Taking Communications to Another Level: Level 3's Acquisition of Global Crossing

Includes: GLBC, LVLT
by: Richard Saintvilus

Level 3 Communications Inc. (NASDAQ:LVLT) and Global Crossing Limited (NASDAQ:GLBC) announced that they have entered into a definitive agreement under which Level 3 will acquire Global Crossing in a tax-free, stock-for-stock transaction.

The combined company will operate a unique global services platform anchored by fiber optic networks on three continents, connected by extensive undersea facilities. The combined network will serve a worldwide customer set with owned network in more than 50 countries and connections to more than 70 countries. This transaction will create a company with pro forma combined 2010 revenues of $6.26 billion and pro forma combined 2010 adjusted EBITDA of $1.27 billion before synergies and $1.57 billion after expected synergies.

Not only did this news catch me by surprise, but it forced me to pause and question what year I was in. Two prominent telecom-networking companies are “hooking up." Deals of this sort were commonplace at the onset of the Internet .com explosion of the mid-to-late 90s and early 2000s, when the need for high speed fiber networks placed high premiums on the companies that provide them.

Under the terms and subject to the conditions of the agreement, Global Crossing shareholders will receive 16 shares of Level 3 common stock for each share of Global Crossing common stock or preferred stock that is owned at closing. Based on Level 3’s closing stock price on April 8, 2011, the transaction is valued at $23.04 per Global Crossing common or preferred share, or approximately $3.0 billion, including the assumption of approximately $1.1 billion of net debt as of Dec. 31, 2010.

Courting Process

Prior to the deal, many experts who had studied Level 3’s business and books were firm believers that the company needed this acquisition or some means of leveraging its debt to present more balance. On the other hand, the tactical needs for Global Crossing involve growing its profit margins on its network in both the United States and overseas, specifically in Europe and Asian markets.

Both companies have expressed (rather openly) for quite some time about their consolidation interests. This is something that has piqued my curiosity, particularly as an investor in Global Crossing back in 2001. But over time, I have come to appreciate the sense that this merger would make. It is quite evident that both companies have pretty much extended their resources and have done as much as they possibly can with not only their current assets, but also how they are structured. Though they have made some improvements and have realized some incremental growth, margins are putrid.

As noted above, Global Crossing emerged out of bankruptcy in 2004. Since then, they have done a remarkable job in growing EBITDA and restoring some semblance of fiscal health. However, they were short of the means and assets to grow their margins and revenues overseas. Based on these realities, it became clear that in order for Global Crossing to sustain and grow, they had to make this deal and Level 3 was the perfect partner.

Synergistic Advantages

From Level 3’s perspective, it seems that its objective in this acquisition does several things. First, it allows the company to lower costs by combining operations. Second, it will help increase its average profit edge by adding to its portfolio of enterprise services with higher margins.

According to Ed Gubbins, senior analyst for New Paradigm Resources Group, “Level 3’s revenue from enterprises will jump from 40% to 56% based on pro-forma 2010 numbers.” He also stated that “the combined network assets give their consolidated sales force much more to sell, which should greatly accelerate their enterprise sales over time.”

I absolutely agree that this transaction will create a company with a unique capability to meet local, national and global customer requirements in a wide range of markets. By combining the strengths of each company, the new entity will offer enterprise, government, wholesale, content and web-based customers a comprehensive portfolio of end-to-end data, video and voice solutions.

Jim Crowe, chief executive officer of Level 3, said in a statement “This is a transformational combination that we believe will deliver significant value to the investors, customers and employees of both Level 3 and Global Crossing.”

“The complementary fit between the two companies’ networks, service portfolios and customers is compelling. By leveraging the respective strengths and extensive reach of both companies, we are creating a highly efficient and more extensive global platform that is well-positioned to meet the local and international needs of our customers.”

It is also worth noting that the deal involves the participation of Singapore Technologies Telemedia, which owns a 60% stake in Global Crossing. After the deal closes, Singapore Technologies Telemedia will get to nominate members to the Level 3 board of directors relative to the size of their stock ownership in the company. They bought its controlling stake in Global Crossing in 2003 after the company filed for Chapter 11 bankruptcy protection in 2002.

Moving Forward

Upon closing of the deal, the combination of the two companies will likely improve its balance sheet, cash flow, credit profile as well as other benefits of integration and consolidation. According to Sunit Patel, Level 3’s CFO, “the transaction accelerates the achievement of Level 3’s target leverage ratio of three to five times debt to Adjusted EBITDA.” He also said, “We expect the transaction to be accretive to Level 3’s Free Cash Flow per share in 2013 and to give us the financial strength to capitalize on the many opportunities available in the global market.”

So clearly there are a lot of financial implications and expectations on this deal. It seems like a marriage made in “fiber heaven." But considering that both firms have had financial struggles, with Global Crossing’s emerging out of bankruptcy and Level 3’s own flirtation with it, leaves me to wonder of the possibility of another known statistic often associated with marriage. But for their sake as well for that of “holy matrimony," let’s remain optimistic.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.