On Thursday morning it will be Level 3’s turn to reveal its Q1 earnings report. The company has changed the way it will break down its revenues, and we therefore will not be getting information on the four customer facing market groups this time, but rather by customer grouping: Wholesale, Large Enterprise and Federal, Mid-Market, and Europe. That will make things read a bit differently, but it doesn’t change the basic dynamic of what Level 3 Communications (NYSE:LVLT, news, filings) needs to do this year: return to revenue growth. Here is a quick tabular rundown of what I am expecting in the context of the prior two quarters in the new reporting format:
| $ in millions | Q3/2009 | Q4/2009 |
Q1/2010 (est) |
|---|---|---|---|
| – Wholesale | 347 | 353 | 355 |
| – Large Enterprise & Federal | 123 | 129 | 131 |
| – Mid-Market | 155 | 151 | 150 |
| – Europe | 75 | 73 | 75 |
| Core Network Services Revenue | 700 | 706 | 711 |
| Wholesale Voice | 159 | 162 | 160 |
| Other | 42 | 38 | 34 |
| Total Communications Revenue | 901 | 906 | 905 |
| Coal | 15 | 18 | 15 |
| Total Revenue | 916 | 924 |
920 |
| – Communications Cost of Revenue | 369 | 361 | 365 |
| – Communications Cash SG&A | 316 | 328 | 325 |
| Communications Adjusted EBITDA | 215 | 216 | 215 |
| Adjusted EPS | (0.10) | (0.11) | (0.11) |
| Capital Expenditures | 75 | 80 | 85 |
| Free Cash Flow | 9 | 97 | (50) – (100) |
Revenue: The first quarter is rarely a big one for sequential revenue growth in this sector, and I see no reason for things to be different this time. Amongst the wholesale and large-enterprise/federal groupings, the goal is to see another quarter of sequential growth to start the year on the right foot. In the mid-market grouping the goal remains merely to stabilize – the company’s local market initiative should become extensive enough to swing this number sometime this year but perhaps not yet. Over in Europe, there are probably foreign exchange headwinds but in constant currency terms I hope to see a return to steady growth.
Adjusted EBITDA & margins: Unless there is a revenue surprise, I don’t expect EBITDA to change very much this quarter nor should EBITDA margins change all that much. Improvement would be very welcome though.
Capex and Cash Flows: In this sector, working capital tends to flow out in Q1 and Q2, and back in during Q3 and Q4. That means free cash flow will likely swing back to the negative side regardless of other metrics – although the magnitude is never particularly predictable. Key to watch will be the capex number, which was small throughout 2009 as the company conserved cash and fought churn. A return to growth by necessity will require an increase in success-based capex, and in fact may be preceded by it. Level 3 has been making expansive noises since winter, and that leads me to expect that spending will have risen in Q1 – but we shall see.
M&A: Unless there is a big announcement before earnings (you never know), the company will surely tow the same line as always and express its willingness and interest if the right opportunity arises and that consolidation is inevitable – but no comment on any particular scenarios.
Balance Sheet: Last week Level 3 announced it would call its 10% senior debt due 2011 a year early, and what management says about the reasons will probably be closely watched. IMHO this move doesn’t really affect the likelihood of a big M&A move this year, simply because the money they are using was earmarked long ago to buy back this debt – it wasn’t cash they could have used in an acquisition anyway. By calling it early, they save a few million bucks in interest – plus this was expensive money and they’ve been trying to get rid of it for years including by swapping it for equity a few years ago.
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if LVLT were trying to save a few million bucks interest, why did they not call the 15% Bonds???
could it really be because the 15%ers are almost all owned by management and high-end shareholders who are acclimated to special treatment with the super high interest rate ???
Rob,
I expect a large drop in cash from the 836 mil on 12/31/09 . They paid off 114 mil in debt [that we know of] & have a 20 mil cash settlement of a dispute [one time item] in addition to the usual working capital needs in Q1. Leaving cash somewhere around the 600 mil mark .
The announced call of the 172 mil 10%/11 bonds brings cash down to the 425 mil mark .There is another 40 mil in debt to be paid in July .
I am somewhat surprised that they have as yet, not tapped the market for some additional cash . Any thoughts on this ?
Morty
I hesitate to say it, but perhaps because they don’t wish to substantially tweak the balance sheet while working out a deal with another operator whose terms are sensitive to that balance sheet?
Rob, I completely disagree with your view on this. If those 15% converts are callable, there would be absolutely no reason to retire those 10% converts over the 15% converts.
The 15% converts are trading at 130 with a Yield to Maturity (YTM) of roughly 3.29%. The holders of those securities would not be thrilled with the decision to retire those but the debt service savings for L3 would be worth it, even if you swapped them out for 10% notes which would provide an annual $20m/year in debt service.
Finally, why would a potential merger/acquisition candidate have a problem with L3 retiring the highest yielding notes in their capital structure?
there was that option on the proxy to raise the issued shares from 50 million this year to 400 million shares…. yes cash on hand is running thin, 400 million shares will buy them some more time, but how long will it take to dillute 6 billion in debt??
It depends on how fast they are growing revs/ebitda.
If we do see growth, the leverage is powerful, financially and operationally. They do 60% incremental ebitda margins on call it 25% present ebitda margin. $4b in revs and $1B in ebitda.
I think they can do double digit growth but assume just mid single digit revenue growth of only 5%. In 3 years, revs are $4.6B and ebitda is $1.4B.Not many places you can find 40% ebitda growth in 3 years in what I think is a conservative topline estimate.
On 6B in debt and $1.4 in ebitda, they are arguably underlevered given their business model. And maybe, they grow revenue a bit faster than 5%.
The fifteen percent usury converts have a $1.80 strike price-notice the very thick wall at $1.77-and would be a voluntary conversion only.
The mandatory conversion requires a $4 pps.
why the thick wall at 1.77 if the 1.80 convert price is voluntary… no one would actually convert until a much higher price
Maybe they should open a financial advisory service – half the industry would like to use/rent this CFO… As for their bandwidth, less interesting. They have gone from an “elasticity espousing” price leader to a pricey (and gripey) telco. They try to get AT&T or vz prices… But those guys have global, enterprise customers who pay for pricey global, enterprise services and L3 doesn’t. Are these guys the next xo ?
Without being in the trading pits or part of the plan generating these computer algorithms presented by Goldman for declaring security “prices,” you present a valid question for why that wall cannot be breached.
I would never discount the machinations by controlling shareholders in preventing certain price barriers from being broken for whatever reasons.
One of the great barriers to this security is having underlying curmudgeons on the bond side like Buffett, Watsa, and Hawkins holding this name.
Never forget that, this is an insiders game, and until the inner eye for calculating fair price blesses a change, a change will not occur.
Yesterday, I heard an interesting comment from one of the TWO WISE MEN who think they’ve mastered “Mr. Market” in their FORTY plus YEAR history together.
This WISE MAN said they’ve changed to thinking about “TECHNOLOGY COMPANIES” different than they had in the past.
Who knows? Maybe Billy Gates has assisted in changing their minds. But this WISE MAN believes he is DAMN RIGHT in having done so at least as respects ISCAR and BYDD.
is this the wise man with 250 credit default sawps with a $63 Billion dollar notional value??
http://www.marketwatch.com/story/buffett-weighs-in-on-derivatives-legislation-2010-05-01
Au contrair. This wise man of two represents that wise man’s ID and EGO.
He was always a proponent of growth while staying away from cigar butts, but never comfortable in the “technology space” after being bitten very hard one time yet still escaping with their behinds in tact.
The other wise man considers his long term, ultimate success to this elder EGOTIST.
even more conCERNd now the time might be right for that man to want to bk this company to pick it up cheap….?