Level 3 Communications: Global Crossing Deal Makes Sense From a Debt Perspective

Jul. 4.11 | About: Level 3 (LVLT)

Level 3 Communications (NYSE:LVLT), and its subsidiaries, is a facilities based provider of a broad range of integrated communications services. The company’s network is an advanced, international, facilities-based communications network designed to employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.

We noted in early February that capital expenditures plus net cash interest expenses of $555 million would exceed a billion dollars going forward. EBITDA will not catch up until 2012, assuming no major events occur and LVLT can maintain some semblance of growth. This, in part, was enough to keep LVLT’s stock price stuck in the low one dollar range until there was more visibility.

A major event has occurred. Level 3 Communications entered into a definitive agreement under which Level 3 Communications announced on April 11, 2011 that it will acquire Global Crossing (NASDAQ:GLBC) in a tax-free, stock-for-stock transaction. 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. The deal includes the assumption of approximately $1.1 billion of net debt as of December 31, 2010. This was a good deal for LVLT for reasons described in our previous article. The stock is presently trading in the mid-$2 range, up 48% since the deal was announced.

There are concerns about LVLT’s debt load going forward, so this article takes aim at the debt. Not only has LVLT debt increased from $6.5 billion in 2010, the acquisition pushes the combined entities debt to a whopping $8.6 billion on a pro-forma basis. Interest expense will top $700 million in 2012 (the deal is expected to close toward the end of this year). We’ll look at the following to understand why the deal makes sense from a debt prospective:

  • How EBIDTA changes will strengthen management's ability to manage the debt.
  • How the deal affects convertible debt resulting in reduced cash outflows.
  • Maturity dates and the ability to repay.

EBITDA Impact

The following chart (click to enlarge image) compares EBITDA for both the combined entity and LVLT as a stand-alone entity through 2012.

LVLT_EBITDAClick to enlarge

Projected 2012 EBITDA is expected to be about $1.7 billion vs. approximately $1.1B on a stand-alone basis, an increase of approximately 55%. The increase in interest expenses is around $152 million. The increase in EBITDA easily covers the interest payments and capital expenditures.

Convertible Debt

Another important benefit is that LVLT will no longer be required to redeem over a billion dollars in debt using cash if the stock price continues to trade above $2/share. How? Below is a summary of the debt at the end of the first quarter, 2011, modified with LVLT’s recent $600 million of Senior Notes scheduled to refinance certain existing indebtedness of Global Crossing:

DEBT

Amt (mil)

GLBC Sr Notes due 2015

737.0

GLBC Sr Notes due 2019

150.0

GLBC Capital Leases

52.0

GLBC-LVLT escrow Sr Notes due 2019

600.0

Conv notes due 2015 series B

275.0

Sr notes 9.375% due 4/1/2019

490.0

Conv Sr notes 3.5% due 2012

270.0

Sr notes 9.25% Due 2014

1,256.0

Sr Secured LIBOR+225bp due 2014

1,679.0

Senior Notes due 2015 LIBOR+3.75%

300.0

Commercial Mortgages due 2015

66.0

Senior Notes due 2018

628.0

Senior Notes due 2019

594.0

Senior Notes due 2017

700.0

Conv Sr Notes due 2016

201.0

Capital leases

29.0

Conv Sr notes due 2015

197.0

Other due 2013 (cr=1.80)

400.0

Derivative contracts

(18.0)

Projected Total

8,606

Click to enlarge

The above debt schedule includes discounts due to embedded derivative contracts, note discounts, and capital leases. The following debt is convertible into stock.

15% Convertible Senior Notes Due 2013 - ($400 million)

These Senior Notes mature on January 15, 2013. The Notes are convertible into shares of common stock at an initial conversion price of $1.80 per share. If at any time following the date of original issuance and prior to the close of business on January 15, 2013 the closing per share sale price of the common stock exceeds 222.2% of the conversion price, then in effect for at least 20 trading days within any 30 consecutive trading day period, the Notes will automatically convert into shares of Level 3 common stock.

7% Convertible Senior Notes due 2015 – ($472 million)

These Senior Notes mature on March 15, 2015. The conversion price is approximately $1.80 per share.

6.5% Convertible Subordinated Notes due 2016 – ($201 million)

The 6.5% Convertible Senior Notes will mature on October 1, 2016. The conversion price is approximately $1.235 per share.

3.5% Convertible Senior Notes due 2012 – ($270 million)

These Senior Notes mature on June 15, 2012. The conversion price is approximately $5.46 per share.

The 3.5% notes may not be convertible by June 15, 2012 given the conversion price of $5.46, but the others are presently above the conversion price. This will wipe out over one billion in debt without the use of cash and reduce interest expense by over $100 million annually. Yes, this dilutes the stock by about 650 million shares, but the current price reflects this. Investors would not (should not) ignore the potential dilution even if the stock trades below the low conversion prices.

Debt Maturity

Of course, LVLT still must generate enough cash to pay maturing debt over time. The table below lists the amount of debt maturing per year along with our projected free cash flows.

Amounts in $millions

Year

2012

2013

2014

2015

2016

2017

2018-2019

total

Total Debt

270

400

2,935

1,575

201

700

2,525

8,606

Refinance

0

1,679

0

0

0

0

1,679

Converted

400

472

201

1,073

FCF

131

559

825

1,172

1,490

NA

NA

Click to enlarge

We do not expect the company to generate sufficient cash flows from operations to repay all of these debt instruments at maturity. There is too much debt maturing in 2014; therefore, the company will need to access the capital markets to meet the liquidity requirements. As shown in the table, we expect LVLT to refinance up to $1.7 billion. Given the increased strength to the balance sheet and management’s ability to access the capital markets, we don’t think this will be a problem.

Summary

Even though the debt will hit new highs, the deal makes sense from a debt perspective for the following reasons:

  • Accelerated EBITDA and free cash flow growth based on modest revenue growth.
  • The deal brings the convertible debt into play, which saves a billion in cash and $100 million in annual interest expense.

Risks still remain. As 2014 approaches, one cannot be certain of management’s ability to refinance the debt or raise additional capital on acceptable terms or at all. There is still a long way to go to realize the synergies that management expects, and the company's track record at integrating acquisitions has not been good. We think the company has learned valuable lessons from past acquisitions and the market also seems to be giving it the benefit of the doubt.

A complete set of detailed financial data and projections reflected in this article is found here.

A further description of LVLT's debt can be found in its 10-K.

Disclosure: I am long LVLT.