Level 3 Finds Growth, Increases EBITDA

Level 3 Communications (NYSE:LVLT, news, filings) reported its Q3/2010 earnings this morning, managing to find sequential growth across all of its core segments as well as in total revenue for once, while holding costs down quite well also.  The result was that they actually managed to beat composite analyst estimates for revenue, adjusted EBITDA, and earnings per share.  But with Level 3 the devil is always in the details, so here’s a quick look in greater detail alongside the past 4 quarters:

$ in millions	Q3/2009	Q4/2009	Q1/2010	Q2/2010	Q3/2010
– Wholesale	347	353	336	342	343
– Large Enterprise & Federal	123	129	136	142	144
– Mid-Market	155	151	151	146	147
– Europe	75	73	71	69	75
Core Network Services Revenue	700	706	694	699	707
– Wholesale Voice	159	162	165	163	161
– Other	42	38	34	30	27
– Asset Sale			7
Total Communications Revenue	901	906	900	892	895
– Coal	15	18	10	16	17
Total Revenue	916	924	910	908	912
– Communications Cost of Revenue	369	361	371	358	353
– Communications Cash SG&A	316	328	327	324	325
Communications Adjusted EBITDA	215	216	200	209	216
Adjusted EPS	(0.10)	(0.11)	(0.11)	(0.10)	(0.10)
Capital Expenditures	75	80	82	104	133
Free Cash Flow	9	97	(90)	(19)	(63)

Revenue: The strongest performer was obviously Europe, while both wholesale and large enterprise/federal grew but only just.  Mid-market revenues actually turned in some growth as well.  So core revenues were up 1%, which is good but not spectacular.  They really need to accelerate a bit before anyone will believe in a ramp.  Can they do it in Q4?  Depends on what all that capex is for, more on that below.

Costs & EBITDA: While revenue growth was acceptable, cost controls were quite impressive.  Cost of revenue declined even as revenues grew, and SG&A didn’t see a measurable bump due to utility costs.  Hence communications adjusted EBITDA of $216M was above my own projections and adjusted EBITDA margins expanded to 24.1%. EBITDA is expected to grow from here as well, which is good.  They need to find a way back toward $250M in quarterly EBITDA, which can support their debt and enough capex to grow.

Capex & Cash Flows: The big standout number in this release though was capex, which surged mightily to $133M – even higher than I had thought.  That *could* forecast a big Q4 coming up, but we should wait to hear on the conference call just what went into that number.  Of course, with capex so high, free cash flow was even more negative than I had projected although not by much.  If it’s for the cause of growth to come, I’m all for it.  The company projected positive cash flow in the fourth quarter as working capital swings back the other way – but not enough to erase the cash burn of the first three quarters of course.

Conclusion: Level 3 had a good quarter, and is spending for better ones down the line.  What the markets will think of it I don’t know, but IMHO this certainly didn’t fall in line with the bear case that has been holding the stock price below $1. I will listen to the CC for further info and update here.

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