In an effort to determine whether Level 3 Communications (NYSE:LVLT) is turning around, it’s important to look at where they have been, giving a better insight into management and the business. This article gives an overview of the history then the numbers, followed by an opinionated summary.
Level 3 was originally founded in 1985 as Kiewit Diversified Group Inc. (KDG), a wholly-owned subsidiary of Peter Kiewit Sons, Inc. In early 1998, KDG announced it was changing its name to Level 3 Communications, Inc. On April 1, 1998, Level 3 common stock started trading on the NASDAQ stock market under the symbol LVLT.
During 1998, Level 3 raised $14 billion. The company constructed 19,600 route miles, and built the world's first continuously upgradeable network fully optimized for internet protocol.
Level 3 Communications was founded on the principles of the "Silicon Economics": Create a global telecommunications network with the scale to reduce unit costs, stimulate demand with these lower costs, support that demand by scaling even more. The concept seemed simple enough; in the 1998 annual report, management said the following in terms of “The Right Question”:
The question that is often asked is, “With so many companies building networks, is there going to be a glut of bandwidth or capacity?” If you locked in today’s price for bandwidth, there might be a glut – but that’s the wrong question. The question should be, “At what price for bandwidth is there a glut?” We and others believe that as you drop the price of communicating, demand increases even faster. At the right price you can’t have too much bandwidth.
LVLT became a Wall Street darling, the stock soaring to $132 on March 10, 2000, but problems loomed large. The internet bubble burst and companies with massive debt and no earnings started to collapse. Some of LVLT’s competitors declared bankruptcy then emerged as stronger competitors via strengthen balance sheets (see, for example, Global Crossing).
Businesses pulled back on spending and over the next few quarters it was becoming obvious there was a bandwidth capacity glut caused by a serious overinvestment in long-haul network capacity leading to extreme price declines that fueled bankruptcies. More devastating was that management’s premise of “The Right Question” was wrong, and with debt approaching a crushing eight billion dollars, no earnings, or positive free cash flow, LVLT went into survival mode. The Asian assets were sold. They increased top line growth with the acquisition of Genuity in 2003. Over the next few years, and through a major industry downturn, Level 3 pursued a strategy that focused on both the balance sheet and investing for a much hoped for industry rebound.
Beginning with the late-2005 acquisition of WilTel, Level 3 has established itself as an industry consolidator. During 2006, the company went on to acquire Progress Telecom, ICG, TelCove and Looking Glass Networks. In 2007, Level 3 acquired Broadwing, the Content Delivery Network services business of SAVVIS, Inc. and Servecast. It looked as if the company was turning the corner but underneath the company was experiencing major problems absorbing acquisitions such as:
- Experiencing an increase in the time it took to activate service for customers, hurting revenue growth.
- The company was taking longer to resolve customer network service issues.
- The company didn't have adequate provisioning capability to convert orders to revenue.
- The company lacked adequate internal controls.
As the problems became public the stock plunged to about $1, then on March 10, 2008 ,Kevin O’Hara, president, COO and co-founder, resigned without notice. Jeff Storey was brought in as president and COO. The problems were fixed but not without cost. LVLT‘s revenue declined at a time it could least afford it.
Today, as a result of financial engineering, LVLT has avoided the fate of many competitors - bankruptcy - but at a cost of massive stock dilution and a stock price that slipped under $1 for long enough that they received notice from Nasdaq on November 3, 2010 (advising them that for 30 consecutive trading days preceding the date of the notice, the bid price of the company's common stock had closed below the $1.00 per share required for continued listing). If compliance with the Minimum Bid Price Rule cannot be demonstrated by May 2, 2011, Nasdaq will provide written notification to the company that the company's common stock is subject to delisting. To date the price has been trading above $1 and the company has authorized a reverse split that the board can impose if necessary.
Where does the company go from here? Is the bandwidth glut over or ending? There are a lot of opinions out there, especially with the explosion of video, but I would argue that if the glut is over it should start showing up in LVLT’s results. Management has stated they expect revenues to grow at a sequential rate per quarter of two percent or better on a sustained basis. Not an impressive growth rate but enough to eventually grow into their balance sheet (think debt) over time and become free cash flow positive on a sustained basis over the next 12-24 months, if accurate. So let’s look at some numbers to glean any trends in this direction.
Core Network Services Revenue (cns): LVLT’s recent cns segments are: Wholesale, Large Enterprise & Federal, Mid-Market, and Europe. Data for these segments are available from 2009 as shown in the following graph (click to enlarge images):
With the exception of Large Enterprise & Federal, most are tracking flat to down.
Free cash flow and EBIDTA:
It's hard to glean any positive trends here. We need a few more quarters of data to know anything definitive.
Core revenue per diluted share:
The graph says it all.
EPS per diluted share:
On a positive note, the EPS per diluted share appear to have bottomed.
So is now the time to buy? Any conservative investor would look at the history and numbers and, at the very least, wait a few quarters for any trends to emerge. The debt load is still massive so the investor can ill afford another setback. There has been an explosion in online video but how much pressure this will put on available capacity is another question. I’ve yet to find a clear cut answer, but there is no lack of opinions out there. Buying LVLT now may prove a smart investment, but it would be based on nothing more than faith at this point: Faith in management's top line growth projection, faith that excess capacity is ending and faith in management's ability to execute.
The company will release their fourth quarter 2010 results on February 2, 2011. Maybe this will add some data pointing to an impending upturn. We’ll see.
The reader can access past data and projections at the bottom of the web page at this link.
Disclosure: I am long LVLT.