Predicting the Next Big One for Level 3

Since FBR speculated that Level 3 might be about to make a late bid for PAETEC, I have been fielding numerous questions offline about the possibility – with skepticism as I have already noted and won’t rehash here.  But one of my main responses is that if Level 3 is hungry then they have tastier targets than a national US CLEC with its own integration to worry about, at which point obviously I am immediately asked who those targets might be.  Let’s talk about just one of them.

What if I told you there was an acquisition candidate out there that had the following characteristics:

• deep metro fiber spanning 38 major cities, 10 being current Level 3 metro markets and a dozen more they still serve only with a PoP or two.
• more on-net buildings than Level 3 has now
• little risk to their current integration tasks in the US
• 19 data centers with a cloud infrastructure business getting current focus
• $2B+ in revenue, with growing data & IP balancing declining lower margin voice
• 20%+ EBITDA margins
• Current EV/EBITDA trading far below 5x, and that’s before any possible synergy thoughts

You’d probably think I was making it up.

Look at this from Level 3’s perspective. What do they need? First and foremost, they need the Global Crossing integration to not hit speed bumps because it gets them so much closer to where they want to be all by itself. You can hear that reflected in everything the company says these days, it is priority number 1.  Any M&A hunger on their part simply can’t risk that without being a truly awesome opportunity, which I think greatly decreases the likelihood of a major US CLEC acquisition of any sort for a year or so.

Second, in terms of assets they already have everything they need  to go to bat against the big boys in the USA, the UK, and Latin America.  The one place their assets are perhaps not so complete is in continental Europe. Last week the company announced the expansion of its enterprise business into Germany, which highlights the fact that their European business outside the UK remains mostly wholesale. They have metro assets there of course, but the coverage doesn’t match their other regions.

European metro assets don’t get the same kind of credit yet as in the US, and hence they aren’t priced for royalty. I think that logically Level 3 can get more bang for its buck sooner by making a big move on a pan-European asset with metro connectivity. Well, if it’s transformational, why not make a bid for Colt? Yes, Colt is the company I was iterating the characteristics of in the list above.  That on-net building count is actually 18,000, and EV/EBITDA is – well it isn’t even close to 5 if my calculations are correct.

Add up the GCUK business, Level 3’s European unit, and COLT’s pan-European assets and enterprise penetration, and you have an operating unit with both asset depth and breadth that already has the scale to make a serious competitor on all fronts and which complements the US and South American portfolios quite nicely. The declining voice business would parallel and compelement the one they already operate in the US, possibly stabilizing as a result.  And you don’t have to break into anyone’s party at the last minute to get this, in fact the other serial acquirers they compete against in the US seem unlikely to even show up at the table.  Assuming of course that there is a table to sit at, but that’s another matter.

Before Global Crossing, Colt didn’t make as much sense as an M&A target for Level 3 because other needs were paramount, but now I think the situation has evolved substantially.  Obviously there are other targets that also fit this general idea to various degrees – euNetworks, Interoute, various regional assets – but Colt seems quite ripe for the picking these days given current valuations and the economic uncertainty over there.

Could they fund it?  It’d be easier than a deal for PAETEC I’d wager…

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Categories: Internet Backbones · Mergers and Acquisitions · Metro fiber