Enterprise sales could boost Level 3 earnings

Level 3 Communications' move into the metro market may help address the company's need for revenues to begin retiring its $6 billion in debt — assuming the carrier can successfully integrate its multiple acquisitions, including last week's $1.2 billion purchase of TelCove, the CLEC created out of Adelphia Cable's former holdings.

In announcing the TelCove buy — its fourth in six months — Level 3 also said it is creating a Metro Networks business that will combine TelCove with Progress Telecom and ICG Communications, two earlier acquisitions, along with WilTel's enterprise business to create a unit that targets enterprises with the need for high-capacity connections. Based on the current sales of the acquired companies, the Metro Networks unit will start with about $700 million in revenue and connections into about 5000 commercial buildings nationwide.

By moving into the metro space and targeting high-end enterprises, Level 3 attracts a higher-margin customer than its current wholesale base and therefore can generate more revenue to fill the IP-based fiber-optic network it paid so dearly to build, analysts say.

“This was more or less inevitable — Level 3 had to do it,” said Brian Washburn, principal analyst for network services at Current Analysis. “They have to get to a point of profitability. Attracting higher-margin customers is one way to do that.”

In announcing the sale, Level 3 CEO James Crowe acknowledged that the move into metro services puts his company into competition with some of its wholesale customers, but he said he expects both segments to remain robust.

“There is definitely channel conflict, but, on the other hand, Level 3's largest customers are the cable companies,” which won't see this as competition, Washburn said. As for other metro-area players that might be unhappy about competing with Level 3, the reality is that with the rampant industry consolidation, they have few other options.

“Where are they going to go — AT&T?” he asked. “Broadwing serves enterprise customers; Global Crossing serves enterprise customers. There really isn't much of a pure-play wholesale service available.”

The challenge for Level 3 will be the integration process as the carrier has acquired other companies at a faster pace than anyone since WorldCom, and that's not a comparison anyone wants to invite.

Level 3 doesn't plan to integrate TelCove into its corporate operation but instead will maintain the company as a separate entity and integrate Progress Telecom and ICG into TelCove, said Sunit Patel, Level 3's chief financial officer, on the analyst call announcing the purchase. The primary savings would be in integrating the networks, so all traffic is carried on-net, and in eliminating some duplicate corporate functions.

“Integrating four acquisitions into two different businesses is certainly a challenge,” Washburn said. “They could approach it in any one of many different ways. They could operate the metro unit like SBC operated SNET when it acquired that company. SNET still had its own operations and gear, and the only economies of scale were going forward. But they might have a customer who wants one holistic billing and customer experience, then how do you translate trouble tickets and flow-through?”

At the end of the integration process, Level 3 winds up with a metro unit that is about the size of Time Warner Telecom, Washburn points out. TWT reaches about 6000 business buildings in the U.S.

As part of the TelCove sale, Level 3 acquires spectrum in the 31 GHz and 38 GHz bands, which Crowe said the company will “look at long and hard.”

That could well mean looking for someone willing to buy the spectrum, Washburn said.

LEVEL 3's ACQUISITION BINGE

MAY:

TelCove
$1.2 billion

APRIL:

ICG
$163 million

JANUARY:

Progress Telecom
$137 million

OCTOBER 2005:

WilTel
$680 million

MARCH 2005:

360networks
undisclosed amount