Level 3 Feels Integration Irritation

Shares of Level 3 Communications Inc. (NYSE: LVLT) dropped 12 percent today as the company reported second-quarter earnings that fell short of expectations. (See Level 3 Reports Q2.)

For the second quarter of 2007, Level 3 lost $202 million, or 13 cents per share, on revenues of $1.05 billion. In the same quarter last year, it lost $201 million, or 23 cents per share, on revenues of $1.5 billion.

Table 1: Level 3's Q2 2007 Scorecard
2Q07 2Q06 Y/Y Change
Revenue (Millions) $1,052 $1,530 -31.2%
Earnings (Millions) -$202 -$201 -0.5%
GAAP EPS -$0.13 -$0.23 +43.5%

The problem isn't growth -- Level 3's core communications services continued to grow this past quarter, but the growth was not as big as the company or analysts had expected. Revenues from communications services were $888 million, which fell short of the estimated $890 million to $910 million.

In recent years, Level 3 had gone on an M&A shopping spree, acquiring companies such as Telcove, ICG, Progress Telecom, and Broadwing. But for now, these acquisitions have been hurting Level 3's bottom line as the company has faced difficulties integrating them into its business.

While the company expects to complete its workforce cuts by the end of the third quarter and has reduced its number of network operations centers (NOCs) from nine to two as part of the integration process, some problems still remain.

"We haven't been able to eliminate 100 percent of all the legacy applications from companies. Employees in our NOCs are having to learn elements of the legacy systems and work in complicated environments," said CEO James Q. Crowe on the earnings call.

The integration issues have prevented Level 3 from cutting costs as quickly as it would like and have also hindered the company from turning its sales into actual revenues.

The struggles of Level 3 and its stock are puzzling, since the company's metro fiber network is expanding rapidly and analysts are expecting solid revenue growth of about 10 percent a year through 2009. (See Level 3's Metro Fiber Frenzy .)

"The analysts like this company because it’s a consolidator and this whole business is about scale" says Greg Mesniaeff, an analyst with Needham & Co. "The more you consolidate, because it's a fixed-cost industry, you can get more leverage out of your asset."

But Level 3's attempt to further consolidate hasn't worked out as well as AT&T Inc. (NYSE: T)'s acquisitions, which resulted in significant cost savings that produced strong quarterly earnings. (See AT&T's Wild About Wireless in Q2.) "That's the way it's supposed to work and often does, but sometimes there's unexpected curveballs" says Mesniaeff. "You can certainly say that Level 3 has made a lot of acquisitions and now has a full plate."

In addition to its traditional business, Level 3 reported that it was encouraged by the early results of its new content delivery network which was launched in the U.S. in May. Level 3 doesn’t expect its content delivery network to generate any meaningful revenues in 2007 and reiterated that it's still very early in the process to make any projections on it.

— Raymond McConville, Reporter, Light Reading

materialgirl 12/5/2012 | 3:04:50 PM
re: Level 3 Feels Integration Irritation You must not take "savings" at face value. Who knows what bogus accruals BLS packed in there over the years. Probably lots. No one will have a clue how the ATT merger is going for at least a year, when we lap comps. Even then, bogus "savings" will probably get squeezed out. Additionally, the ATT-BLS networks are similar. They just cut assets and consolidate traffic flows. How hard is that?

On the other hand, who is surprised at LVLT's struggle? They bot a significant number of different assets at once. They came up with rapid consolidation estimates. They were not reasonable on the face of it.

In addition, they bought CLECs, companies who have recently existed on scraps thanks to recent FCC moves. Their accruals are thin. Due to this, LVLT's numbers are more realistic than ATTs on a going forward basis. If LVLT is indeed an asset play, this delay is no big deal in the scheme of things.
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