BUFFETT LENDS TELECOM CREDIBILITY

Through the tech boom of the late 1990s, billionaire investor and self-described technophobe Warren Buffett avoided the communications sector, preferring to put his money in businesses with less complex regulatory, technical and competitive issues. But by participating in a $500 million round of funding for wholesale carrier Level 3 Communications, the Oracle of Omaha is breathing a little life into an industry he previously shunned. His investment also may lead others to re-evaluate the sector and could even portend a major acquisition.

With a $100 million commitment, Buffett's firm, Berkshire Hathaway, was a secondary participant in the funding, which gives the companies junior subordinate notes that can be converted to equity representing a 27% stake. Longleaf Partners Funds led the round with a $300 million investment. The third participant, Legg Mason, put in $100 million.

But Buffet was a key figure in making the funding possible, said James Crowe, CEO of Level 3.

For years, Buffett has had a working relationship with Walter Scott, Level 3's founder and chairman and a member of Berkshire Hathaway's board. “It was in the context of a conversation among Mr. Scott, myself and Mr. Buffett that the subject of an investment in Level 3 came up some months ago,” Crowe said.

Because of his relationship with Scott, Buffett preferred not to be the lead investor responsible for negotiating the deal. Instead, he suggested that Level 3 contact O. Mason Hawkins, chairman and CEO of Southeastern Asset Management and an advisor to Longleaf.

Hawkins and Level 3 hammered out the deal, and Legg Mason and Berkshire Hathaway signed on once an agreement was reached.

While Buffett's reputation as investor was further solidified by his avoidance of the tech sector crash, the disarray caused by the telecom implosion convinced him at last to get involved in the domestic communications industry. With the number of assets available on the market, a company with liquid resources and strong financial backing is “well equipped to seize important opportunities,” Buffett said in a statement.

Indeed, Crowe said the cash infusion will be used to acquire other carriers.

Crowe declined to name any companies Level 3 was interested in acquiring, but he did lay out a few guidelines: Any acquisition Level 3 makes would be one that added to its customer base, he said. Acquisition targets would offer services Level 3 already provides in a region the company already serves, he said, and would not add any net debt to the $6.4 billion the Broomfield, Colo.-based company already carries.

Perhaps most significantly, Crowe said Level 3 would avoid any business mired in the latest round of corporate scandals — a position that takes a lot of potential acquisitions off the table.

“There are a number of companies that are under investigation for a number of problems,” he said. “We're not investigators and we don't know how to do forensic accounting, so we'd steer clear of anything that might have liabilities or risks we can't understand.”

Crowe also denied that the new money would lead to any strategic changes at Level 3. Most analysts, however, said the investment will force the company to evolve.

“Before, they were intending to be a maverick pricer and drive prices down,” said Scott Cleland, CEO of Precursor Group. “Now it appears they're talking about becoming a roll-up in order to try to raise prices.”

But Crowe rejected the notion that looking for acquisitions represents a change in strategy for the company. Any pricing pressure Level 3 has created in the market is a result of a well-reasoned approach to pricing, he said.

As with most other technology pricing formats, Level 3 uses lower prices to attract more customers to its network, thereby raising margins. The industry's current financial troubles are a result of overbuilding and will simply have to be worked through, Crowe said.

Regardless of the specific acquisitions the $500 million infusion could bring, Buffett's investment could be a sign of more significant long-term aspirations. All three parties in the new investment said they would consider putting additional money into Level 3, and at least one analyst speculated that a major acquisition could be in the cards.

A $500 million acquisition does not necessarily guarantee Level 3 and its new investors a spot at the winners' table, said David Fraley, principal analyst with Gartner Group. Instead, the three investing parties could use their stakes to gain access to Level 3's financial information and could leverage the company to plot a major acquisition — including possibly the purchase of a Bell company or a large IXC, Fraley said.

“This is a way of getting themselves in the door, getting the initial paperwork done, getting on the board and getting a look at the books,” Fraley said. Level 3 declined to comment on the specifics of any future investment.

One of the most important commodities the current investment offers, however, is the credibility of Buffett, arguably one of the most successful investors of the past 100 years. Largely on the strengths of his name, Level 3 shares rose from $2.89 at the beginning of last week to more than $5.50 by Thursday's closing.

“This money ratifies our position in the industry,” Crowe said. “When the capital markets are in any condition to be approached, you'd think the quality of investors who have partnered with us would have an effect.”

And the effect on the capital markets might spread to a few others. Some carriers that have cleaned up their balance sheets and are looking for new funding may get a final push from Buffett, according to Vic Grover, managing director of equity research at Kaufman Bros.

Similarly, Robert Rosenberg, president of Insight Research, said the investment would cause fund managers to take another look at telecom. “More important than the dollar amount is who invested,” Rosenberg said. “One of the most brilliant investors in second half of the 20th century has decided to go in. That is emblematic.”