Earnings Preview: Watching Level 3’s Momentum

Last quarter the question was whether Level 3’s revenue and EBITDA growth would justify its stock price gains, and they came through big.  On Tuesday they’ll report their Q2 numbers and the dynamics are rather less organic as we have the tw telecom deal hanging overhead.  But it is important that the company maintain its growth momentum going into the merger.  Here are my guesses for Level 3’s Q2 numbers in the usual historical context:

$ in millions	Q2/13	Q3/13	Q4/13	Q1/14	Q2/14 (my guesses)	Comments
– North America – Wholesale	367	365	374	368	368	Wholesale will probably continue to drift, while enterprise revenue growth will be the key.  Their North American enterprise revs will be watched closely.
– North America – Enterprise	603	622	651	675	685
– EMEA – Wholesale	88	88	89	87	87	Same as in North America, but with enterprise revenues at an earlier stage in the growth process.
– EMEA – Enterprise	132	134	134	138	140
– Latin America – Wholesale	40	39	41	40	41	Looking for a better number here than last quarter.  However I am not up to date on the currency fluctuations.
– Latin America – Enterprise	149	149	154	149	151
Total Core Network Services	1,379	1,397	1,443	1,457	1,472	The growth in CNS has been getting steadily better.
– Wholesale Voice & Other	186	172	159	152	143	The usual downtrend for this segment.
Total Comm. Services	1,565	1,569	1,602	1,609	1,615	A bit higher than street estimates.
Comm. COGS	616	608	618	614	616
Comm. Cash SG&A	562	576	518	537	540
Comm. Adjusted EBITDA	387	385	466	458	459
Adjusted earnings per share	(0.11)	(0.09)	0.06	0.47	0.31	A few pennies higher than estimates currently put it, but this number is not yet very predictable.
Adj. Gross margin %	60.6%	61.2%	61.4%	61.8%	61.8%	After a strong bump last quarter, I expect a smaller one this quarter
Adj. EBITDA margin %	24.7%	24.5%	29.1%	28.5%	28.4%
Capital Expenditures	208	194	189	163	~200
Free Cash Flow	8	(90)	197	(22)	0-100	Could be anything near breakeven or above.

The street doesn’t seem to be expecting too much this quarter, at least from my perspective, with Yahoo Finance consensus estimates at $1.60B in revenue and $0.28 per share in earnings.  My own guesses are a bit better than that, but it still feels conservative if enterprise revenue growth hasn’t taken a breather.  However, on the EBITDA line I expect some early costs from the tw telecom deal preparation will hold things down a bit, while gross margins should hold relatively steady.

But while revenue momentum will be closely watched, I expect analysts will be looking for any details Level 3 is willing to divulge on next quarter’s big project.  That of course would be the tw telecom integration, which will be a big, big job no matter how they slice it.  I’m sure Level 3 will be ready to say what they can, but it probably won’t be much.

The tw telecom deal has one major difference from the many others Level 3 has done over the years.  I’m not talking about the technology or assets or even the difference in customer base, but in the motivation.  This is the first big deal Level 3 has done that was truly offensive and opportunistic.  From Genuity through WilTel, Broadwing, the metro purchases, and Global Crossing the underlying thread was gaining the scale to match the long term debt they came out of the dotcom boom with.  They were essentially forced moves, ones Level 3 almost had to make.

This year they didn’t need to do it.  The balance sheet issues no longer hang over their head, and the decision to buy tw telecom is therefore driven by something new — optimism.   That being said, I doubt very much they will express any appetite for further M&A in the near term given the integration task ahead of them.  I mean, they could do it in Europe I just think they are less likely to risk it for a while.

 

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Categories: Fiber Networks · Financials