Qwest: The Issues go beyond Accounting

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.

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.

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.

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

Insider Selling
27, 1997
goes public at $5.50 a share, adjusted for stock splits
30, 2000
completes $50 billion merger with US West
2, 2001
Philip Anschutz sell 10 million shares for $408 million to
Donaldson, Lufkin & Jenrette
15, 2001
CEO Joseph Nacchio concludes his last major stock sale, bringing
his total sales in the first five months of the year to $75 million
10, 2001
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
10, 2001
announces that it will not meet 2001 revenue and earnings forecasts.
Stock falls 7% to $18.57
11, 2002
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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