Level 3 Communications Inc. (NYSE: LVLT) is on the prowl for more acquisitions, and it’s getting more serious about buying another metro service provider, according to Light Reading sources.

Two leading candidates are AboveNet Inc. (NYSE: ABVT) and XO Communications Inc. , according to one reliable source familiar with the talks, who asked to remain anonymous. And a number of analysts say that Level 3 could be looking at up to half a dozen candidates.

So what’s driving all this activity? The thirst for metro fiber assets, apparently. Andrew Schmitt, general partner with investment firm Nyquist Capital, says that AboveNet and other service providers with large amounts of fiber assets make a lot of sense.

"There aren’t many people left that have fiber in the rights of way, and that’s extremely valuable” says Schmitt. “AboveNet is little known and that makes it an opportunity. It’s a pure fiber play -- they’ve got fiber in a lot of metro areas."

Since last Halloween, Level 3 has announced acquisitions of Progress Telecom LLC , ICG Communications Inc. (Nasdaq/Frankfurt: ICGX), WilTel Communications Group Inc. , TelCove Inc. , and Looking Glass Networks Inc. With the addition of those properties, Level 3’s metro access business unit is expected to generate approximately $700 million to $750 million in revenues in 2007, the company says.

(See Level 3 Takes TelCove, WilTel Sale Completed , Level 3 to Buy Progress, Level 3 Acquiring ICG, and Level 3 to Buy Looking Glass.)

That Level 3 wants to make more acquisitions is common knowledge. In fact, the company has said as much.

Level 3 spokesman Chris Hardman referred Light Reading to comments made by Level 3 CEO Jim Crowe during a May 15 shareholder meeting: “Given the superior margins, given what we believe are superior capital efficiency, we’ve said repeatedly that Level 3 is the logical consolidator,” Crowe said, referring to his company’s positioning for amassing more metro fiber properties.

“I know that they are looking to do more acquisitions,” says Colby Synesael, an analyst with Merriman Curhan Ford & Co. "There are probably more than half a dozen acquisitions that could fit in to what they could do."

Synesael believes AboveNet could be considered, but he thinks it’s “not as likely as some of the other ones.” Acquisition candidates he sees as more likely include Yipes Enterprise Services Inc. , 360networks Inc. , and Expedius.Buckingham Research Associates analyst Qaisar Hasan says AboveNet is a real possibility, though he said he’s not heard specific details about the company being a target.”If you follow the industry, you know that these guys have pretty deep metro fiber assets. It’s one of the handful of metro assets that’s still available. tw telecom inc. (Nasdaq: TWTC) is another, but it is probably too big for them. If you want to create additional depth there are only a few companies remaining."

An AboveNet marketing executive, who asked that his name not be used, said speculation about an acquisition by Level 3 isn’t suprising. “I’m sure it's probably something that is speculated quite often, given that Level 3 appears to be gobbling down everything it can get its hands on -- I guess that wouldn’t be shocking speculation.”

A February 1, 2006, SEC filing reveals that AboveNet is in the mood for selling off at least some of its assets. According to the filing, AboveNet retained The Bank Street Group LLC to solicit offers for its data center operations. “The company has determined that its data center operations may not be core to its metro-network connectivity business in the future,” the filing reads.

Light Reading's anonymous source, a telecom industry insider who has been correct on such matters in the past, says AboveNet is all but a done deal and that XO Communications is also a possibility.

One thing that might make the deal tricky is the murkiness of AboveNet’s finances. The company trades on the pink sheets.

The Securities and Exchange Commission (SEC) initiated a formal investigation of the company on June 3, 2002. The investigation followed AboveNet's announcement in April 2002 that it would need to restate its financial statements for the first three quarters of 2001. The investigation will remain open, according to the filings, until AboveNet has filed its full-year 2006 results and all other filings dating back to 2001.

“I think it’s a strong property, but you have to look at some of the baggage that comes along with it, meaning the financials, the SEC probe, and the fact that they haven’t made a quarterly [earnings] filing in the last four years,” says Synesael, of Merriman Curhan Ford. Synesael says the last time AboveNet filed, which he believes was back in 2001, the company was doing $90 million a quarter in revenues.

But most of the metro and fiber assets today are either coming out of bankruptcy reorganization or in private hands. Another potential target, XO Communications, fell into the hands of a private equity firm after it filed for bankruptcy protection in 2002.

— R. Scott Raynovich, Editor in Chief, and Mark Sullivan, Reporter, Light Reading