FBR: Analysis of Level 3 2Q13 Results; Revenue Outlook Remains Uncertain

David Dixon of FBR Capital Markets:

Level 3 Communications (http://www.level3.com/) reported weak 2Q13 earnings due to below-consensus consolidated EBITDA. Core revenues were line with consensus with growth weighted once again to Latin America and enterprise. While this was encouraging, we remain concerned that top-line trends are likely to remain weaker than expected, and the cost structure of the company may shift more than expected due to the change in the nature of content relationships which may drive a review of peering interconnections with end-user networks and the potential migration of customers to single integrated wireline/wireless providers.

While management continued to cite strong demand from enterprise customers, we reiterate our belief that this is largely for lower-margin “feeds and speeds” versus “higher-margin managed services.” Growth is consistently coming at lower price points, as North American transport and related services are commoditized.

The Internet is changing; impact of software-defined networks (SDNs) is unclear. We expect significant increases in the long-haul network utilization of major carrier networks at dramatically lower opex costs. The simplification of routing protocols and a focus on source origination and destination of application flows could increase disintermediation risk for Level 3 Communications.

New acquisition on the horizon? The company has already captured much of the initial benefits from the Global Crossing acquisition as two-thirds of the $300 million in savings having already occurred in the first six quarters after the merger (ending in 1Q13). Management reemphasized that the company has just begun to see the advantages of improved operating leverage. However, this would require the unified migration of long-haul AND metro network systems, processes, and data, which has eluded Level 3 in past transactions.

While we do not foresee Level 3 as being acquired (i.e., by Sprint to enhance its network backhaul positioning), we
believe the company may be a quarter or two from its next acquisition, given the moderating organic outlook.


1.  Level 3 Reports Second Quarter 2013 Results


2.  Level 3’s 2Q2013 earnings call replay can be accessed by dialing 1 800-633-8284 (U.S. Domestic) or 1 402-977-9140 (International), conference code 21660691

Or register to hear it on line at:  http://www.media-server.com/m/p/e6feabzi

End Note:

Level 3 is one of the few competitive nationwide wireline carriers left in the U.S.  The others include Century Link (which includes x-RBOC U.S. West/Qwest), Frontier, TW Telecom, XO Communications, TDS Telecom, Cogent, Zayo, Reliance Telecom, Integra Telecom, and others. 

Some like Cogent and Level 3 mostly re-sell their telecom facilities to other carriers.  Zayo, Reliance and Integra are mostly Business Ethernet carriers.  TW Telecom and XO also are Ethernet providers, but in many locations do not own their own fiber and have to resell other carrier (e.g. AT&T) services.