Qwest’s Dangerous Liaison

What was that again about fools rushing in? The proverb came to mind last week during the bizarre negotiations between German giant Deutsche Telekom, American upstart Qwest, and Baby Bell US West. Deutsche Telekom, looking to expand its global presence and anxious to get a foothold in the lucrative market for data transmission, wanted to buy Qwest, which over the past few years has essentially constructed its own fiber-optic national network. The key stumbling block was US West, as staid a Baby Bell as there is, which Qwest, for reasons that still remain baffling, bought last summer. And not at a discount, either. Deutsche Telekom didn’t want US West, but it was willing to take the Baby Bell at the right price if that’s what it took to get Qwest.

Unfortunately, though, because of the deal Qwest had made with US West, the “right price” was effectively an impossibility, which is why Deutsche Telekom sensibly walked away. (It’s the angel in this story, not the fool.) In buying the Baby Bell, Qwest had got locked into a bidding war with a company called Global Crossing, and like all bidding wars, this one ended badly for the winner. Qwest not only overpaid for US West and assumed $12 billion in debt but also sealed the deal by guaranteeing US West a massive breakup fee if the deal fell through. On top of that, because the acquisition was paid for in stock, Qwest ensured that as its value rose, so too would the price it would have to pay for US West.

None of this would have been especially egregious had Qwest really wanted US West and had the synergies between the two companies been worth the $36 billion that Qwest was shelling out. But the record since last summer suggests that neither of those things is true. The managements of the two companies have been having a difficult time getting on the same page, with US West’s CEO actually announcing that he’ll be stepping down once the deal’s done, and Qwest’s immediate interest in being acquired by Deutsche Telekom tells us that it hardly sees US West as the ideal partner. That seems especially true when you consider that Qwest apparently didn’t tell US West about its talks with the German giant until they were well under way.

Given all this, and given the simple economics of the Qwest-US West deal, it’s hard to see why US West should have reacted to the news of the Deutsche Telekom offer any differently than it did, which was to insist that if it were going to be bought by anyone else, it couldn’t be for less than Qwest was going to have to spend and that if Qwest tried to walk away from the deal, well, US West would be seeing it in court. Deutsche Telekom reportedly valued US West initially at $63 a share, which was a far cry from the $99 a share Qwest was going to have to pay. And even though Deutsche Telekom upped its offer, it never came close to what US West was, in essence, guaranteed. And the very fact that a deal seemed to be in the offing drove up Qwest’s stock price, which in turn inflated US West’s value.

It is true that the collapse of talks with Deutsche Telekom sent Qwest’s stock price into a minor tumble, but US West is still worth much more than the German company was willing to pay. And it’s also true that US West’s insistence that it was really committed to the Qwest deal rang a little hollow in light of its management’s obvious lack of interest in continuing with the company post-acquisition. But the essential point here is that US West pulled off a fantastic deal for its shareholders last summer, which put it in essentially an untouchable position. Taking advantage of that position is all shareholders should expect executives to do.

It’s Qwest, in fact, that has come out of this deal looking shaky. The company remains fantastically positioned to take advantage of the ongoing explosion in broadband and data, and undoubtedly it will be the object of other suitors in the future. But it now seems clear that Qwest is about to be married to a partner it does not want, believes it overpaid for, and wishes it could simply leave at the altar. And that raises a simple question for Qwest management: Is there really anything you know now that you didn’t know last summer?