Would You Buy a Used Phone Company from This Man?

By combining new-world technology with old-school principles, Qwest chairman and CEO Richard Notebaert has brought a distressed company back from near-ruin. But his next act may be Qwest’s last.

From ColoradoBIZ, 2005

By Stewart Schley

Richard Notebaert wants to topple Colorado’s prevailing telephone regulations, settle federal investigations once and for all, and get somebody at Comcast to air his ads for high-speed Internet service. But all that can wait. Right now, what’s important is the blue wristband.

 “Here,” says Notebaert, tossing a package across a conference table. “Put this on.”

The wristband is a thin strip of blue rubber, with the catchphrase “Spirit of Service” carved neatly into its surface. Inspired by an employee’s suggestion, Notebaert ordered boxes of the things, and he hands them out ritually to visitors, bankers, co-workers and just about anyone who passes through his office. It’s 8 a.m. on a Wednesday at Qwest’s 18th Street headquarters building in Denver. While half the city is still lumbering to work, Notebaert is hustling to spread the “Spirit” message with the enthusiasm of a high-school basketball coach on a Friday night.

For the 56-year-old chairman and CEO of Qwest Communications, the “Spirit of Service” slogan is more than a corporate tag line. It’s the expression of Notebaert’s determination to reinvigorate the reputation and the workforce vibe of a company wracked by service woes, bruised by customer losses and tormented by the most notorious accounting scandal in Colorado corporate history. 

 If there is a more stressful job in Colorado, it’s hard to imagine. When then-chairman Philip Anschutz and Qwest’s board of directors hired Notebaert to succeed Joseph Nacchio in mid-2002, the company formed by a merger of Anschutz’s Qwest and Denver-based U S West was already in tatters. By 2002, when Nacchio was fired, Qwest was reeling from deteriorating results, suspicions of faulty accounting, anger over Nacchio’s rich compensation package and the general implosion of the Anschutz- Nacchio “Ride the Light” vision. Since then, Notebaert has had to juggle the job of reviving the company’s operating performance with the task of dealing with Justice Department and SEC investigations, plus a collection of shareholder lawsuits tied to inflated financial statements under the Nacchio regime.

The carnage is well known: Under Notebaert, Qwest has restated two years’ worth of earnings, admitting it understated losses by $2.5 billion in 2000 and 2001. The company took a huge 2003 write down, reporting a net loss of $38 billion. Qwest’s stock, worth $66 a share in the winter of 2000, has tumbled below $4, and a steep debt load racked up by Nacchio prompted Qwest to sell its hugely profitable Dex publishing unit and its wireless phone infrastructure, and to cut thousands of jobs. In the meantime, the U.S. telecommunications market has gone topsy-turvy, with new technologies and competitive providers causing incumbent phone companies like Qwest to lose residential phone connections for the first time since the Great Depression.

 “It’s like the Toby Keith song,” says Notebaert, describing the current landscape. “I wish I didn’t know now what I didn’t know then.”

Union man

Notebaert started his phone-industry career washing trucks for Wisconsin Bell while attending the University of Wisconsin in 1969. He will earn $4.6 million in compensation this year from Qwest, but there is a quality of earnestness about Notebaert that makes it possible to imagine him as the union laborer he once was. The former Chicagoan is an animated conversationalist who peppers his language with phrases like “My gracious!”, and makes it a point to reply directly to email messages he receives from customers and employees alike. (“They’re not all positive,” Notebaert says. “Some of them rip my face off.”) Notebaert seems to become genuinely emotional when he says he took the difficult job as Qwest’s top executive “because some folks said they needed me.”

 These Midwestern characteristics make him in many ways the anti-Nacchio, conciliatory instead of combative, humble rather than egomaniacal, and prone to crediting others – Qwest’s employees, in particular – for any advances Qwest has made. For a company that became one of the poster children of the Enron age, Notebaert has been the perfect antidote. “He’s just the real deal,” says Jordan Haines, a retired Kansas banking executive who served on Qwest’s board of directors during the Nacchio-to-Notebaert transition, “He doesn’t do anything for show.”

“He was an outstanding, trustworthy, forthright breath of fresh air after Nacchio,” says Scott Cleland, a telecommunications industry analyst from Washington, D.C. “He’s an Eagle-scout type.”

Notebaert is among the handful of CEOs who ran the U.S. phone industry in the post-AT&T breakup era, when seven regional companies were splintered off from Ma Bell in 1984 at the insistence of the U.S. Justice Department. As CEO of Chicago-based Ameritech, the Baby Bell that encompassed Illinois and four other Midwestern states, Notebaert ran a $40 billion company that steadily churned out cash and shareholder dividends and ultimately was sold in 1988 to a larger Bell company, Texas-based SBC Communications, for $62 billion. With speculation of a possible Qwest sale now building, it is the sort of transaction that many believe could be repeated.

Quaint  era

The era of the post-breakup phone industry almost seems quaint now. It was the last chapter of telephony’s analog age, before the disruptive and transformational technologies of the new digital era would wreak havoc on telephone services and business models. 

 In taking over at Qwest, Notebaert has had to contend with a very different world, one where young customers are ditching traditional land-line phones for wireless connections, where digital technology is reducing the price of making a phone call, and where cable TV companies are beginning to pose serious competition for telephone services. From June of 2003 through June of 2004, Qwest retail customers disconnected more than 280,000 phone lines – an average of nearly 6,000 a week. The phone industry generally blames two main culprits. Customers are either replacing landlines with cheaper wireless phones, or they’re replacing dial-up phone lines for high-speed Internet connections. But a new type of competition is heating up, too. In Omaha, Neb., where Qwest’s predecessors U S West and Mountain Bell have provided phone service since the 1920s, half of the households now get their phone service from Cox Communications, a cable company. (In the Denver area, cable provider Comcast is preparing to introduce a new form of telephone service, voice over Internet Protocol, or VoIP, in 2005.)

This emerging wire line competition, plus the continuing erosion of Qwest’s phone business, has turned Notebaert into one of the industry’s most vocal proponents of deregulation, and one of its most zealous advocates of a technology transformation.

In September, Notebaert authorized Qwest attorneys to seek release from almost all Colorado phone-pricing regulations, except for base-level $14.95 per month phone rates. The request, which is being considered by the Colorado Public Utilities Commission, represented a surprisingly aggressive posture within an industry that historically has sought to win sparing, incremental regulatory freedoms. But Notebaert is adamant that the way Qwest is regulated has to change.

For one thing, he says the days of making solid profit margins on basic phone services are gone for good. In an interview, Notebaert rattles off the names of seven providers that deliver dial-tone service in the Denver-metro area. “The voice traffic on the traditional public switched telephone network is commoditized,” Notebaert says. “Qwest was the first to just come out and say that.”

Partly as a result, one of Notebaert’s first big initiatives at Qwest was to focus on service as a differentiating factor. The company’s phone-service performance had begun to improve in the Nacchio years from an abysmal record under U S West in the late 1990s, says Ken Reif, the director of Colorado’s Office of Consumer Counsel. But Notebaert went even further, making service-improvement efforts the central focus of Qwest’s transformation. Aiming to restore an internal cultural pride, he also went public, launching the “Spirit of Service” marketing campaign that celebrates the dedication of Qwest employees. Notebaert says Qwest’s service record still isn’t where he wants it to be. “I don’t want to mislead…we still make mistakes. We’re humans.” But his efforts have drawn praise. John Thompson, the outgoing president of the Communications Workers of America’s Colorado chapter, says Qwest, under Notebaert, has worked closely with the union to produce big improvements in Qwest’s service approach. “It was absolutely embarrassing. That’s changed,” Thompson says.

Recognizing that competition had produced a commodity environment also has prompted Notebaert to chase new markets. For instance, he wants unfettered freedom to pursue new digital services, like VoIP, with the same regulatory liberty that other providers enjoy. Riding atop new high-speed data networks Qwest and other providers have put into place, VoIP promises to provide more functionality at much lower cost than traditional phone calling. Qwest also is angling for a deeper presence in high-speed data service enhancements and in new digital phone features like unified messaging, which lets customers route phone calls and data messages to any number of devices they choose. In the world Notebaert sees emerging, customers value mobility and portability, and they enjoy a wider choice of providers than ever before.

But Notebaert says despite the onset of competition, Qwest has to abide by far more burdensome regulations than other providers, stunting its speed to market and its ability to compete. For instance, in Minnesota, where it’s first introducing VoIP service, Qwest has had to secure state authorization to offer the new Internet-based calling service. Other VoIP providers, such as the national upstart Vonage, generally do whatever they please. To Notebaert, phone industry regulations linger on needlessly even as the business has morphed from a monopoly environment to a highly competitive environment. Of course, not everyone agrees. Reif, from Colorado’s Office of Consumer Counsel, says federal efforts to provoke telecommunications competition have generally disappointed. And while wireless substitution of land lanes is a genuine trend, he says Qwest still maintains a dominant share of the state’s phone business: “For residential and small-business service, they have somewhere between 80 and 85 percent of the market, and I just don’t think you can determine that to be competitive.”

While he champions release from regulations, Notebaert also been quicker than peers to exploit some new technologies. Qwest was the first of the regional telephone companies to allow customers to buy its DSL high-speed Internet service even if they didn’t keep a Qwest residential phone line. The so-called “naked DSL” approach lets Qwest preserve a relationship with customers even if they’ve disconnected traditional phone lines. (Grinning, Notebaert says he’s proud of the term “naked DSL” that Qwest invented. “When we said ‘standalone DSL’ people just kind of glazed over,” he says.)

Qwest is also conducting some early experimentation with high-speed wireless networking technologies, dubbed WiMax, that may provide an efficient way to connect business and residential customers to the Internet or even to video-delivery networks. On the business front, too, Qwest has been an innovator. It was the first regional Bell company to sign a negotiated agreement to lease back portions of its network to a rival provider, MCI. Other industry leaseback agreements were force-fed by a now-defunct set of federal regulations that dictated prices and terms.

Those efforts have won back some fans among analysts who had previously been brutal as Qwest’s financial condition deteriorated. They’ve also helped to alter the perception of Qwest on a national scale: A New York Times headline in January proclaimed that Notebaert had “rescued Qwest.” And they’ve helped to lift Qwest’s reputation from a troubled industry also-ran to a technology innovator.

But none of the new initiatives has yet proven to be the home run Qwest needs to re-emerge as a growth company. After restating its 2000 and 2001 earnings to expose $2.54 billion in additional losses, Qwest reported a staggering loss of $38 billion in 2002, reflecting $40 billion in asset write-downs and accounting adjustments. Last year Qwest reported $1.2 billion in losses from ongoing operations. For 2004, Qwest could end up producing a modest positive cash flow. But through the first half of the year, the bleeding has continued. Not including special reserves set aside to pay settlement charges, Qwest reported an operating loss of $261 million for the first six months of the year as its revenue fell by 4.1 percent, to $6.9 billion, from a year earlier. There was some positive news, as erosion in phone lines eased during the second quarter, partly because AT&T retreated from the local phone business. Also, Qwest’s DSL, long-distance and wireless businesses are growing, and its new VoIP business is targeted to roll out to business customers in 26 markets by the end of the year.

But modest financial improvements hardly mean the company’s economic troubles are over. The legacy of profligate spending in the Nacchio era is nearly $16 million in debt – far more than carried by Qwest’s telephone industry peers on a debt-to-cash flow ratio – and Qwest’s stock price of less than $4 a share signals investors aren’t counting on a spectacular rebound anytime soon. In a particularly dour report earlier this year, Wall Street analyst Richard Klugman, of Jefferies & Co., theorized that Qwest is barely worth more than the debt it’s carrying.

Even so, there are at least signs of life at a company some had given up for dead. Notebaert and former Ameritech colleague Oren Shaffer, Qwest’s chief financial officer, have erased more than $10 billion in debt, avoiding a bankruptcy filing some thought was inevitable.

“I predicted they’d go bankrupt. I was wrong,” said Cleland, president of the market research firm Precursor Group. “I did not think Dick could pull a Houdini.”

Second act

Notebaert may have kept Qwest out of bankruptcy court, but the question now is whether the Qwest chairman can perform a second amazing feat by remaining competitive – and independent – in a fast-changing telecommunications environment.

An enormous debt load severely constricts Qwest from making big capital investments at precisely the same time other telcos – all of them substantially larger than Qwest in revenues and customers – are transforming their infrastructures to capitalize on new possibilities in video and data delivery. Emboldened by favorable court decisions and FCC rulings, Qwest’s larger industry cousins BellSouth, SBC and Verizon have all announced multi-billion dollar efforts to run high-capacity optical fiber networks to neighborhoods or individual households. The trio of Bell companies promise speed and performance capabilities that will allow them to deliver a full range of video, data and voice services – the much exalted “triple play” of the new telecommunications era. Verizon, for example, says it will be able to sling TV programs and super high-speed Internet services to more than 1 million homes by the end of this year. Fast fading is the tradition of a separate provider for telephone calls, a separate provider for TV signals, and a separate provider for wireless services. The battle now is to bundle everything up in one bill, from one company, and the ensuing skirmishes already are tense. Notebaert, for instance, is livid over what he says is Comcast’s refusal to accept TV ads from Qwest promoting its high-speed Internet service, which competes with Comcast. Cable providers, meanwhile, are grappling for market share with satellite TV and telephone intruders. In short, it’s war. “In every single product today we have competition like we’ve never seen,” says Marwan Fawaz, the chief technology officer of the Denver-based cable company, Adelphia Communications.

 Within that environment, Notebaert remains somewhat of a lonely figure. He is the only CEO among the four regional Bell operating companies without an expansive wire line video play, and without ownership of his own wireless network. (Qwest sold its wireless network assets to Verizon this year for $418 million, and now resells wireless service in a partnership with Sprint.) Although Qwest continues to operate a video delivery network in Phoenix, and is allied with DirecTV in reselling satellite TV service, Notebaert says he won’t spend shareholder money to build out super-fast, video-capable fiber optic networks to every home. “To go into Cherry Creek, for example, and just run fiber to every home, the economics don’t work,” says Notebaert. But even if they did, it’s unlikely Qwest could pursue a triple-play strategy over its own facilities. With its stock languishing and long-term debt already high, Qwest simply can’t afford to spend the $500 per household or more that enriched fiber-to-the-home networks will gobble up.

For sale?

Where does that leave Qwest? In the eyes of many, awaiting an acquisition by a larger, better-capitalized telecom player. Notebaert acknowledges that further consolidation in the telecommunications market is inevitable. He sees the current landscape collapsing to the point where only three or four dominant telecommunications providers remain from a pool that now includes BellSouth, MCI, SBC, Sprint, Verizon and Qwest. “There’s just not enough room. There are not enough customers to chase,” says Notebaert. “I mean, that’s just a fact.”

Does that mean Qwest is for sale? Notebaert answers with a qualified “maybe.” 

“There are three scenarios,” Notebaert says. The first is that Qwest continues to operate as an independent company, advancing its VoIP and data services and continuing partnerships with the likes of DirecTV for video and Sprint for wireless telephony. The second – rarely talked about – is that Qwest itself might grow by acquisition. The company made a $390 million bid this year for Allegiance Telecom, a regional provider.

The third option: “We could be acquired,” says Notebaert. But the man who prepared Ameritech for its 1998 sale to SBC says Qwest is focused squarely on scenario one. “If you aren’t running good, you probably won’t have a chance at the other two strategies,” Notebaert says. Still, he doesn’t discount the possibility of a larger provider swallowing up Qwest and its 16 million customers. “We’ve got our ear to the ground and we talk to a lot of people,” he says.

Some Qwest-watchers believe that in a market environment that demands a new round of capital spending to compete, the only sensible outcome for Qwest is a sale. But they wonder if the company is likely to attract a mate at all. Precursor Group’s Cleland says he sees little rationale for anybody to bid on Qwest anytime soon. “Why do you buy something? You buy something because it has growth,” says Cleland. “If you’re not growing, it’s very difficult.”

 Still, the recent settlement of a longstanding SEC investigation – Qwest agreed in October to pay $250 million to settle charges, without admitting wrongdoing – could be the action that prompts prospective suitors to take a fresh look at Qwest. There has been some speculation that Sprint, which has been working to grow its local phone operations and is partnered with Qwest in the wireless market, may be a candidate. If a deal does happen with the Kansas-based Sprint, or any other outside company, it could mark the end of Colorado’s long run as a corporate headquarters for the region’s dominant phone company. In some form – Mountain Bell, U S West or Qwest – the phone company has called Denver its home for more than 100 years. The possible departure of Qwest from the Denver corporate community would have a big impact. “Qwest is an important player in the state of Colorado,” says Reif. “They’re a huge employer, they’re a big force in the community, and Notebaert has strengthened that dramatically.”

But right now, history is the least of Notebaert’s concerns. “Forget the past,” says Notebaert, invoking a favorite analogy. “Let’s look to the future, out the windshield, and let’s figure out where we’re going.”

 Until a deal happens – if it happens at all – he’ll continue what he came to Qwest to do: Settle the legal problems, pursue a deregulation agenda and further the company’s transition to a digital world. That, and keep handing out wristbands.