Will Directories Make LBO Connection? –

Two weeks and counting.

That’s the amount of time that industry experts are giving Qwest Communications Inc. to sell off its directories unit before the deal succumbs to a combustible mishmash of accounting, regulatory and legal pressures. It’s also a period in which the fates of alternate yellow pages offerings from such incumbent telcos as Sprint Corp. and Bell Canada could be determined.

“I really think that the Qwest sale could fall apart if they can’t get it done by July 31,” says Greg Gorbatenko, a telecom analyst with Loop Capital Markets. “Even if it does go through, I believe that Qwest restating its earnings [by $1 billion] must affect the transaction price and, consequently, the transaction price of future directories deals.”

Denver-based Qwest originally put its directories unit, named Qwest Dex, on the block in May as part of a desperate restructuring aimed at adding some black to its reddening balance sheet. Like most other yellow pages publishers, Qwest Dex is viewed as a business whose lack of top-line growth is more than offset by its consistent profit production at high margins. It is also the fourth-largest yellow pages publisher in North America based on publishing revenue, with 2001 Ebitda of $700 million.

The deal was pitched with an $8 billion to $10 billion price tag, which could make it the second-largest leveraged buyout in history if it is consummated at more than $8.4 billion, that is. Official bids were accepted through July 12, at which time Dow Jones reported that a pair of LBO syndicates made offers at undisclosed prices. One group is said to have included The Carlyle Group, J.P. Morgan Partners, Madison Dearborn Partners and Welsh, Carson, Anderson & Stowe. The other involved Bain Capital, The Blackstone Group, Providence Equity Partners and Thomas H. Lee Partners.

Bid prices were still unknown at press time, and the company is staying mum as to whether it would accept a final price below its expensive range, or if it would hold onto its Qwest Dex cash cow in order to hedge against the possibility of additional accounting scandals or criminal litigation. Moreover, the company also has not commented on its supposed desire to sell Qwest Dex in two pieces, split unevenly to satisfy various balance sheet obligations – a plan that sources say isn’t gaining investor traction because the smaller piece (estimated at $2 billion) is not rich enough to satisfy an entire quartet of top-tier buyout investors.

Sprint To The Finish

The net result, then, is that investors from at least one of the two active syndicates is going to be left without a piece of a directories market that it has spent the past three months getting hot over. A likely scenario is that the losing syndicate breaks apart, with one or two firms bidding on the smaller piece and the remaining firms getting involved in other yellow pages deals.

To be sure, there are plenty of deals to choose from in this space. Market research firm Simba Information Inc. is anticipating more than $13 billion in domestic yellow pages M&A activity in 2002, which is up nearly 400% from the $3.3 billion of activity in 2001, and well over twice the $6.2 billion and $6 billion the sector raised in 2000 and 1999, respectively.

The largest non-Qwest offering on the table right now comes from Sprint, which is trying to unload its Sprint Publishing & Advertising group (SPA) for approximately $2 billion. The group is the sixth-largest North American yellow pages publisher, according to Simba Information rankings based solely on publishing revenue.

Like Qwest, Sprint is being forced into the deal by spiraling financial fortunes, although the company has yet to see its stock price flirt with $1 per share or have its executives referred to as future prison inmates.

“Sprint is in very bad shape because its commercial paper has dried up and the capital markets have tightened on it,” says Loop Capital Markets’ Gorbatenko. “They’re seeing what AT&T saw when it had to really crank up the spread to get a decent debt deal done, and the long distance business of [Sprint] has really fallen apart as the Baby Bells get greater [regulatory] approval.”

The SPA offering is attractive in part because the Sprint directory business encompasses greater geographical diversity than do groups like Qwest Dex. According to the Yellow Pages & Directory Report, a number of private equity firms have already expressed interest in SPA, including Clayton, Dubilier & Rice, Kohlberg Kravis Roberts & Co. and Texas Pacific Group, which was rumored to be in the hunt for Qwest Dex after having bought the Findexa directory arm of Norway’s Telenor SA last year. The trade publication also reports that Hicks, Muse, Tate & Furst and Apax Partners, which last May bought British Telecom directory business Yell for approximately $3 billion, also have submitted bids for the Sprint division.

It is also possible that the SPA deal will ultimately go to a strategic player rather than a pure buyout shop, such as R.H. Donnelley or Thomas H. Lee Partners-controlled TransWestern Publishing. “R.H. Donnelley probably has a bit of an edge because it has an existing sales relationship with SPA, but anything is possible,” explains Cindy Szabo, senior editor of Yellow Pages & Directory Report.

The final directories offering currently in the market also comes from a telecom company looking for added liquidity, albeit for completely different reasons than either Qwest or Sprint.

The new deal is the endgame of Ameritech’s 1998 decision to purchase 20% of Bell Canada from Canadian telecom giant BCE Inc. After Dallas-based SBC Communications bought Ameritech earlier this year, BCE moved to regain its stake via a $4.3 billion repurchasing plan. In order to secure part of the needed capital, BCE has proposed selling off its directories business for between $1 billion and $2 billion.

Ranked seventh on Simba’s North American yellow pages publisher rankings, the BCE unit named Bell ActiMedia will be sold either on the traditional M&A market or via an asset-backed securitization.

In a Thomson/First Call report on the repurchasing plan, CIBC World Markets analyst Dvai Ghose supported the securitization option, although he did not make any predictions. “BCE’s… financing plan should at worst be only slightly negative on EV to Ebitda multiples and on EPS if BCE decides that Bell Canada should sell its directories business outright,” he writes. “The overall transaction could be slightly accretive to EPS if BCE chooses to monetize Bell Canada’s yellow pages through an asset-backed loan, rather than an asset sale.”

The deal is expected to occur sometime in the third quarter.

Will There Be More?

Although there are no indications of future directories sales from relatively healthy incumbents like Verizon or BellSouth, it’s possible that the price may be right if groups like Qwest Dex hit their upper targets.

“A lot of people are getting educated about this space, and you may see some of the incumbents sell just because of how high some of these deals are getting done,” suggests Salem Shuchman, general partner with Yell directories buyer Apax Partners.

But not everyone agrees.

“It’s somewhat difficult because the yellow pages provide a significant portion of the operating cash flow for many of the telcos,” argues Benjamin Coughlin, a principal with Spectrum Equity Investors, owner of directory publisher CBD Media (which recently purchased Cincinnati Bell). “Assuming the telco doesn’t have financial constraints, I doubt you’ll see many more outright sales to private financial firms.

Coughlin adds that he believes the future of yellow pages M&A may lie with local media companies scooping up smaller independent directories businesses. “For now I expect to keep seeing larger guys picking up the smaller independent directories, but in the next couple of years you may see other media organizations like newspapers and outdoor advertising firms begin to look at the market.”