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February 06, 2005

Archimedean Finance

"Give me a lever and a place to stand, and I will move the world." -Archimedes

Well, right now Mr. Notebart is looking for a lever, and I'm not sure they have a place to stand. Qwest (Q) is in talks to buy MCI (MCIP), formerly WorldCom, formerly MCI. The problem is, they don't actually have anything to buy WorldCom with.

As of last week, MCI had a market cap of $6.7 billion. As of the end of the third quarter, their cash balance was $5.6 billion. After going through scandal-induced bankruptcy, the company is relatively lean on the debt side. MCI's problem is that they can't make any money. Even as the sector was booming these last couple of years, the company has hemmhoraged cash, even from its operations.

Qwest has the opposite problem. Qwest is like that Monopoly(tm) player who's mortgaged everything to keep the roofing in shape on the Park Place/Boardwark hotels, and then sees everyone draw "Move Directly to Go!" cards. They have a little cash, so they can stay in the game. But they overpaid massively for US West and had to write off $30 million of goodwill in 2002. Goodwill is an asset. Which means that simultaneously, $30 million of shareholder equity disappeared. Poof. Gone. Ex-equity. Equity-no-more.

Which is a problem if it isn't there. That's right. Right now, Qwest owes more than the company is worth - it has negative equity. It's got negative book value, and you can't calculate half the valuation ratios because they make the not-altogether-unreasonable assumption that the company is actually worth something, at least on paper.

Their operations are showing a slight inflow, and they're not bleeding cash like MCI, which is how they've managed to avoid the big Chapter 11 in the Sky so far. Certainly, nobody's going to be lending them any money on their own.

So MCI may want Qwest, because it can't make any money, and it needs someone who can. Qwest wants MCI because it has cash, only it doesn't have any way of paying for it.

Enter the LBO - Leveraged Buyout. These were wildly popular in the 80s, until people started going to jail for being a little too creative on the financing end, and just for being so successful which we had a recession. Basically, the company borrows against the acquisition they'll be making, and the benefits they'll get from it.

This never works. Well, hardly ever. The problem here is that Qwest is going to be taking on not only cash, but also money-losing operations. They might be able to structure a deal, but my guess is that these are a couple of fish waiting to be eaten.

The other speculation is that MCI is trying to play Qwest off against other companies. Again, the problem here is Qwest's state-of-the-art fiber optic network. Those other companies, Verizon has been most prominently mentioned, will only rush to bid if they think they won't have a shot at both of them later. Qwest's network means that if it does wait, Verizon can pick up both companies, and Qwest won't be just dead weight.

Posted by joshuasharf at February 6, 2005 11:30 PM | TrackBack

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