opened

an informal inquiry into its accounting practices.

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Qwest may end up having to explain more than just its accounting. A

BusinessWeek review of insider stock sales found that Qwest’s top execs were

selling stock at the time its critics allege accounting improprieties may have

occurred at the company. CEO Joseph P Nacchio sold 2 million shares of Qwest

stock in the first half of last year, realizing $74.6 million. And on May 2,

2001, Qwest founder Philip F Anschutz sold roughly 10 million shares for $408

million, according to SEC filings.

The sales have angered Qwest employees. In early March, workers filed two

lawsuits, claiming they were encouraged to keep their retirement savings in

company stock even as top execs sold hundreds of millions of dollars in shares.

"Senior management had a fiduciary duty to employee stock plans, and here

they are urging employees to invest while selling off their own stock,"

says Joseph Whatley, one of the attorneys who has brought suit against Qwest’s

senior management.

Anschutz isn’t commenting. Nor is Credit Suisse First Boston, which in 2000

acquired Donaldson, Lufkin & Jenrette Inc., the investment bank that

structured Anschutz’s stock sale through a Cayman Islands subsidiary. That

transaction represented only 3.3% of Anschutz’s 301 million-share stake in

Qwest. A spokesman for Qwest says that Nacchio sold shares to diversify his

holdings and still has options on 20 million shares.

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The timing of the sales may be critical because they occurred just before

Qwest’s stock nose-dived. The company’s shares held up better than the rest

of the telecom industry during the first half of last year, largely because

Nacchio insisted that Qwest could outpace its rivals in revenue and earnings

growth. But in the second half, the company stumbled. On Sept. 10, Nacchio

conceded that Qwest would not meet its revenue and growth targets for the year

and for 2002.

The SEC’s investigation involves accounting practices Qwest used that made

its financial performance look good through the middle of last year. One area

the SEC is examining is Qwest’s sales of capacity on its network. Qwest, like

many telecoms, sold slices of capacity on its network–known as indefeasible

rights of use (IRUs)–to other phone companies while buying IRUs from other

service providers. Such sales can be legitimate if, for example, Qwest needed

capacity between San Francisco and Seattle and AT&T needed capacity between

New York and Boston.

But capacity sales also can be used to inflate revenues and profits. A sale

of an IRU is counted as revenue, while a purchase is counted as a capital

investment. If two companies, for example, sell each other IRUs valued at $100

million, both companies can book revenues of $100 million today, but they spread

the cost of the $100 million purchase over the life of the contract, typically

20 or 25 years. The result is that a company’s financial statements look good

today, although no net cash has changed hands.

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What the SEC is investigating is whether Qwest, Global Crossing Limited, and

others sold each other network capacity to inflate their financial statements,

without any real business purpose. In the first six months of 2001, Qwest sold

$857 million worth of network capacity to other telecom players. It also bought

$450 million in capacity from some of those same companies. The sales helped

Qwest’s revenues rise 12%, to $10.3 billion, for that time period. Without

those transactions Qwest’s revenues would have grown only 7.5%, to $9.4

billion.

Mapping

Insider Selling
at

Qwest
June

27, 1997
Qwest

goes public at $5.50 a share, adjusted for stock splits
June

30, 2000
Qwest

completes $50 billion merger with US West
May

2, 2001
Founder

Philip Anschutz sell 10 million shares for $408 million to

Donaldson, Lufkin & Jenrette
May

15, 2001
Qwest

CEO Joseph Nacchio concludes his last major stock sale, bringing

his total sales in the first five months of the year to $75 million
Sep

10, 2001
Qwest

discloses that $857 million of its $10.2 billion in revenues for the

first six months of the year came from controversial capacity sales

with other telecom companies, including Global Crossing
Sep

10, 2001
Company

announces that it will not meet 2001 revenue and earnings forecasts.

Stock falls 7% to $18.57
Mar

11, 2002
Qwest

discloses that SEC is investigating its accounting practices

Qwest’s transactions were first examined as part of the SEC’s ongoing

investigation into Global Crossing, the former telecom highflier now in

bankruptcy. According to a whistle-blower lawsuit filed by former Global

Crossing employee Roy Olofson, Qwest and Global Crossing exchanged about $200

million worth of network capacity in the first and second quarters of 2001. And

Global Crossing Chairman Gary Winnick entered into a $123 million stock sale in

the same month that Anschutz sold–May of 2001. It may all be a coincidence,

but there were certainly a lot of shares being sold at a curious time.

By Ronald Grover and Christopher Palmeri in Los Angeles and Peter Elstrom in

New York in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc

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