Level 3 Earnings Primer – Q4/2009

Tomorrow morning before the bell, Level 3 Communications (NYSE:LVLT, news, filings) will report earnings.  As long time readers know, I have long kept a detailed model of the company’s rather complicated financials and it is time once again for an earnings preview.  Level 3 has had a tough year, enduring something a perfect storm of an economic crisis, customer migrations, and the (hopefully) final repercussions of its earlier integration problems.  There probably aren’t many people in Broomfield who are unhappy to put the final nail in the coffin of 2009.  But In the third quarter the bleeding slowed, and the company has projected a return to growth in both core revenues and communications EBITDA in the fourth quarter, as well as neutral free cash flow for the full year.

Will they make that guidance?  My model suggests there is nothing standing in their way.  Here are my current personal projections for both Q4 and Q1, and a bit about the full year 2010:

Core Wholesale Markets –  we saw an uptick here at last in Q3, and I expect it will continue.  This is Level 3’s core business, and as it goes so will their overall fortunes. With capex levels rising back to normal levels across the sector, Level 3 ought to win its share.  If they don’t, it would be a bad sign.

Business Markets – In Q3 this business was still reeling, and the hope for Q4 is simply that the bleeding stops and things turn around in Q1.  The local markets initiative has now had time to have a measurable effect, and the recession has ebbed so churn should also.

Content Markets – Seasonally, Q4 is big for both Vyvx and the CDN sector, which normally would bode very well for this segment.  However, this quarter we have pricing pressure brought on by Akamai’s price cuts, which would tend to counterbalance that effect.   I feel this projection is the least reliable of the set

European Markets – This should return to its historical steady and strong growth profile, but tempered by continuing pricing pressure in Eastern Europe.

2010 Core Revenues – Even with a fairly nice return to sequential growth in core revenues, they will probably guide to something like ‘low single digit‘ revenue growth for 2010.  That’s because sequentially they will have to grow as quickly in 2010 as they declined in 2009 just to break even, as they are starting from a lower base.

EBITDA – My projection of $226M is of course an improvement from Q3, and would put the full year number at $920, generally in the middle of guidance ($900-950M).  My model suggests that if revenues continue to recover at a reasonable rate, they will probably guide to a $950-1000M level for full year 2010 EBITDA.

Free Cash Flow – The full year 2009 of ‘neutral’ seems likely to be met.  For 2010, free cash flow depends on how conservative they are with their capex spending.  If capex to rises back to 10% of revenues, we can look forward to something like $50-100M in positive free cash flow.  If they look to grow more aggressively and loosen those purse strings, the number will be more like $0-50M.  My guess is they will simply tell us it will be positive for the full year and let that be enough detail.

Conclusions – My projections are probably a bit above the street’s projections, as usual – I do tend to see the sector a bit more optimistically than most, else I wouldn’t find it so interesting and write this stuff.  But overall there is no question that the thing to watch for in Level 3’s release is revenue growth or the lack thereof, and in which segments it occurs.

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Categories: Financials · Internet Backbones