Tag Archives: telecom investments


After a week like the one just gone, where the S&P500 hit the 10% down threshold for the year, it’s perversely healthy to see debates rage about the likelihood of a recession, the future for oil prices, the bursting of the unicorn bubble, the impact of negative interest rates and the fallibility of central bank macro policy in the developed world, to name just a few. Considering and factoring in such risks are exactly what should be happening in a well functioning market, rather than one far too long reliant upon the supposed omnipresent wisdom of central bankers to answer any market ills that may come along. Although the market volatility during the opening months of 2016 hasn’t been pleasant and will hopefully find a floor soon, valuations didn’t reflect risks and an adjustment was needed.

I have no idea where the market is headed, although I suspect we are just one more shake-out from capitulation. Valuations have come off their unsustainable highs and a select few are beginning to look attractive. After some of this week’s indiscriminate falls, it’s always a good risk management discipline to assess current and possible new positions in light of developments. I assessed AAPL’s valuation recently in this post and offered my thoughts on the new Paddy Power Betfair in this post.

The subject of this post is Level 3 (ticker LVLT), a facilities-based provider of a range of integrated telecommunications services. Prior to their earnings on 4th of February, I had been re-examining my investment rationale on LVLT, one of my highest conviction positions that I last posted on a year ago. As I have highlighted before, LVLT is not an investment for the faint hearted and the past week has again proven that (a beta level of 1.5 according to Yahoo just doesn’t capture it!) with daily moves following the Q4 report of +6.9%,-5.7%,-9.4%,+3.7%,+3%, 0.5%, and Friday’s +1.7%. The graphic below shows the movement in the share price in LVLT, the S&P500 and the S&P High Beta index (SPHB) since the start of 2015. Also shown are the daily changes in LVLT against those of the S&P500.

click to enlargeLevel3 SP500 Share Price & Volatility

To recap on the bull case, the strength of LVLT is its deep and global IP optic network which following the recent mergers with Global Crossing and TW Telecom now has the business scale for the experienced management team to finally achieve operating margins to support its debt (current net debt to 2016 guided EBITDA is approx 3.5) and throw off meaningful cash-flow in the coming years (average FCF growth of 8% according to my estimates over the next few years). The Q4 2015 results and 2016 guidance showed the bull case is intact and the demand for new products such as the security and intelligent network services show how LVLT’s network is a competitive advantage in today’s technology driven world. The CEO Jeff Storey summarized their case at the Q4 conference call as follows:

“Most importantly, is our movement towards our vision of one, one set of products that we take to an expanding market, one network to deliver those products globally, one set of operational support systems to enable a differentiated customer experience, and one team with the singular goal of making Level 3 the premier provider of enterprise and networking services. As we look to 2016, our strategy remains the same. We are focused on operational excellence throughout our business, providing a superior experience to our customers and developing the products and capabilities to meet their complex and evolving networking needs.”

As the talk of a possible recession fuelled worries on business telecom spend, I thought it would be useful to look at the historical “as if” results of the now enlarged LVLT through the financial crisis. This involved looking through old Global Crossing and TW Telecom results and making numerous assumptions on the historical growth of acquired businesses and the business classifications (and numerous reclassifications) of each firm over time. The historical “as if” results combined with the reported figures for 2014 to 2015 and analyst estimates for 2016 to 2018 are shown below.

click to enlargeLVLT Proforma Revenue Split 2007 to 2018

Within the context of the caveat above, the drop in enterprise revenue from 2008 to 2011 was 12.5%, primarily driven the financial crisis with other factors being Global Crossing refocusing its portfolio and the operational missteps by legacy Level3 in integrating its multiple acquisition from 2006-08. TW Telecom’s consistent top-line growth since 2007, despite the financial crisis, can be seen in this post. It’s interesting that the wholesale revenues have been relatively stable historically ranging between $2.10-2.35 billion, supporting the view that price decreases are offset by unit increases in IP traffic.

Since 2012, the benefits of scale combined with the integration prowess of the current LVLT management team (Jeff Storey became CEO in 2013) are vividly shown in the impressive increase in EBITDA margin from 22% in 2009 to 32% in 2015. After cutting capex in 2008-09, the combined business has required 14%-16% since then, now targeted at 15% to support the 8% annual growth in enterprise revenues (on a constant currency basis) that management have set as their target.

In Q4, LVLT’s revenue was derived 80% from the US and management claim that their enterprise business has only a single digit market share in the US leaving plenty of room for growth, particularly against the incumbents Verizon and AT&T. The graph below shows enterprise and wholesale revenues from each firm with AT&T showing revenue stability against a declined trend for Verizon.

click to enlargeVZ AT&T Business Telecom Revenue

Numerous analysts confirmed their estimates on LVLT following the Q4 results and the average target is above $60, approximately 30% above the current level. Regular readers will know that normally I don’t have much time for analysts’ estimates but in this case my own DCF analysis suggests a medium term target of per share in the low 60’s is reasonable. According to my estimates that translates into an EV/EBITDA multiple of approx 8.5 in 2018 which looks reasonable given LVLT’s free cash growth. I used the historical “as if” figures above to calculate a downside valuation for LVLT on the basis of a recession occurring over the next 2 years. I assumed that a 2016-2018 recession would have approx half the impact of the 2008-2011 crisis upon LVLT’s enterprise revenue (e.g. approx 7% decline) before stabilising and recovering. My valuation of LVLT in such a scenario was in the mid 30’s or an approx 25% downside potential from Friday’s close. So at a 25% downside and a 30% upside, LVLT’s risk profile is finely balanced.

LVLT itself may become a target for a firm like Comcast or CenturyLink or another large communication firm looking to bulk up its regional reach or network business. Two interesting items came out of LVLT’s Q4 call; the first being the tightening of its target leverage range to 3 to 4 times EBITDA (from 3 to 5 times) and the second being a renewed appetite by management to use free cash-flow for disciplined M&A rather than shareholder returns such as buy-backs or even initiating a dividend. With LVLT proving their ability to get in excess of $200 million in EBITDA savings from adding TW Telecom’s revenue base of $1.6 billion at the time of the merger (or an impressive 12.5% EBITDA pick-up), the case for disciplined M&A by LVLT’s management is strong. Possible targets in the US include Zayo (their share price is having a hard time of late) or Carl Icahn’s privately held XO Communications (now that the maestro has milked the firms of its tax losses), amongst others. In Europe, possible targets include the now private Fidelity owned COLT (see this post on background) or Interroute, another privately owned pan-European network.

Whatever happens, I am content to hold my position in LVLT at this level. I like the firm’s current risk profile, the developing product range in the ever important network age, and particularly the recent execution record of management. As ever, I would highlight the stock’s volatility and recommend the use of options to protect downside risks (which are not inconsiderable if the probability of recession grows). I again repeat that LVLT is not one for the faint hearted, particularly in this market where near term volatility looks all but certain, but one I trust will be an attractive investment.

Will it be different for Level3 this time?

As per my previous post on telecom experiences, I reviewed my projections and valuation methodology for Level3. Level3 has a frustrating yet fascinating past. It miraculously survived the telecom implosion with an over sized debt load through growing into its debt by buying up smaller metro focused telecoms and its most recent merger with a post chapter 11 Global Crossing.

Level 3 struggled with the integration of its numerous merger partners from 2005 to 2007 and, with the downturn in 2008 to 2010, suffered reductions in the both of the top and bottom lines of the combined entities. There is however now some hope that the integration with Global Crossing will not suffer the same fate. For a start, Level3 approached the integration with a much sharper focus on the customer experience during the merger and ensuring minimal service disruptions. Also, Global Crossing itself had a number of years following its restructuring where it focused on its core products and de-emphasised the low margin commodity business. Finally, the recent replacement of long time CEO Jim Crowe with the COO Jeff Storey seems to have brought a new focus in the company on growing the larger business organically rather than through continuous M&A.

I developed 3 scenarios to illustrate the benefits and the dangers of the current Level3 leveraged business model. The pessimistic scenario assumes that Level3 does not succeed in growing the top line and stumbles on achieving material ebitda margin improvement, only managing margins in the middle 20’s range. The base scenario assumes that Level3 does grow its higher margin business modestly (against a stodgy economic background with interest rates gradually stepping up over the medium term) which offsets reductions in voice based business, achieving an ebitda margin around 30% in the medium term. The optimistic scenario assumes Level3 gets on-going synergies and material ebitda margin improvement achieving a 33% margin by 2017 and thereafter. Graphs representing the scenarios are below and also show the resulting leverage ratios the business achieves.

LVLT Projection Pessimistic Scenario (click to enlarge)Level3 Pessimistic

LVLT Projection Base Scenario (click to enlarge)Level3 Base

LVLT Projection Optimistic Scenario (click to enlarge)Level3 Optimistic

The pessimistic scenario assumes that Level3 can’t get its leverage materially below 500% and would ultimately need to be restructured. Assuming the equity would be wiped out here may be conservative given the equity’s history to date at higher leverage levels. Also, a takeover may give the equity some value in this scenario. Notwithstanding these possibilities, the pessimistic scenario does illustrate the dangers to investing in a highly leveraged firm and given the current macro-economic headwinds and the likely higher interest rate environment to come, I believe an equity wipe-out remains a risk for Level3 in a pessimistic scenario.

The thin line between madness and sanity for highly leveraged firms is illustrated by the upside that modest and healthy growth of both bottom and top lines could result in the base and optimistic scenarios respectively. The following table shows the DCF results at discount rates ranging from 5% to 15%. The discounted cash-flow analysis assumes a termination multiple of discounted free cash-flow after 10 years in 2022 (different multiples for each scenario). As I stated in the previous telecom post, I take the results of a DCF analysis for these firms with a healthy pinch of salt given the timeframe involved and the number of assumptions that have to be made (e.g. cost of debt). Focussing on a discount rate of between 7.5% and 12.5% (which is where I think LVLT should be) does show that the leveraged business model of Level3 provides a 2 to 3 times upside against a 100% downside risk profile (assuming a current $21 per share price).

Summary of DCF Analysis (click to enlarge)

LVLT Share Price Upside & Downside

An alternative valuation method is to look at the EV/EBITDA multiple valuation that the scenarios above may imply. This analysis confirms a possible 200% to 300% upside for the base and optimistic scenarios respectively over a 5 year time horizon (and the 100% downside!).

EV/EBITDA Projection Pessimistic Scenario (click to enlarge)Level3 Pessimistic EV EBITDA multiple

EV/EBITDA Projection Base Scenario (click to enlarge)


EV/EBITDA Projection Optimistic Scenario (click to enlarge)



Level3 has broken many hearts in the past. However, if the new CEO can execute on organic growth and margin improvement, the stock offers an attractive upside over the next few years due to its leveraged balance sheet and operating model. A lack of macro-economic turmoil will also be an important factor in any success. For even more aggressive investors, playing the stock through long dated out of the money options offers the prospect of leveraging returns even further (with the accompanying increase in risk profile). As I keep stating, Level3 has promised much in the past and failed to deliver on a spectacular basis. This time, maybe, just maybe, it could deliver something for patient investors. Anybody considering Level3 should always keep in mind that it remains a high risk/return play and is not for the faint hearted.

My Erratic Telecom Habit

One of the sectors that I have followed for nearly 15 years now is the emerging telecom sector, specifically the so called altnet or CLEC sector. My affiliation with this sector has been the cause of many highs and lows, some very painful lows, through the telecom/internet bubble & bust, the 2000’s and to this day. Initially the attraction was the boom in internet and data traffic and the leveraged nature of many of the firms. After spectacular gains in the go-go days of the bubble (I bought hook line and sinker into the “picks and shovel” rationale), the subsequent reality of the telecom bust and the “nuclear winter” left me with big losses. For those unfamiliar with the stories of the bubble era, Om Malik’s excellent book “Broadbandits: Inside the $750 bilion Telecom Heist” goes deep into the madness that prevailed.

Over the past 10 years odd, I have had a much more cautious and opportunistic approach on the sector and have had some success at dipping in and out of stocks/debt/options of restructured companies as they moved in and out of favour (particularly prior to the financial crisis). Successes in recent years include the post-bankruptcy Virgin Media and Global Crossing. One notable failure was a firm called XO Communications backed by the vulture investor Carl Icahn. A self publicised champion of the minor investor, when it suits him, investing alongside Icahn in XO proved to be a grave error. This article illustrates some of the drama. I Iearned much from the experience including the dangers of illiquid stocks, the nonsense of following a self hyped dominant “star” investor, and the obvious perils of over-leveraged stocks with poor balance sheets in commoditising businesses. Despite these up and downs, the core thesis of a rapidly increasing data consuming society with the potential for high return/high risk (and often leveraged) investments remains for those with an aggressive risk appetite, particularly now that most of the overcapacity from the telecom boom years is becoming less of a factor. For any investor in this space, Robert Powell’s website Telecom Ramblings is the go-to place to get sensible and experienced insights.

One commonly used valuation metric for telecoms is the EV/EBITDA multiple (although it needs to be supplemented with other metrics such as debt and cash-flow measures to get a holistic picture in the altnet space). The graph below shows the variation that has been prevalent in the sector (for selected firms that survived & there is many names that didn’t).

Historical EV/EBITDA Valuations (point selections as at Year End) click to enlarge

Historical EVtoEBITDA Multiples CLEC sector May 2013

As I was preparing to crystallise my thoughts & analysis on this sector (the discipline of having to write down my analysis for this blog is a big reason I am continuing with this blog experiment), the comments from Keith Meister of Corvex at the Ira Sohn conference this week on Level 3 and TW Telecom have been extremely timely. By the way, Meister is an old colleague of Carl Icahn and served as his envoy on the XO board. Given this pedigree, I would therefore totally discount anything he says as 100% self serving. This post will outline some of the historical experience and a follow-on post will outline my valuation analysis for the future of Level 3 and TW Telecom.

Anybody familiar with this space is well aware of the ups and downs of the soap opera that is Level 3. One of the key players in the telecom boom, it built a wholesale network with the help of vast amounts of equity and debt in the bubble years (raised $14 billion in 1998!) and through the 2000’s became a serial consolidator purchasing firms such as Genuity, Wiltel, Progress Telecom, ICG, Telcove, Looking Glass networks and Broadwing to rebalance its business away from the wholesale business into the enterprise space. It is quite incredible that this company avoided the Chapter 11 route that so many companies in this space had to go through to right-size their balance sheets in the face of the new reality of the sector in the 2000’s. With its merger with the restructured Global Crossing announced in 2011, Level 3 seems to have finally reached a level where its balance sheet fits its business. The company also now has diversity across products and regions which indicate that it may be the right time to focus on organic growth. The arrival of the new CEO, Jeff Storey who previously served as Level 3’s COO and previously was the CEO of Wiltel, and his comments on the latest conference call seem to have signalled that Level 3’s consolidation days are behind it and the focus will now be on driving the company forward given its extensive global assets and improved balance sheet. The company is also a potential attractive takeover target for larger established telecoms looking to expand or from regional telecoms or bandwidth hungry technology companies looking for diversification (the more fanciful speculation highlights Level 3’s chairman Walter Scott & his friendship with Warren Buffet and his place on Berkshire’s Board). Again, Robert Powell posts, such as the one this week on TW Telecom, are the place to go to get sensible and knowledgably views on items such as M&A speculation.

TW Telecom, on the other hand, is at the opposite end of the spectrum to Level 3. It always had a focus on the enterprise space and has such a determined management that its business execution normally results in an ability to predict its quarterly result to the nearest million. Its leverage has always being far more rational than that of Level 3 and it has grown into its balance sheet gracefully over the past years. TW telecom is the sensible stable child to Level 3’s wild rebel in this space. Indeed, TW Telecom’s lack of adventure has been recently cited as a reason why it may be ready for a takeover.

In order to get some context on these two US based firms and a view of what has happened to a European focussed altnet, I also include a historical review of a European company called COLT Telecom (recently cited by Telecom Ramblings as a potential acquisition target for Level 3).

Graph of Historical Share Price for LVLT, TWTC, COLT click to enlarge

Historical Share Prices LVLT TWTC COLT

The historical operating figures for these three companies are highlighted below.

Historical Level 3 Operating Metrics (US$s) click to enlarge

Historical Operating Metrics LVLT

Historical TW Telecom Operating Metrics (US$s) click to enlarge

Historical Operating Metrics TWTC

Historical COLT Group Operating Metrics (€s) click to enlarge

Historical Operating Metrics COLT

In the interests of open disclosure, I currently own stock & options in Level 3 and have owned some of the other companies named in this post in the past. I am currently re-examining my valuation methodologies for the sector, specifically for estimating Level 3’s future path using TW Telecom as an example of firm’s experience in a relatively steady state and COLT as an example of firm’s experience on a cross border basis. I have used traditional discounted cash-flow and EV/EBITDA multiple analysis in the past but have recently become more sceptical about the underlying theory for such methods. I am trying to adapt them to get a more realistic view of the sector based upon previous experiences. I will post a follow-up of my thoughts and conclusions.