Divining the Future of a Combined Level 3 and Global Crossing

Level 3 Communications (LVLT) entered into a definitive agreement under which it would acquire Global Crossing (GLBC) in a tax-free, stock-for-stock transaction on April 11. Global Crossing shareholders would receive 16 shares of Level 3 common stock for each share of Global Crossing common stock or preferred stock that was owned at closing. For more detail, see this article.

Level 3 and Global Crossing released their second quarter results on July 27 (GLBC results – LVLT results). It's important to look at the combined numbers going forward, since LVLT and GLBC will be one company by year end. We’ll look at the pro-forma numbers, along with past results and guidance to identify trends.

LVLT-GLBC pro-forma results:

($mil)	2010			2011
-	Q2	Q3	Q4	Q1	Q2
Total Core Network Services	699	707	720	729	744
Wholesale Voice Services	163	161	161	164	151
GLBC	630	648	683	661	692
Total Communication Revenues	1,522	1,543	1,587	1,575	1,605
Other	16	17	17	15	19
Total Revenue	1,538	1,560	1,604	1,590	1,624
Total Cost of Revenue	805	808	817	828	834
Cost of Communications Revenue	789	793	804	813	815
Cost of Other Revenue	16	15	13	15	19
Gross Margin	733	752	787	762	790
G&A, Selling & Marketing	425	419	435	449	453
Deprec.&Amort	305	297	298	284	289
Stock based compensation	19	25	22	29	21
Total operating expenses	749	741	755	762	763
Operating income	(16)	11	32	0	27
One time charges/gains	(2)	(2)	(1)	(21)	(12)
Other expense/income	(194)	(122)	(204)	(181)	(229)
Income before taxes	(212)	(113)	(173)	(202)	(214)
Provision for Income taxes	5	11	(66)	37	2
Net Income	(217)	(124)	(107)	(239)	(216)
Adjusted EBITDA	307	332	352	309	323
Total shares outstanding - DILUTED	3,656	3,757	3,831	3,841	3,848
FCF	(63)	(57)	209	(208)	16
Margin-Comm. Revenue	48.16%	48.61%	49.34%	48.38%	49.22%
Margin-Comm EBITDA(adj) to Comm. Revenue	19.84%	21.06%	21.61%	19.62%	20.12%
Actual cap ex.	167	177	178	151	171
cap ex./Comm Revenue (%)	11.0%	11.5%	11.2%	9.6%	10.7%

Year over year revenue trailing 12-month revenue growth was 3.8% while the quarter was 5.6% over the same period last year. The GLBC CEO gave this guidance in February:

In 2011, we are targeting invest and grow revenue growth in the 6% to 9% range which consists of our business serving global enterprises and carrier customers excluding wholesale voice.

LVLT management gave the following guidance in July:

CEO: First, our improving revenue growth rate, together with the very high operating margins we've enjoyed, puts us squarely on track for the double-digit adjusted EBITDA growth we projected at the beginning of the year. … And importantly, given the overall low market share we have in our various addressable markets, we think we can continue to accelerate this growth rate over time.

Next, as Jeff said, we're making good progress in the Global Crossing integration planning and I'd like to add, we continue to see opportunities to improve the economics of what we think is already a great transaction. As Jeff said, we still expect to close by the end of the year.

Sunit Patel: As we've indicated in the past, we are shooting for 2% sequential growth -- and I think that the momentum you see in the second quarter should continue in the second half of the year .… Our sales were up in the second quarter. Sales funnels up also. So we feel good about the second half of the year and our objective is to keep increasing the pace of -- and keep working towards our 2% objective.

The following graph shows actual and projected revenue growth based available data and management guidance.

This represents an average yearly growth rate of close to 9%, or a quarterly rate of 2.1%. Most investors will be disappointed if the company does not exceed this rate, but this is where the combined guidance leads us until more data is available.

More importantly, EBIDTA and FCF (free cash flow) will grow at a faster clip once synergies are factored in. Revenue growth of 9% translates to EBITDA growth of 20%. FCF turns positive by the end of 2012 with substantial growth after this date. Some of these synergies were described in a presentation (slide 8) given in April as:

• $2.5 billion NPV of expected synergies.
• $340 million of expected annualized Adjusted EBITDA and capital expenditure synergies through elimination of duplicative network and operational costs, primarily in North America.
• Expect to achieve two-thirds of run-rate synergies within 18 months of closing.
• Provides strong improvement to balance sheet.
• Stock-based acquisition with substantial synergies provides significant deleveraging and credit improvement.
• Level 3 debt to Adjusted EBITDA ratios improve immediately upon transaction closing, and further improve as synergies are realized.
• Expected to be accretive to stockholders.
• Consolidated Free Cash Flow accretive on a per share basis in 2013.
• Over time, potential for substantial Pro Forma Free Cash Flow generation enables investment in value accretive opportunities.

Based on the data, our view has not changed because the longer term increase in EBITDA and FCF (updated below) are higher based on the pending acquisition.

[Click to enlarge]

I know someone will ask, “What about that debt load?” A detailed discussion on the debt can be found in the article linked above. Hopefully LVLT has finally found its footing. The integration process could pose the biggest risk going forward.

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

Disclosure: I am long LVLT.

Source: Divining the Future of a Combined Level 3 and Global Crossing