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Level 3 Still Hungry for Fiber

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

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airfiber 12/5/2012 | 3:51:45 AM
re: Level 3 Still Hungry for Fiber Agree with your assessment. However, we are at the stage in the roll-up process where customers/revenue/margins are much more important than fiber assets (It's been that way for some time, just now getting around to acknowledging it).

Level 3 needs revenues otherwise it is headed toward a "Big D" (for dilution) event to prevent bankruptcy. They remain in a big whole but are executing on a well thought out strategy - it just might work.
fiber_r_us 12/5/2012 | 3:51:45 AM
re: Level 3 Still Hungry for Fiber Level3 and Abovenet (MFN) co-built many fiber routes in metro areas. Their conduits are in the same trenches in lots of locations. So, buying Abovenet does not give Level3 a significantly larger fiber footprint. If Level3 buys Abovenet, it will probably be pretty cheap due to the fiber route overlap and Abovenet's poor financials.
materialgirl 12/5/2012 | 3:51:43 AM
re: Level 3 Still Hungry for Fiber One challenge LVLT faces in growing from their MSA-based POP architecture, into direct customer connections, is how they are going to handle all of these "small" customers, with support and billing and the like. This is not their forte.

I also wonder what it is they have learned about telco economics that make them interested in adding this new complexity and expense. Perhaps it is the changed regularory environment.
airfiber 12/5/2012 | 3:51:42 AM
re: Level 3 Still Hungry for Fiber Level 3 is a public company:

Balance Sheet
(in millions of USD) Total Current Assets
Total Assets 8,284.00
Total Liabilities 8,830.00
Total Equity -546.00

For you non-bankers out there the above means a negative net worth and they are also cash-flow negative to boot (also known as digging the hole deeper)

As I said, they need to issue more stock, dilute the existing shareholders, buy revenue and buy down debt. It can be done, but its no better than a 50/50 shot

Mark Sebastyn 12/5/2012 | 3:51:42 AM
re: Level 3 Still Hungry for Fiber Buying someone else who has the same infrastructure you do consolidates the industry and improves pricing power. The pie doesn't get bigger but it tastes better.

Also, I'd like to know how you can say their financials are so terrible considering they haven't published any in four years.
airfiber 12/5/2012 | 3:51:42 AM
re: Level 3 Still Hungry for Fiber Level 3 is not entering the retail space with these acquistions, at least not yet. These are wholesale plays where the customers are primarily wireless carriers. Wireline opportunities like Ethernet in the first mile, etc. is a shrinking part of the pie. These acquisition moves are being driven by the needs of the wireless carriers.

They can do their bills on an Excel spreadsheet.
Mark Sebastyn 12/5/2012 | 3:51:41 AM
re: Level 3 Still Hungry for Fiber That was a kick ass comment.
American Indian 12/5/2012 | 3:51:41 AM
re: Level 3 Still Hungry for Fiber
AboveNet is redundant to Level 3 in big cities - no deal. Do you think Kluge is dumb, he know he sits on gold. Xspedius, not a single Xpedisu route is unique - loaded with other carriers. XO is pocked. Icahn lives in his own world -- XO focused on Fixed Wireless.

Yes, you need to own fiber in the metro in order to move customers on it. After the metro fiber buy-outs subside in about 6 months, you will see an uptick in M&A on CLECs that are renting from the ILECs - but you will not see the multiples that metro fiber holders are getting. Why? ILECs are raising their costs to CLECs while ILECs lower prices as they compete with CLECs -- a death trap for all the asset light CLECs out there. The value of CLEC customers, depending upon churn and segment will either equate to 1x revenues becuase of the costs to move them or the cost of acqusition for L3 just to take them away because L3 owns local plant.

Telcove is in the retail business, Crowe has spelled this out in integrtaion. L3 is moving fast towards customers.

Level 3 knows by owning the local metro fiber you have innoculated yourself from any future FCC, PUC or ILEC paying off Congress crap. Jim Crowe is not dumb.

In the long run, copper and wirecenters do not matter. L3 is buying metro players now because supply is limited, it increases pricing power, it takes years to build out a metro, costs 50% more to build out a metro today than what it costs a metro fiber owner 5 years ago, creates a barrier of entry, subpositions the ILEC resale model for CLEC renters while devaluaing the CLEC enterprise vlue of thos who don't own fiber, innoculates L3 from regulatory grabage ...

... fiber glut, what fiber glut ...

... Wall Street wake-up there is no fiber glut in metro markets outside of NYC, LA, Chicago, Dallas, Houston, San Fran, Miami, Atlanta, DC, Boston, Phoenix and Denver ...

... L3 is very, very smart.

materialgirl 12/5/2012 | 3:51:36 AM
re: Level 3 Still Hungry for Fiber Dear American Indian:
If you think LVLT is moving from POPs to the edge, do you have some concern (as I do) about how they will handle billing/customer service headaches as they add to their customer count? Not a show stopper, but a risk none-the-less.

I agree that owning assets is the only way to insure against a hostile FCC.
American Indian 12/5/2012 | 3:51:31 AM
re: Level 3 Still Hungry for Fiber

Telcove is more than adequate to handle any and all billing at a retail level.

I figure their are about 6 really good metro owners left out there for Level 3, mostly private concerns. The big players will never target htem beciuase all they do is think in terms of billions for a deal.

Level 3 doing a National M&A play would be suicide. Their focus on picking strategic companies will pay dividends.

Wall Street may eventually figure it out - owning local metro fiber gives you staying power over ILEC rental biz models and soon enough, copper will not be the medium of choice so no need for wirecenters or end offices.
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