CenturyTel-Qwest: CenturyTel’s $11 billion deal to buy similarly-sized US rival Qwest Communications International at first sight looks cheap. But the two telecom groups are suffering from shrinking businesses and, on Qwest’s side, too much debt. It’s largely a merger of necessity.
CenturyTel, which will formally rename itself CenturyLink, is paying only a 15 percent premium to Wednesday’s Qwest share price - though rumors may have pushed that up a bit beforehand - and is offering only stock. Including assumed debt, the transaction puts Qwest’s enterprise value at $22.4 billion, about 5.2 times its estimated Ebitda for 2010. The price isn’t punchy by either measure.
Moreover, the two companies may be understating cost cuts. At $625 million a year, some 5.4 percent of Qwest's sales, the expected synergies are only just over half the 9.4 percent of target companies' sales achieved in the average recent telco deal, according to Stifel Nicolaus. Yet, the seemingly low deal price is justified considering the ongoing problems for US land-line telephones. Once a necessity, they have been in decline for years as more households go wireless or install cheap Internet phones. High fixed costs mean that as revenue declines, profit falls faster - necessitating consolidation so that expenses can be stripped out. Falling profit also means that Qwest’s debt burden, some 53 percent of its enterprise value, is harder to service every year. Merging with the less-leveraged CenturyTel somewhat lightens the combined load.
On the more positive side, the extra scale should help the enlarged CenturyLink build out more broadband infrastructure, an area where business is growing. A proposed shift in government subsidies from voice telephony to the provision of broadband access would have hurt CenturyTel but could be beneficial for the merged group.
The deal doesn't, however, have the glamour of one that promises dramatic transformation or pumped-up growth. But, at least combining CenturyTel and Qwest allows them to prop each other up and keep reality at bay for a while longer.