LEVEL 3 KEEPS AN EVEN KEEL WITH DISTRIBUTOR PURCHASE

Delivery could take on a new look when software meets infrastructure

Needing a revenue boost to comply with certain bank covenants and avoid the predicaments of its competitors, Level 3 Communications last week acquired Corporate Software, a global distributor of enterprise software based in Norwood, Mass. The new addition's $1.1 billion in revenue is expected to do the trick, keeping Level 3 in compliance through mid-2003.

Although seen by some outsiders as creative financing, the deal — in which Level 3 paid $90 million in cash and assumed $50 million in debt — also could help change the way software is distributed.

“It is something of an indictment of the entire communications industry that we move information, including software, over [transportation] networks and on optical and magnetic media rather than over broadband networks,” said Level 3 CEO James Crowe.

Level 3 intends to change that through its wholly owned subsidiary, (i)Structure, and the acquisition of Corporate Software. (i)Structure is a infrastructure outsourcing company that provides managed IT services from its data centers in Omaha and Tempe, Ariz. Corporate Software is a software distributor for Microsoft, Novell, Sun Microsystems, Symantec and about 200 other companies in 128 countries. It currently has about 800 employees, which Level 3 says it will keep.

Together, the companies plan to begin distributing software electronically by the end of the year.

“There are a lot of synergies with (i)Structure that we can take advantage of right away,” said Howard Diamond, chairman and CEO of Corporate Software. “But even the more broad-based things we can do with Level 3 to change the way we distribute software is not 10 or 15 years away. It's six to 18 months away.”

Microsoft applauded the transaction, saying it shares “a common view of the direction of the broadband and the software distribution industries,” according to a statement by Paul Bazley, Microsoft's vice president of U.S. enterprise and partner sales.

Upon closing, expected by the end of March, Level 3 will become one of Microsoft's top 10 customers and vice versa, Crowe said.

It is still unclear exactly what the stated vision is or how Level 3 and its (i)Structure subsidiary plan to distribute software. Delivery of software with ongoing management of licenses through the network is one option. Hosting applications at (i)Structure's data centers is another.

Delivering software over its network has been on Level 3's to-do list since its inception.

“In the first public document published by Level 3, we identified the opportunity to offer software functionality as a service rather than packaged in shrink-wrapped boxes,” Crowe said.

But Level 3's decision to make the issue an immediate priority was based more on financial concerns than strategic, analysts said.

“They're buying a revenue stream to meet their bond covenants,” said Rob Carlson, senior network analyst for Current Analysis. “I don't know how much integration there will be between the two.”

Upon closing, revenue from Corporate Software will be included in the Minimum Telecom Revenue (MTR) covenant Level 3 is required to meet for restricted subsidiaries such as (i)Structure.

In first-quarter projections offered by Level 3, the carrier stated it is expected to remain in compliance with all the terms of its credit facility through the first quarter. But Level 3 also said it possibly would violate the MTR by the end of the second quarter if sales, disconnects and cancellations continue at the pace established during the second half of last year.

This acquisition extends that compliance another year, if conditions don't deteriorate.

“One thing is for sure: Disconnects will come to an end,” Crowe said.

Such sentiments generated questions about the strategic value of the deal from many, including Thomas Lord, executive vice president of corporate development and chief financial officer for Allegiance Telecom.

“I can't buy my way out of the problem,” he said. “I wish our banks would allow me to do that.”

However, criticizing a carrier for doing what it needs to do to stay solvent when those around it crash and burn appears misplaced, particularly if the result helps solve issues for which it previously was criticized, such as building a network with nothing to put on it.

“Anything a wholesale bandwidth provider can do to diversify and move up the value chain in any direction — whether it's software distribution or an ASP-type application — is good right now,” Carlson said.