Two of my favourites names in the telecom space – Level 3 (LVLT) and TW Telecom (TWTC) – have announced an agreement to merge. I have posted previously on both – here and here respectively. Overall, my initial reaction is positive on the deal as I believe that LVLT have bought a quality asset, albeit at a high multiple of 12.8 times TW’s 2014 estimated EBITDA (TW’s deep metro fiber business model has a high EBITDA margin of approx 35% with a high capex spend in the low to mid 20% range).
There is always execution risk in these deals particularly when taking over a tightly managed and focussed player like TW. LVLT’s successful integration of recent M&A and the new CEO’s focus on operational results mitigates the risks somewhat. My guess is that cultural issues may be the hardest issue to manage as it looks like TWTC’s management will exit after the deal. However, the businesses are very complementary and the sector is one where scale and depth is becoming increasingly important to compete for the demands of the growing bandwidth hungry enterprise sector.
On the financials, based upon my quick and dirty analysis, I estimate that the combined entity could generate approx. $9 billion of revenue and $3 billion of EBITDA by 2016. Despite taking on extra debt for the deal, I estimate that LVLT can meet its leverage target by getting net debt to EBITDA below 3.5 by the end of 2016. Maintaining the leverage target was emphasised by LVLT during the deal presentation. At an EV/EBITDA multiple of 8.5 (assuming 350 million shares after the deal and LVLT 2015 debt conversion), a target price for LVLT of $45 looks sensible to me. Been more positive, a 9.5 multiple gives a target price of $55. Those targets may disappoint LVLT shareholders given the stock was at $44 before the deal was announced and there was further upside potential from a standalone LVLT due to the virtuous cycle of operational efficiencies, reducing interest expense, and growing core revenues .
My view is that now is the opportune for LVLT to use their highly valued stock as currency to purchase a quality asset like TWTC. A classy bride does not come cheap but over the longer term the rewards should come. Either that or you end up broke!