Level 3 (LVLT) is a cheap stock. At $3.40, the company has a tiny market cap for an operation its size. Securities analyst are actually looking for its revenues to shrink slightly in the 2007 fiscal year. Consensus estimates are that Level 3 will lose $1.01 in 2006 and $.88 in 2007. So, why isn't it just an outright dog?
Level 3 has a couple of things going for it. The company has a 23,000 mile broadband fiber optic network. No other company has anything quite like it. This network can be used for VOIP, broadband transport, colocation and the company's own managed modum system. A number of the world's largest ISPs, content providers, systems integrators, and the RBOCs use the Level 3 network.
The company has good customers, a great network and a large market share. But investors think the company is in a race that some think it cannot win. Long term debt was over $6 billion at the end of the 2005, but by renegotiating it, the company has pushed the due date for a fair amount of this out to 2010. The company has over $800 million in cash and investment according to analyst estimates.
The acquisition of WilTel should add to the company's competitive advantages in providing bandwidth to the largest telcos and internet companies in the U.S. and abroad. We have to assume some integration risk, but this is a business that Level 3 knows well.
The reasons Level 3 can win the race against the due dates on its debt, is that, after years of sharp declines in what companies can charge for bandwidth, it appears that the era of overcapacity may be ending. Level 3 management has said that bandwidth costs, which were dropping at 40% in 2004, are dropping at closer to 20% now.
But, this could get much, much better for companies like Level 3. The emergence of VOIP and the amount of data, files, audio and video that is being sent over the internet is beginning to suck up the bandwidth capacity. According to the Bandwidth Price Revolution by Phil Harvey, 2005 is the year for the turnaround because bankruptcy will have weeded out a number of competitors and demand for bandwidth will begin to equal supply. According to WebMetro, the demand for bandwidth is being lead by the consumer demand for broadband. And, all the communicating and downloading that is a by-product.
One other very interesting note in all of this is the recent comments by telcos and cable companies that they want to start charging large portals like Google (GOOG) and Yahoo! (YHOO) for bandwidth use because these companies are distributing larger and larger files, especially audio and video. When there is talk of raising prices and a fight is about to break out between those who provide the highway for internet traffic and those who provide the traffic, it is a sure thing that someone has figured out that the cost of raw bandwidth is heading up. Soon.
Is Level 3 a risk? Yes. But, with the largest providers of broadband saying they have to charge someone for all this new traffic and charge a toll to keep the speed of downloads where they are today, I like Level 3's chances of beginning to actually raise prices soon.
Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He was also president of Switchboard.com when it was one of the ten most visits sites in the world, according to MediaMetrix. He has also been chief executive of On2 Technologies, Inc. He does not own any of the securities mentioned here.