In view of the legal wrangles, what information policy should Qwest pursue?

UV3887 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) By the end 2002, Qwest Communications, Inc. (Qwest)a major U.S. communications companywas reaching a precarious level of illiquidity in the face of debts totaling $24.5 billion. Qwest sales had fallen by 22% from $19.7 billion in 2001 to a predicted year-end figure of $15.4 billion. Although the company's operating income was predicted to be positive by the end of 2002, the investment community was expecting major write-downs, placing its net loss at more than $15 billion. During the previous year, the company enjoyed operating income of $2.0 billion, while posting a net overall loss of $4.0 billion (see selected financial data in Exhibit 1). Qwest's market capitalization had shrunk considerably as its stock price had declined from $40.875 in 2000 to $14.24 in 2001 to $4.84 in 2002, yielding an aggregate market value of approximately $8.3 billion in December 2002. (For information on Qwest's stock, see Exhibit 2.) In hope of reducing its debt, on November 20, 2002, Qwest offered its institutional investors the chance to exchange $12.9 billion in unsecured bonds in Qwest's subsidiary, Qwest Capital Funding (QCF), for new senior subordinated secured notes. Individual bondholders holding the remaining $100 million of QCF bonds were excluded from the offer, which was set to expire on December 20, 2002. At the time of the offer, bondholders had no reliable data on Qwest's financials, as the company was restating its balance sheet information in the midst of a Securities and Exchange Commission (SEC) investigation into its accounting practices. On December 18, 2002, the swap offer cleared a final hurdle when a U.S. District Court in New York denied a motion by individual bondholders to stop the swap. History1 Qwest Communications first came into prominence when it was purchased by Philip Anschutz, a well-known businessman who had realized his first successes in the oil industry. Anschutz purchased Southern Pacific Rail in 1988 and formed Southern Pacific Telecommunications (SPT), laying down fiber-optic cable along railway lines. By the early 1 Qwest Corporate Capsule, Hoovers, http://www.hoovers.com (accessed 17 December 2004). This case was prepared by Matthias Hild, Assistant Professor of Business Administration, with the assistance of Jordan Mitchell. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. -2- UV3887 1990s, SPT was offering long-distance and switching phone services. Anschutz saw the opportunity to include Qwest Communications in his telecommunications portfolio with the intention of building a fiber-optic network spanning the entire country. In 1997, Qwest hired a former AT&T executive, Joseph Nacchio, to lead the company. Under Nacchio's leadership, Qwest went public in 1997 and entered into several new lines of business with major acquisitions such as the long-distance reseller Phoenix Network, the longdistance provider LCI International, and the European Internet service provider EUnet. The largest acquisition came in 2000, when Qwest purchased US West, a local fixed-line phone provider in 14 states. To meet with regulatory approval, Qwest agreed to sell off its long-distance providers in those 14 states. One year later, Qwest embarked on a major restructuring effort, laying off 11,000 people16% of its employee base. By 2002, Qwest had approximately 25 million local phone-service customers in 14 states and had become the fourth-largest long-distance company in the country behind AT&T, MCI, and Sprint. By using its network, Qwest was able to offer a wide range of services, including broadband data, voice, video services, and wireless access. In late 2002, Qwest sought approval from the Federal Communications Commission (FCC) to offer long-distance services in some of the states where it owned local line networks. By 2002, the U.S. economy was suffering, and growth had halted in the telecommunications industry. In response, Qwest delayed expansion of its network, cut 25% of its employee base, and sold Qwest Dex, a phone-directory business, for $7 billion, along with other assets. Spurred by the accounting scandals at Enron, Global Crossing, and WorldCom, the SEC started to review the Qwest's practice of posting revenues on assets exchanged with other telecom companies. While it had been common practice since 1975 for telecom companies to exchange assets such as minutes of voice traffic with one another, it had only been since the late 1990s that some companies recorded revenues from these transactions.2 Shortly after Richard Notebaert replaced Joseph Nacchio as Qwest's CEO in June 2002, Qwest reversed $950 million in revenues from such transactions. Bond-Swap Offer In an attempt to reduce its debt, Qwest management, with the help of six investment banks, created a plan to swap a selection of older bonds for newer bonds with a lower face value and a more advantageous maturity schedule. The older bonds were unsecured and registered under Qwest's wholly owned company called Qwest Capital Funding (QCF). Approximately 12% of the old bonds had a 30-year maturity and were originally issued by US West in 1998. At the time, US West offered what many people believed to be a stable investment, as the bonds gave a solid yield of 6.9% per year for a 30-year term. As one observer described them, \"They 2 Dennis Berman, Julia Angwin, and Chip Cummins, \"What's Wrong?\" Wall Street Journal, 23 December 2002, A1. This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. -3- UV3887 were ideal investments for widows and orphans.\"3 At the time, US West had broken a record by selling $1.5 billion of these bonds, making it the largest long-term bond issue in U.S. history up to that point. When Qwest took over US West in 2000, the company assumed the bonds as part of deal. Exhibit 3 shows Qwest's total long-term borrowings, and Exhibit 4 outlines Qwest's credit ratings from various agencies. The new bonds to be issued were to be senior subordinated secured notes with registration under both Qwest Corporation and Qwest Services Corporation (QSC). In its filing on November 20, Qwest requested that institutional investors exchange $12.9 billion of their existing $1,000 bonds for new bonds with a face value of $545, ranging in maturity dates and discount rates (Exhibit 5). The offer was set to expire on December 20, 2002 and excluded the individual bondholders who owned the remaining $100 million of bonds. Judicial Challenge At the time of the offer, Qwest could not provide audited financial reports, as it had recently made major changes to its historical numbers (Exhibit 6). A subgroup of institutional bondholders who collectively owned approximately $4 billion of Qwest's bonds launched a lawsuit against the company arguing that Qwest's bond-swap offer was fraudulent and coercive. Qwest maintained that it could not be penalized for information that was not available at the time. Qwest's management also believed that companies did not typically \"owe a fiduciary duty to bondholders\" and issued the following statement: \"The restated information and other information we intend to include in future SEC filings is not available at this time, and were it available, could be material to your decision whether or not to participate in the exchange offer.\"4 On December 18, 2002, Judge Denny Chin in U.S. District Court in New York denied the bondholders' motion and allowed Qwest to continue with the bond-swap offer. The judge believed that the bondholders had failed to prove that the swap would inflict \"irreparable harm\"5 and commented: \"The issue isn't whether the offer is fair or good to bondholders.\"6 In response to claims that Qwest was not divulging specific and vital financial information, Judge Chin said, \"I think this is a case where the egg can be unscrambled.\" The judge believed that if fraud were uncovered in the future, the bondholders could seek to recover damages by performing retroactive calculations on the bond swap.7 After the court's decision, bondholders had two days to accept Qwest's offer before it expired. 3 Floyd Norris, \"A Bond Swap Available Only to Big Players,\" New York Times, 18 December 2002, 1. Norris. 5 \"Qwest Says Bondholders Drop Complaint on Debt Swap,\" Reuters News, 20 December 2002. 6 Kris Hudson, \"Qwest Can Proceed on Bond Plan,\" Denver Post, 19 December 2002, C02. 7 Chris Nolter, \"Judge Won't Halt Qwest Bond Swap,\" Daily Deal, 19 December 2002. 4 This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -4Exhibit 1 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Selected Financial Data BALANCE SHEET Assets Cash & Equivalents Receivables Net Inventories Other Current Assets Total Current Assets Long Term Receivables Investments in Unconsolidated Subsidiaries Other Investments Property, Plant & Equipment - Gross Accumulated Depreciation Property, Plant & Equipment - Net Other Assets Total Assets Liabilities Accounts Payable ST Debt & Current Portion Due LT Debt Accrued Payroll Income Taxes Payable Dividends Payable Other Current Liabilities Total Current Liabilities Long Term Debt Provision For Risks And Charges Deferred Taxes Other Liabilities Total Liabilities Shareholders' Equity Minority Interest Preferred Stock Common Equity Total Liabilities & Shareholders' Equity Common Shares Outstanding 12/31/1999 12/31/2000 12/31/2001 (Dollars in millions) $ 349.20 1,158.80 n/a 277.20 1,785.20 0.00 680.00 120.00 4,468.90 360.20 4,108.70 4,364.20 $ 11,058.10 $ 154.00 4,235.00 275.00 712.00 5,376.00 0.00 8,186.00 0.00 48,318.00 22,735.00 25,583.00 34,356.00 $ 73,501.00 $ 257.00 4,502.00 377.00 621.00 5,757.00 0.00 1,400.00 0.00 55,099.00 25,122.00 29,977.00 36,647.00 $ 73,781.00 $ 209.90 1.40 n/a n/a 0.00 1,027.10 1,238.40 2,368.30 n/a 106.70 288.20 $ 4,001.60 $ 2,049.00 3,645.00 644.00 n/a 0.00 3,555.00 9,893.00 15,421.00 2,735.00 1,768.00 2,380.00 $ 32,197.00 $ 1,262.00 5,073.00 319.00 517.00 0.00 2,818.00 9,989.00 20,197.00 2,923.00 2,194.00 1,823.00 $ 37,126.00 55.20 0.00 7,001.30 11,058.10 0.00 0.00 41,304.00 73,501.00 0.00 0.00 36,655.00 73,781.00 750.00 1,672.22 1,663.55 This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -5Exhibit 1 (continued) INCOME STATEMENT Sales Cost of Goods Sold Depreciation, Depletion & Amortization Gross Income Selling, General & Admin Expenses Other Operating Expenses Total Operating Expenses Operating Income Extraordinary CreditPretax Extraordinary ChargePretax Non-Operating Interest Income ReservesInc (Dec) Pretax Equity Interest Earnings Other Income/ExpenseNet Earnings Before Interest and Taxes Interest Expense on Debt Interest Capitalized Pretax Income Income Taxes Net Income Before Extraordinary Items and Disc Ops Extraordinary Items & Gain (Loss) Sale of Assets Net Income Before Preferred Dividends Net Income Available To Common 12/31/99 12/31/00 12/31/01 (Dollars in millions) 3,927.60 $ 16,610.00 $ 19,695.00 2,159.10 5,433.00 7,111.00 404.10 3,342.00 5,335.00 1,364.40 7,835.00 7,249.00 1,009.30 4,260.00 5,231.00 0.00 0.00 0.00 3,572.50 13,035.00 17,677.00 355.10 3,575.00 2,018.00 n/a n/a n/a 31.50 2,669.00 4,499.00 n/a 0.00 0.00 0.00 0.00 0.00 n/a n/a n/a 410.90 261.00 (35.00) 734.50 1,167.00 (2,516.00) 204.10 1,192.00 1,629.00 53.10 151.00 187.00 583.50 126.00 (3,958.00) 125.00 207.00 0.00 $ $ 458.50 0.00 458.50 458.50 $ (81.00) 0.00 (81.00) (81.00) $ (3,958.00) (65.00) (4,023.00) (3,958.00) Source: http://www.sec.gov (accessed 17 December 2004). This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -6Exhibit 2 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Qwest's Stock Information Qwest's Stock Chart (Dec 1999 to Dec 2002) 60.000 40.000 30.000 20.000 Stock Price Close 50.000 10.000 12 / 31 / 2/ 19 25 99 4/ /20 28 00 6/ /20 30 00 8/ /20 0 2 10 5/2 0 /2 00 12 7/2 0 /2 00 0 9 2/ /20 23 00 4/ /20 27 01 6/ /20 29 01 8/ /20 31 01 10 /2 /2 00 11 6/2 1 /3 00 0/ 1 1/ 20 25 01 3/ /20 29 02 5/ /20 31 02 7/ /20 26 02 9/ /20 0 2 11 7/2 2 /2 00 9/ 2 20 02 0.000 This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -7Exhibit 3 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Long-Term Borrowings Long-term Borrowings 2001 2000 (Dollars in millions) Qwest Corporation: Notes with various rates ranging from 4.375% to 9.125% and maturities from 2003 to 2043 Maturity in 2003 Maturity in 2004 Maturity in 2005 Maturity after 2005 Unamortized discount and other Capital lease obligations and other Qwest Communications Corporation: 7.25% Senior Notes due in 2007 Unamortized discount and other Capital lease obligations and other Qwest Capital Funding: Notes with various rates ranging from 5.875% to 7.900% and maturities from 2002 to 2031 Maturity in 2004 Maturity in 2005 Maturity after 2005 Unamortized discount Qwest Communications International Inc.: 7.50% Senior Notes due in 2008 7.25% Senior Notes due in 2008 Unamortized discount and other Senior Notes with various rates ranging from 8.29% to 10.875% and maturities from 2007 to 2008 Notes payable to Qwest Digital Media Note payable to Anschutz Digital Media Other: Capital lease obligations Total long-term borrowings unsecured 5,817 1,177 866 457 3,194 (122) 86 6,177 350 (13) 50 350 (14) 26 13,000 1,250 500 6,800 (39) (17) secured secured 750 300 (35) 750 300 (40) secured 33 34 1,016 85 34 19 20,230 4 15,541 secured unsecured (125) 195 Source: Qwest Corporation and Quest Communications Corporation Annual Reports 2002, http://www.sec.gov (accessed 17 December 2004). This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -8Exhibit 4 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Credit Ratings Corporate Rating Qwest Corporation Qwest Services Corporation Qwest Communications Corporation Qwest Capital Funding, Inc. Qwest Communications International Inc. December 2001 Moody's S&P Fitch NA BBB+ NA A2 BBB+ A NA NA NA Baa1 BBB+ BBB+ Baa1 BBB+ BBB+ December 2002 Moody's S&P Fitch NA B- NA Ba3 B- B NR CCC+ NR Caa1 CCC+ CCC+ Caa2 CCC+ CCC+ Baa1 Caa1 BBB+ BBB+ CCC+ CCC+ A rating of NA means \"not applicable\"; \"NR means \"not rated.\" Moody's: With respect to Moody's, a Ba rating is judged to have speculative elements, meaning that the future of the issuer cannot be considered to be well assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times. Issuers with Caa ratings are in poor standing with Moody's. Those issuers may be in default, according to Moody's, or there may be present elements of danger with respect to principal and interest. The \"1,2,3\" modifiers show relative standing within the major categories, 1 being the highest modifier in terms of credit quality. S&P: With respect to S&P, any rating below BBB indicates that the security is speculative in nature. A B- rating indicates that the issuer currently has the capacity to meet its financial commitment on the obligation, but adverse business, financial or economic conditions will likely impair the issuers' capacity or willingness to meet its financial commitment on the obligation. A CCC+ indicates that the obligation is currently vulnerable to nonpayment and the issuer is dependent on favorable business, financial and economic conditions in order to meet its financial commitment on the obligation. The plus and minus symbols show relative standing within the major categories. Fitch: With respect to Fitch, any rating below BBB is considered speculative in nature. A B rating is considered highly speculative, meaning that significant credit risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment. A CCC+ rating indicates default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic developments. The plus and minus symbols show relative standing within major categories. Source: Qwest Annual Report 2002, http://www.sec.gov, December 31, 2002, p. 131. This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. -9- UV3887 Exhibit 5 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Filing for Bond Swap with SEC QWEST COMMUNICATIONS INTERNATIONAL INC. ANNOUNCES PRIVATE DEBT EXCHANGE OFFER FOR $12.9 BILLION OF DEBT SECURITIES OF QWEST CAPITAL FUNDING, INC. DENVER, November 20, 2002Qwest Communications International Inc. (NYSE: Q; QCII) announced today that it has commenced a private offer to exchange $12,902,653,000 aggregate principal amount of outstanding debt securities of Qwest Capital Funding, Inc. (QCF), a wholly-owned subsidiary of QCII, in a private placement for new debt securities. The new securities include up to $4,000,000,000 of new senior subordinated secured notes of Qwest Services Corporation (QSC), a wholly owned subsidiary of QCII. To the extent the offer of new QSC notes is oversubscribed, new senior secured notes of QCII will be issued. The offer is made only to qualified institutional buyers and institutional accredited investors inside the United States and to non-U.S. investors located outside the United States. The purpose of this private exchange offer is to reduce outstanding indebtedness and extend some near-term debt maturities. The new QSC notes to be issued in this offer will be senior subordinated secured obligations of QSC (new QSC notes), secured by a junior lien on QSC's assets that secure its bank debt, principally the capital stock of Qwest Corporation. To the extent that the offer of new QSC notes is oversubscribed, tendering eligible holders of the existing QCF notes will receive new QSC notes on a prorated basis. The remaining portion of tendering eligible holders' existing QCF notes will be exchanged for new QCII notes that will have the same principal amount, coupon and maturity date as their existing QCF notes. In addition, the new QCII notes will be secured by a first lien on the stock of QSC. The offer will expire at 11:59 p.m., New York City time, on December 20, 2002, unless extended. The offer is subject to certain conditions as described in the confidential offering memorandum. This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. UV3887 -10Exhibit 5 (continued) The table below lists the series of QCF notes that are the subject of the offer as well as the series of new QSC notes to be issued in the offer subject to proration. For Each $1,000 Principal Amount of Existing QCF Notes: Outstanding Aggregate Principal Amount 1,250,000,000 500,000,000 1,250,000,000 583,839,000 1,984,990,000 1,745,885,000 2,250,000,000 393,370,000 477,850,000 1,476,889,000 989,830,000 Existing QCF Notes to be Exchanged 5.875% 6.250% 7.750% 6.375% 7.000% 7.900% 7.250% 6.500% 7.625% 6.875% 7.750% Notes due 2004 Notes due 2005 Notes due 2006 Notes due 2008 Notes due 2009 Notes due 2010 Notes due 2011 Debentures due 2018 Notes due 2021 Debentures due 2028 Notes due 2031 Amount of New QSC Notes 825 750 680 625 635 640 635 525 540 545 545 New QSC 13.0% Notes due 2007 New QSC 13.0% Notes due 2007 New QSC 13.0% Notes due 2007 New QSC 13.5% Notes due 2010 New QSC 13.5% Notes due 2010 New QSC 13.5% Notes due 2010 New QSC 13.5% Notes due 2010 New QSC 14.0% Notes due 2014 New QSC 14.0% Notes due 2014 New QSC 14.0% Notes due 2014 New QSC 14.0% Notes due 2014 Each of the New QSC 13.0% Notes due 2007, the New QSC 13.5% Notes due 2010, and the New QSC 14.0% Notes due 2014 is a separate series of debt securities which will have its own CUSIP numbers. Each series of New QCII Notes is a separate series of debt securities which will have its own CUSIP numbers. Accrued interest up to but not including the settlement date will be paid in cash on all validly tendered and accepted QCF notes. The new QSC notes and new QCII notes have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. QSC and QCII will enter into a registration rights agreement pursuant to which they will agree to file an exchange offer registration statement with the Securities and Exchange Commission with respect to the new QSC notes and new QCII notes. Source: SEC Web site, http://www.sec.gov (accessed 19 December 2004). This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016. -11- UV3887 Exhibit 6 QWEST COMMUNICATIONS BOND-SWAP OFFER (A) Qwest Filing to SEC Notification of Late Filing As announced in its press releases, each filed as an Exhibit to Forms 8-K filed on July 29, 2002, August 8, 2002, September 23, 2002, and October 29, 2002, earlier this year Qwest Communications International Inc. (\"the Company\") and its board of directors began an analysis of, among other things, revenue recognition and accounting treatment for optical capacity asset sales (particularly sales to customers from which the Company agreed to purchase optical capacity assets), the sale of equipment by the Company to certain customers and certain accounting policies and practices with respect to its Qwest Dex, Inc. (\"Qwest Dex\") directories business, including, among other things, the changes in the production schedules and lives of some of its Qwest Dex directories. The Company expects that it will restate prior periods as a result of its determination that certain accounting policies may have been inappropriately applied and certain transactions were recorded incorrectly. These releases also gave updates on the status of investigations by regulatory agencies, the Company's internal review and the audits and reviews by the Company's external auditors, KPMG LLP (\"KPMG\"). As all restatement matters are subject to audit by KPMG, the Company can give no assurance that all adjustments necessary to present its financial statements in accordance with generally accepted accounting principles have been identified as of the time of this filing. Accordingly, the Company cannot state with certainty when a restatement will be completed, and consequently, the Company is not in a position to timely file its Quarterly Report on Form 10-Q. The Company will file its Quarterly Report on Form 10-Q for the third quarter ended September 30, 2002 when (1) its restatement is complete, (2) KPMG has completed a re-audit of the relevant periods, and (3) the Company's chief executive officer and chief financial officer are able to make the certifications required by Section 302 of the Sarbanes-Oxley Act. The Company cannot state with certainty when these events will be completed. Source: SEC Web site, http://www.sec.gov (accessed 19 December 2004). This document is authorized for use only in B6261 - T3 (2015-2016) by Assoc Prof Tan Kok Hui, Nanyang Technological University from February 2016 to July 2016