Rumors have swirled in recent weeks that Qwest Communications might get taken out by a smaller LEC.  Most of the speculation has pointed to either CenturyLink or Windstream as the most likely buyer, though analysts also pointed out that both companies are still digesting recent acquisitions, and it’s unlikely that either one would make a move in the near-term.

An analysis indicates that the company could be worth upwards of $24b, based on a discounted cash flow analysis—but over time negative trends in connections could put additional pressure on our conclusion, which further highlights the company’s need to do something.

I agree with most analysts that Qwest has largely done what it can to contain costs and that its underlying business faces serious challenges—in the 12 months ended September 30, 2009, Qwest lost 11% of its voice connections and revenue had fallen to $12.6b from nearly $13.5b in calendar year 2008.  But the company recently said that cash flow for 2009 would come in at around$4.4b, the high end of its previously released guidance, and its cash balances are now in excess of $2b.  So what should Qwest do next?

I am taking a longer-term view than most analysts when pondering this question, and my answer is…not only should all three companies—Qwest, CenturyLink and Windstream—get together, but they might want to consider throwing Sprint Nextel into the stew as well.

AT&T and Verizon Communications have been taking over the United States telecom world with their dominant wireline, wireless and fiber operations.  Cable companies like Comcast and Cox are trying to stay in the game on the backs of their established video offerings and generally faster broadband connections, but to date they have little going on with wireless.

As AT&T and Verizon get their 4th generation wireless networks deployed over the next few years, there will be few places where consumers don’t have at least one of these two providers as an option.  In order to compete, communications service providers are going to have to match—or at least come darn close to— the service bundles and pricing offered by AT&T and Verizon.  In my mind, that means including wireless.

All four of these companies face challenges—in particular Qwest and Sprint are heavily leveraged.  But, based on year end share prices and 3Q09 debt levels, the four companies had a combined market cap in the neighborhood of $83b, comprised of about 60% debt and 40% equity. Revenue (adjusted for Windstream’s pending acquisitions) would be about $56.4b and OIBDA of$16.3b—but I bet synergies here could be significant over time.

By way of comparison, AT&T had a market cap of $240b and Verizon’s was $157b, and revenue for each was more than double that of our hypothetical roll up—meaning, I think, that the Justice Department wouldn’t object too much to the deal.

I am not saying, necessarily, that all of these companies will merge in the near future…but if we’re going to speculate about future combinations, then why not?  It might just work.