Technology  November 14, 2014

Analysts are bullish on new telecom merger

Level 3 posting profits as it closes tw deal

The recently completed merger of Colorado telecommunications companies Level 3 Communications Inc. and tw telecom inc. should lead to faster growth in revenue and market share than the two could have achieved on their own, according to analysts, and any job losses associated with cost-saving synergies are expected to be “gentle” in relation to other mergers.

Level 3 (NYSE: LVLT), which employs about 2,400 people at its headquarters in Broomfield, closed its acquisition of Littleton-based tw telecom on Oct. 31. The deal, announced in June, was valued at about $7.3 billion including assumed debt.

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The two companies bring with them distinct strengths, and chief executive Jeff Storey said in Level 3’s recent earnings call that there is less than a 5 percent overlap between their customer bases.

“They each have a little different angle at the market,” Oppenheimer analyst Tim Horan said. “They’re in a much better position as a combined company.”

While tw telecom employees and products are now officially under the Level 3 flag, company officials expect full integration of the two to take about 18 months.

Horan said investors will be watching closely during that time for the revenue synergies that are expected to occur now that Level 3 can market the best product offerings of each company and utilize the two vastly different fiber optic networks as one.

Investors already have been bullish on the company’s stock of late as the thirst for bandwidth has increased exponentially in recent years. A fast-growing company with a long history of quarterly losses, Level 3 now has swung to profit for the last four fiscal periods in a row. Its share price has risen steadily over the past 17 months, more than doubling in that timeframe, going from $19.99 on June 24 last year to $45.85 in recent trading.

Chief administrative officer Laurinda Pang said there is a lot to the integration of two companies that have combined annual revenue of about $8 billion, including bringing together employees, meshing products and services, and combining the two companies’ networks and IT systems.

Level 3 provides communications services worldwide, with a large network of long-haul fiber optics between cities, while tw telecom is noted for its Ethernet services and an extensive metropolitan fiber optic network in the United States.

Some overlapping products will be eliminated, but that doesn’t necessarily mean the people working on those products would all be eliminated as many would be transitioned into selling or developing the companies’ combined offerings as well as new products to come.

“This is a growth business,” Pang said. “This is not about synergies.”

Level 3 officials have acknowledged that the merger would lead to some layoffs, although it has not specified how many, which locations would be affected or when they would occur. Level 3 is keeping both its Broomfield headquarters and the former tw telecom headquarters in Littleton, where about 1,300 employees are stationed. The company has also committed to core offices in Phoenix, Atlanta, Tulsa, Okla., and O’Fallon, Mo.

The company has said about $90 million in annual cost savings from the merger would come from operations, with an unspecified amount of that coming from staff reductions. Analysts don’t have firm estimates for how many people would need to be laid off to hit those cost-reduction targets. But, for instance, if $30 million of that is derived from layoffs of people with an average salary and benefits package of $100,000, that would be about 300 of the combined company’s roughly 13,600 employees worldwide. Few layoffs, analysts said, are likely to come from sales or network functions, but rather from corporate functions such as finance, human resources or accounting.

“It’s a personal tragedy for each of those people,” Recon Analytics analyst Roger Entner said. “But from the corporate perspective, 300 out of (13,600), it’s not a lot. That would be a very gentle merger. There have been mergers that have been a lot more brutal to the workforce.”

There are plenty of factors working in Level 3’s favor to support the notion that the merger is more about growth than reducing costs.

For one thing, the broader fiber footprint and suite of products will help Level 3 not only serve more customers but also reduce some costs. Tw telecom, for instance, leased some of its long-haul fiber from providers other than Level 3. That’s business that will now be brought in-house. James Moorman, an analyst with D.A. Davidson and Co., said the deal also doubles Level 3’s sales force in North America, a sales force that should be intrigued by the broader product mix.

Moorman added that Level 3 has also been strategic about some of the tw telecom leadership it’s kept. While chief executive Larissa Herda has left, key players such as tw telecom chief operating officer John Blount and chief information and technical officer Harold Teets remain as regional president for North America and CIO, respectively.

“I think they’ve done a pretty good job in picking out trouble spots and trying to avert them by maintaining leadership at (tw telecom),” Moorman said.

The other major strength for Level 3 is its fiber network, which now includes more than 200,000 route miles globally, 30,000 on-net buildings in the United States and more than 50,000 customers worldwide.

Founded in 1985 as a subsidiary of Peter Kiewit Sons’ Inc., Level 3 has grown steadily through network expansions and acquisitions of companies such as Progress Telecom, ICG and Global Crossing.

All of those quarterly losses in the 2000s and early 2010s, Entner of Recon Analytics said, came during lean times for the telecom industry. And while many companies sat on nice margins and didn’t invest in fiber or other network upgrades – leading to their demise or eventual acquisition – Level 3 took the route of growth and scale over short-term profitability.

“They were looking long-term and said this is a very capital intensive business,” Entner said. “Once you have the capital in the ground, it’s like a license to print money. You had to be smart enough not to go broke. But you had to go out and build for the demand that’s materializing now.”

Horan said the telecommunications market is about a $300 billion industry in the United States, about half of which is wireless. Level 3 still is a relatively small player compared with behemoths such as AT&T and Verizon. But in terms of the enterprise and wholesale infrastructure portion of the market, Horan said Level 3 has as much as 15 percent to 20 percent market share post-merger.

“So they can have some impact on pricing and products and innovation in the enterprise market for sure,” Horan said.

Level 3 is growing to the point that the analysts said it would be difficult for another company to acquire it, in part because regulatory approval likely would be difficult for the large players in the United States to make such a purchase. But that doesn’t mean the company couldn’t become an acquisition target of foreign buyers.

“It would be somebody who’s not competing with them right now,” Entner said.

As for further Level 3 purchases, Pang said the company has plenty on which to focus now with the tw telecom integration, and doesn’t see any other acquisitions in North America any time soon.

“But we are a global company,” Pang said, “and there’s lots of opportunities in other parts of the world.”

Joshua Lindenstein can be reached at 303-630-1943, 970-416-7343 or jlindenstein@bizwestmedia.com. Follow him on Twitter at @joshlindenstein.

Level 3 posting profits as it closes tw deal

The recently completed merger of Colorado telecommunications companies Level 3 Communications Inc. and tw telecom inc. should lead to faster growth in revenue and market share than the two could have achieved on their own, according to analysts, and any job losses associated with cost-saving synergies are expected to be “gentle” in relation to other mergers.

Level 3 (NYSE: LVLT), which employs about 2,400 people at its headquarters in Broomfield, closed its acquisition of Littleton-based tw telecom on Oct. 31. The deal, announced in June, was valued at about $7.3 billion including…

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