ANALYSIS: Level 3 makes its biggest move yet

It would be very easy for Level 3 Communications to rest on its laurels. However, the temptation to add tw telecom to its growing list of subsidiaries appeared too good to miss.

The company’s acquisition strategy has indeed been impressive over the years, with tw telecom now representing its largest deal to date.

It has now spent $25 billion in acquiring a string of companies and assets in a bid to establish competitive ground with both AT&T and Verizon. As a result of these deals, many in the market credit the company for being one of the first US telcos to prepare its network for the video content revolution gripping the world’s operators at the moment.

Level 3 has already seen its stock price double over the past two years, after investing heavily in its network to become a major player in the US and across the world. It is already strongly positioned in the infrastructure space, so how will the move for tw telecom enhance this?

Level 3 is splashing out $5.7 billion in a cash-and-stock deal to snap up the metro provider, in what seems to be a direct response to the aggressive consolidation strategy the US is seeing from the incumbent telcos and cable companies. Both AT&T and Comcast are also in the process of completing multi-billion dollar consolidation deals in cable.

And it appears Level 3’s CEO Jeff Storey is keen to follow suit. He confirmed after the tw telecom tie-up that Level 3’s “primary competitors are now the very large companies, whether they are incumbents or cable providers”.

Acquiring tw telecom builds on Level 3’s acquisition of Global Crossing – secured in 2011 for approximately $3 billion – which again was intended to beef up its backhaul offering and connect local networks across the US.

Level 3 has positioned itself as the middle-mile provider between the large ISPs and content-heavy OTT players, and has been actively seeking ways to counter the loss of its shrinking wholesale business, with a specific target on corporate and government customers.

“This deal brings together the global reach of Level 3’s internet backbone with the US metro focus of tw telecom at a time when traffic from streaming videos through Amazon or Netflix and use of sensitive corporate data is increasing around the globe,” said Richard Karpinski, senior analyst at Yankee Group.

This certainly appears to be the strategy, however, the deal actually only gives a combined Level 3/tw telecom entity a 6% share of the fixed corporate communications market in the US. AT&T, Verizon and CenturyLink combined have 59.8%.

This could be set to change. Analysts claim Level 3’s growing IP backbone could prove invaluable in tempting corporate customers that require links to Europe, Asia and Latin America. Sunit Patel, EVP and CFO at Level 3, spoke to Capacity a day after announcing the deal and outlined the company’s intentions to gain additional corporate customers through the tie-up.

“Our market share in enterprise is still in the single digits, but with this tie-up, we will have nationwide networks in all the key cities and markets in the US providing connectivity in and out of the country, which should prove attractive to potential customers,” he said.

On the whole, the acquisition appears to be a shrewd move. However, despite the company’s recent investments, Level 3 has not made an annual profit since 1998, with rates continuing to fall for its traditional long-distance traffic business. It is also significantly debt-laden, which is why Level 3 has opted for a significant proportion of the transaction to be paid in the form of shares. The financial market too, appeared to react badly to the deal, with Level 3’s shares dropping by 4.1%.

Patel tells Capacity that this was because of a rumour of the deal that broke before it was announced, causing shares in the company to rise rapidly before falling. He commented that the company’s largest investors “are very enthusiastic about this transaction. It is an attractive deal from both sides, with the deal expected to cut costs by approximately $200 million a year”.

ATLANTIC-ACM’s Charlie Reed, director of quantitative analytics, echoes these sentiments, and goes as far as to predict that the synergies between the two companies could result in the creation of a new major player in the US telecoms market.

“The merger is not likely to decrease competition,” he said. “Given that Level 3 is historically priced very competitively, it may bring that perspective to tw telecom’s operating markets, driving increased competition. The combined company will likely make stronger plays in bids for large contracts – placing competitive pressure on AT&T, Verizon and CenturyLink.”

Level 3 has made its biggest move to date. Will it pay off?