Level 3 Earnings Primer: Q1/2009

On Tuesday morning, Level 3 Communications (NYSE:LVLT, news, filings) reports earnings for the first quarter of 2009.  As regular readers of this blog know, both I and thejuice follow the company closely.  As the the largest of the non-RBOC USA backbones, their earnings reports can be complex.  This primer is designed to help track and interpret the company’s progress or lack thereof.  Personally, I expect no earthshattering news tomorrow.  The economic environment is horrible, but so far bandwidth itself seems to be holding out ok.  The company did not provide guidance for the first quarter or the full year, so we are left with more guesswork than usual.  My projections and the underlying model are as follows:

My projections differ from thejuice’s most recent model in that based on how the recession is affecting revenues so far I don’t project a deep dip in revenues for Level 3.  However, I also don’t expect cost savings of quite the same magnitude to compensate.  So we wind up not far off in terms of EBITDA.   My cash flow projections are lower due to the higher levels of capex I am assuming.

Revenue – The effects of the economy will show up to the greatest extent in revenue from the Business Markets group.  While CDN revenues will probably hold up well, the first quarter is seasonally weak for Vyvx so I expect that to translate to a small sequential decline.  Wholesale Markets has the best chance at a good quarter, as less capex by other carriers implies less self-building and more leasing from others.  European Markets should rise sequentially as usual, however with the recession spreading across the Atlantic any progress may be dimmed – we shall see.  Wholesale voice?  As usual it’s anybody’s guess.

Costs – Assuming no major change in product mix due to wholesale voice revenue fluctuations, I see no major drivers for improving Gross Margins this quarter.  Most COS reduction opportunities would seem to require capex which is being tightly controlled, e.g. for consolidating duplicate routes etc.  On SG&A, we should see further downward trends as headcount continues to fall, but nothing as dramatic as last quarter’s drop is likely this quarter IMHO.

EBITDA and Cash Flow – What all that adds up to is Q1/2009 EBITDA of around $260-270M, give or take $5M.  This continues to be a high enough for positive free cash flow on a run-rate basis, but in an amount smaller than working capital swings.  Since working capital swings strongly negative in the first quarter for Level 3, Q1 FCF of -$50M to -$100M seems likely.  For the full year, that would still leave them on track for over $100M in positive free cash flow, but it’s hard to project next week these days let alone three quarters ahead.  So while my model predicts $170M in 2009 I take that with a boulder of salt.

For me the currency markets are a wildcard and these projections are on a constant currency basis.  I don’t follow or even pretend to understand foreign exchange fluctuations, but they had a huge effect last quarter on Level 3 as well as on others with substantial European footprints like Global Crossing and Cogent.  It will be interesting to see how they affect Q1.  It is possible that after Q1 the company will have better visibility and will give guidance for the remainder of the year, but I wouldn’t hold my breath.

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Categories: Financials · Internet Backbones