The company hopes to capitalize on 'explosive growth' in content delivery

April 27, 2007

4 Min Read
Level 3 Looks for Big CDN Push

While investors fretted over slower organic growth at Level 3 Communications Inc. (NYSE: LVLT), the company quietly outlined the foundation for a strategic move into the content delivery business during its first-quarter earnings call yesterday.

Level 3 has spent the last 18 months in acquisition mode, ringing up purchases of WilTel Communications, Progress Energy, ICG Communications, TelCove, Looking Glass Networks, BroadWing, Savvis's content delivery network (CDN) business, and certain assets of AT&T Inc. (NYSE: T). (See Level 3 Takes Out WilTel, Level 3 to Buy Progress, Level 3 Acquiring ICG, Level 3 Takes TelCove, Level 3 to Buy Looking Glass, Level 3 Acquires Broadwing, Level 3 Buys Broadwing for $1.4B, Level 3 Spends $135M on Savvis CDN, and Level 3 Buys AT&T Assets.)

Most of those acquisitions were directly related to Level 3 expanding its metro fiber access, but in the case of Savvis's CDN, the buy was about the company positioning itself to offer content delivery services.

That purchase, which Level 3 made for $135 million, will allow it to use its extensive fiber network to compete with companies like Akamai Technologies Inc. (Nasdaq: AKAM) and Limelight Networks Inc. (Nasdaq: LLNW). (See Level 3's CDN Story Rides on Fiber.)

The key advantage it has over those providers is that it doesn't have to pay interconnection fees, as it owns the backhaul network. So, theoretically, Level 3 can move content to some places at a lower cost than can Akamai and Limelight.

Level 3 hopes it can convince existing customers like Google (Nasdaq: GOOG), YouTube Inc. , and MySpace to join companies like Microsoft Corp. (Nasdaq: MSFT) as customers of its CDN services.

For now, there has been little payoff on the CDN front. Level 3 reports total CDN sales at $3 million, which is just a fraction of the company's total revenues. That's compared with $139.3 million booked by CDN market leader Akamai in the same quarter. (See Akamai's Big Q1 Disappoints and Akamai Reports Q1.)

Revenues have been low in part because Level 3 is still working on integrating the Savvis CDN assets into its business. On the earnings call, Level 3 COO Kevin O'Hara said, "The integration of the CDN acquisition is a key part of the content market group's challenge and opportunity this year... We have been working on refining the initial product set, and preparing the systems and servers for product launch."

However, while O'Hara says the company expects to launch the CDN business in the second quarter, he says Level 3 "does not expect the CDN business to contribute in a meaningful way in 2007."

Level 3 CEO Jim Crowe underlined this point later in the call when he said, "We expect [the CDN business] to be a very large contributor over the next few years. The amount we get currently from CDN, we view as immaterial, and you should expect that we want a much, much larger piece of the overall CDN market."

Just how large of a market does Level 3 expect? Crowe estimates the whole CDN business today at between $500 million and $1 billion but says, "If we expect that that is what the business would be, we wouldn't be taking the actions we are taking. I think we would have lots of company when we say we expect explosive growth in the CDN business."

Other than that bright spot, Level 3's earnings call disappointed investors. The company reported its quarterly loss nearly tripled over the previous year's quarter, due in part to a massive debt restructuring. And its slow organic growth spooked investors.

Level 3 posted a net loss for the first quarter 2007 of $647 million, or 44 cents a share, compared with a loss of $237 million, or 20 cents a share, for the year-ago period.

The loss included a $427 million, or 29 cents a share, one-time charge related to the company's restructuring of about $3 billion in long-term debt. Excluding the charge, Level 3 posted a loss of 15 cents a share.

The company says the restructuring will reduce its annual interest expenses by about $110 million.

Total consolidated revenues for the first quarter 2007 were $1.06 billion, compared with $1.27 billion in the prior year's first quarter. The first quarter 2006 numbers included $445 million in revenues from its Software Spectrum subsidiary, which was sold in the third quarter of last year. (See Level 3 Sells Software Subsidiary.)

Excluding the Broadwing and Savvis CDN acquisitions, Level 3 reported organic core revenue growth of about 3 percent. According to a research note published by UBS Research analyst John Hodulik, that compares with 8 percent in the fourth quarter and 6 percent in the third quarter of 2006.

Analysts see this trend reversing, due to integration of Level 3's several acquisitions and a completely realigned sales force.

"The picture provided by the numbers was very different from that conveyed during the company's conference call where management suggested underlying trends were improving rather than slowing down," Hodulik writes.

In a research note published this morning, Merriman Curhan Ford & Co. analyst Colby Synesael writes, "Level 3 completed realigning its sales force, combining all acquired companies. By doing so, the company should also be able to begin to accelerate sales growth."

— Ryan Lawler, Reporter, Light Reading

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