Is now the time to buy Qwest Communications (NYSE: Q)? Wall Street analysts think so. Investment bank, JPMorgan (NYSE: JPM), has upped its rating on the Denver-based telecom carrier to "overweight" and set a price target of $6 - well above Qwest's $4.30 price tag.
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Qwest's market capitalization is just under four times projected 2009 free cash flow and the company's dividend delivers a whopping 7.4% yield. Based on those figures, investors might think now is the time to snap up a few Qwest shares. But bargain hunters, beware! Before hitting the buy button, it's probably worth looking at Qwest's numbers a bit more closely.
A Look At Valuation
At $4.30, Qwest has an equity market cap of $7.4 billion plus net debt of $13.3 billion. Add those together, and you get an enterprise value of $20.1 billion. Qwest is projected to produce free cash flow of about $1.8 billion. $20.1 billion divided by $1.8 billion gets you a multiple of 11, which is not cheap.
The other problem for Qwest is that free cash flow could shrink as Qwest's earnings gets squeezed. In contrast to its bigger telecom competitors, AT&T (NYSE: T) and Verizon (NYSE: VZ), Qwest relies heavily on traditional fixed-line telephony for more than half of its top line. Unfortunately, this business is drying up as customers disconnect their home phones in favor of cell phones or cable telephone services. The total number of lines was down about 10% in the most recent quarter. Unlike AT&T, Verizon and Sprint (NYSE: S), Qwest doesn't own a wireless network to compensate for losses of land line customers. (For more, see Dial Up Choice Telecom Stocks.)
It appears that the free cash flow generated in the last quarter came thanks to hefty cost cutting measures and layoffs rather than from fundamental business growth. But, it's hard to imagine free cash flow increasing when opportunities for spending cuts run out. Frankly, Qwest can't fire its way to growth.
So, what would be a fair enterprise value-to-free cash multiple for a struggling telecom company of this kind? Probably about five times. To trade at five to six times, Qwest's enterprise value would have to get halved, to $10 billion, which -given the amount of debt - would wipe stockholders out.
Trading on a forward price-to-earnings multiple of 13 times, Qwest isn't exactly cheap. AT&T and Verizon, by comparison, both trade at under 11 times 2009 earnings, even though they both have diversified businesses with plenty of direct exposure to high-growth wireless and digital TV opportunities.
Can They Sustain The Dividend?
Then there's Qwest's dividend to consider. As impressive as it may be, the company's 7.4 % dividend yield may be warning sign. It could be an indication that the market is worried about Qwest's growth prospects going forward or, even worse, that Qwest is headed for trouble. What's more, the dividend payout ratio looks rather steep at 74%. Qwest's ability to maintain its dividend is far from a sure thing. (For more, see Is Your Dividend At Risk?)
Bottom Line
Digging deeper into numbers, Qwest doesn't look like such a good deal after all.
