Level 3 Revenues Sink Further

It sure has been a tough sales year so far at Level 3 Communications (NYSE:LVLT, news, filings).  In their Q2 earnings report today, they lost another 4% sequentially off the top line with total revenues of $942M.  Core Network Services revenue, its the key growth engine, fell by 2% sequentially to $877M.  That revenue pressure was less than during the first quarter, but still quite a bit tougher than expected by most, including myself.  The company blamed the economic environment for its sales weakness, stating that while things improved during the quarter they didn’t happen as quickly as they expected.  Large wholesale customers continued to reign in spending at levels that will be unsustainable at some point.

Partially balancing the revenue declines were another impressive chunk of cost savings, as cash SG&A fell 3% sequentially to $311M.  But holding EBITDA steady under such conditions isn’t possible, and hence the company reported $229M and lowered its EBITDA guidance for the year to $900-950M.  The company did manage to generate $20M of free cash flow but guided the full year number to ‘neutral’ from ‘positive’.  Overall it was a disappointing quarter on almost all fronts, but on the only one that really counts in the end they managed to meet expectations:  a loss per share of $0.08 was not bad at all.

On a segment basis, it was the company’s flagship wholesale markets core network services that took the biggest hit, dropping 5% to $340 from $358M in the first quarter.  The content markets group echoed Akamai’s results yesterday with a similar sequential decline.  I wonder if it is everyone or if Limelight Networks (NASDAQ:LLNW, news, filings) picked up some CDN marketshare this quarter, we shall see.  The company’s Business Markets group has been blamed for much of the company’s troubles over the past few years, but this quarter it held its own compared to wholesale and content, perhaps the new local focus is helping already.  The sole real bright spot was of course European core network services, which managed a 5% gain sequentially.

The question one has to ask is this:  just how much of Level 3’s troubles are really from the economic slowdown and how much are of its own making?  Who else has seen revenue pressure of this sort other than legacy laden wireline divisions of ILECs and Sprint?  Not Global Crossing yesterday, not Paetec, TW Telecom, Cogent, or XO either so far although we still have to hear about each of their Q2 results.  On the other hand, Level 3 is not having unusual trouble these days with provisioning or service or products and its revenues aren’t burdened by legacy churning off – so what gives?

I submit that Level 3’s revenue contraction is actually due to the credit crisis, or more specifically due to its unique response to the credit crisis because of its large debt.  Despite the  talk about economic pressures it isn’t really about trouble finding people to buy their services, the sales pressure is because the company is holding its capex in a vise (just $80M again this quarter) in order to hold the bottom line in check.  To do so, they are forgoing revenue opportunities they might otherwise have pursued, and their smaller but less debt burdened non-ILEC brethren are picking up the slack – and the marketshare.  So for Level 3 the top line suffers while they throw every ounce of support they can muster underneath the bottom line.

Yet anyway.  This can’t go on forever, or more than a year or two.  One way or another Level 3 needs to grow into its debt.  They have gotten this far via inorganic growth, and if organic growth opportunities don’t resurface soon they may indeed have to give that another shot.

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Categories: Financials · Internet Backbones