Wholesale/transport services

Level 3: 'Size Matters' Isn't Enough

There was a time when you could say of Level 3 Communications Inc. (NYSE: LVLT) that it never met a network acquisition it didn't like the look of.

Deal after deal, big, small and in-between, the fiber-rich and IP-infused Level 3 just kept buying other companies and other networks, with its whole corporate strategy seemingly based on another simple maxim: You can never be too big, or have too much bandwidth.

The company was the poster boy for an entire industry's preoccupation with size. Its attempts to win the "mine is bigger than yours" game proved habitual, with its frequent acquisitions making it look like it was always in the network-building business, rather than the business of selling capacity and services.

Level 3's big ol' network
Level 3's big ol' network

The price that Level 3 investors have paid for much of that 15-year acquisition binge is ongoing quarterly losses and broken promises that the buying spree and network-building boom would stop someday. The man they had to thank for all that was James Crowe, company co-founder and chief executive for Level 3's entire corporate life until this year. (See Level 3 CEO Sets His Exit).

Even now, Level 3 continues to have financial problems that acquisitions and bandwidth band-aids won't fix. The company once again posted a quarterly loss for the second quarter of 2013, this time amounting to $24 million. That loss was much narrowed from the previous quarter, when it was about $78 million, and from the second quarter of 2012, when it was $62 million. Quarterly revenues remain flat, just shy of $1.6 billion.

But we have seen this movie before, and it often ends with Level 3 adding to its debt, losses and integration agenda by buying another network operator. (See Level 3 Surges on Positive Outlook).

That movie will end differently this time only if Level 3's new management understands that playing the size game won't work anymore. The network is table stakes, but what you compete on is services, price and customer experience. Other comments and indicators from the second-quarter earnings call suggest the new management is beginning to understand that. For example, Level 3's enterprise business is growing and the company even hinted that it doesn't yet need the 100G circuits the rest of the industry is so eager to deploy. New CEO Jeff Storey even said M&A is no longer a priority for Level 3. (I had to have a short lie down after that announcement...)

That sort of restraint isn't common for a company that has spent 15 years trying, without success, to turn size into profit.

Level 3 still has to prove that it has turned over a new strategic leaf, though: If it has really changed its ways, when next faced with a potential acquisition it will say "no deal."

— Dan O'Shea, Managing Editor, Light Reading

Telco 9/6/2013 | 7:15:03 AM
Re: Following up with Level 3 It is critical for Level 3 to continue to add to it's network size, perhaps as much as another 40 more years.  The key is the build needs to focus on retail applications and retail loops.  The reality was the 2nd major network for Mr. Crowe who was one of about 5 major investors in fiber networks completely competitive to the transmission networks of incumbents.  Level 3 was one of about 5 companies to take the pain of making resale a last option to win business, in hopes that it's continued effort to build a network will actually be on-net for most of it's customer base.  Level 3 almost sunk itself with a major wholesale agreement with the cable consortium and then winning Internet 2 and three major Content Delivery Networks.  Wholesale traffic is not what Level 3 needs now.

Level 3 now needs retail applications and retail loops.  Level 3 must build these out because soon, frankly resale will not be an option soon.  Adding retail will improve margins.  I am quite concerned finding retail will be achievable with copper-over-ethernet and cable metro ethernet land grabs going on between telco and cableco tier one vendors.  If retail with healthy margins is not achievable, the debt from builds with wholesale margins will again force a restructuring.  Like Amazon, this infrastructure build is a 30 year proposition, not a 3 year to liquidity play for investors.
DOShea 8/28/2013 | 4:31:29 PM
Following up with Level 3 Level 3's response to this blog was to offer me an interview in mid-September with CTO Jack Waters, so expect to see a follow-up story or blog on this topic in a few weeks.
Carol Wilson 8/16/2013 | 9:14:37 AM
But will size eventually matter? Level 3 at one point had an innovative approach to providing access to its long-haul fiber network for mobile backhaul - I wonder if that is still in play? Its networks traverse parts of the U.S. where backhaul bandwidth will be in demand as LTE networks are (finally?) built in the hinterlands. It will be interesting to see if a fiber-rich network counts for anything by then. 

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