Regains Luster Amid Web-Video Boom
By Li Yuan and Gregory Zuckerman
The Wall Street Journal
Thursday, December 21, 2006
Fiber-optic network operator Level 3 Communications Inc., a
high-flyer during the telecommunications bubble, almost went
bankrupt after the sector burst in 2000.
Now, it is back, with a stock price that has almost doubled
in the past year and bond prices that have risen about 20%.
Behind the gains: Explosive growth in video viewing over
the Internet, which requires high-speed networks of the sort
Level 3 offers. At the same time, a hearty appetite by
investors for risky debt has enabled the company to put
itself on firmer footing by refinancing its debt at lower
rates. There also are good reasons to believe that Level 3
might be an acquisition candidate, though many feel such
speculation is overblown.
But there are reasons to be wary: The company remains
saddled with debt, it is in a business that still has excess
capacity, and it has reported a quarterly profit just once
in its more than 20-year history. With the stock and bonds
at lofty levels, it could be that any future possible good
news already is priced in.
Even bullish analysts acknowledge that to keep the stock
climbing, demand for video and voice over the Internet will
have to be strong enough to allow Level 3 to increase what
it charges big telecommunications, cable and other
businesses for access to its fiber network, one of the
world's largest. Level 3 also will have to demonstrate that
it can skillfully integrate a series of recent
acquisitions. The company will also have to show that it is
getting closer to pulling more cash out of its business than
it is putting in.
Level 3 shares, which traded above $120 in the Internet
boom, closed yesterday at $5.65 on the Nasdaq Stock Market,
By one measure, Level 3 stock and bonds are a bit pricey.
Its enterprise value, or the value of shares plus debt, is
about 13 times the company's expected earnings before
interest, tax, depreciation and amortization for 2009. Time
Warner Telecom Inc., which sells telecom services to
business customers, trades at well under 10 times its
expected Ebitda, though the two companies may not have the
same growth potential.
Level 3's bonds, which sported yields of about 18% a year
ago, now have yields as low as 8.5%, thanks to their
increased prices. That rate isn't especially generous for a
junk-bond-rated company that isn't expected to turn a profit
Level 3 has been refinancing its debt and extending some
maturities to at least 2010, giving it more breathing room.
This month, the Broomfield, Colo., company sold about $650
million of bonds with interest rates of 9.25% to pay off
debt with a 10.75% coupon. Still, the company is burdened
with $6.8 billion in debt. It needs to repay $2.3 billion
of debt in 2010 and another $2.9 billion in 2011.
If the financial market shuts the door and refuses to
refinance that debt, it could ramp up pressure on the
company. For now the debt markets are willing to buy Level
3's debt and the company is upbeat. "Something will have to
go very wrong both at Level 3 and the market" for the
company not to be able to refinance its existing debt, a
Level 3 spokeswoman says.
Level 3 says more than half the traffic on its network is
from Internet video, up from no such traffic in 2000, and it
is increasing its capacity. "Video has exploded as a
generator of traffic for them," says Michael Mahoney, a
partner at EGM Capital, an investment management firm that
has owned Level 3 shares for about nine months. "All of a
sudden, the pipe Level 3 built in the late 1990s looks
But Level 3's management acknowledged to a group of
investors last week that even though traffic from Internet
video is huge and growing fast, it is at least two years
away from becoming a large revenue contributor. Analysts
say it needs more YouTubes to emerge to make this a big
And prices for access to networks have fallen about 15% this
year. While much slower than the 50% rate of 2004, that
still is a troubling sign in a market where demand for
network capacity has increased at a rate of about 60% a year
in the past two years. The capacity glut is so huge that it
could take years before it is filled up.
Since late 2005, "we started to see a change in the pricing
environment," says Kevin O'Hara, president and chief
operating officer of Level 3, who says still-falling prices
for the use of Level 3's network are being more than offset
by strengthening demand for its high-speed networks. The
company projects revenue will rise about 20% this year, but
it will remain unprofitable, due to its high debt level. In
2005, revenue rose 18% to $3.61 billion.
The market also is upbeat because of the six acquisitions
Level 3 made in the past year that help distinguish it from
its competitors, analysts say. Those acquisitions enable
Level 3 to offer higher-profit phone and data-communications
services directly to business customers, encroaching on the
turf of regional phone companies like AT&T Inc. and Verizon
Some investors have been looking at Level 3 as a possible
acquisition target for providers of Internet video,
including Google, which acquired YouTube last month. The
logic: With bandwidth prices stabilizing, owning their own
networks could help Internet video sites and other heavy
users of data protect against possible pricing pressure down
It remains likely, however, that the high price tag and
hefty debt burden of Level 3 would deter any Google
interest. A Google spokesman said, "We don't comment on
rumor or speculation."
Qwest, whose share price is up more than 40% this year, is
looking at potential deals, and Level 3 is rumored to be one
of several possibilities. A spokesman for Qwest declined to
-- Kevin J. Delaney and
Amol Sharma contributed to this article.
Write to Li
email@example.com and Gregory Zuckerman at