Would Level 3 Really Sell Its Data Centers?

August 2nd, 2010 by · 10 Comments

In their earnings call last week, Level 3 Communications (NYSE:LVLT, news, filings) mentioned that they have been re-evaluating their colocation business.  Specifically, in response to an analyst question about their plans for their colocation footprint, CEO James Crowe made the following comment:

“This is a matter of some strategic importance.  We’re doing a review that is largely completed.  We will make some decisions here in the coming months.  Our data center business would be one of the larger colocation/data center businesses in the industry if it were a standalone.  It’s a big opportunity for us.  We want to make sure we take advantage of it properly.”

Since then, I have received several questions from readers regarding whether Level 3 is likely to sell this segment of its business.  I didn’t post on the subject immediately, though, because I felt it required some thought.

Now, on one level it’s easy to see why this might be attractive.  Level 3 has a huge colocation footprint that it has always operated as carrier neutral, in that they encourage other providers to offer access in their facilities.  However, because they are (obviously) a carrier, their facilities are still not generally viewed as the same kind of ‘carrier neutral’ as those of a pure colocation provider like Equinix (NASDAQ:EQIX, news, filings) – it’s somewhere in between.  So while the colocation business is good and growing for Level 3, it is not valued by the markets at the same level as it might be if the same facilities were operated wholly separately.  Therefore, the idea of separating it and selling it off has come up before and will surely come up again.  From a spreadsheet point of view with some broad strokes, it certainly makes a lot of sense.

I do think that Level 3 is facing some decisions here.  To put it bluntly, a colocation business requires capex for new space and, especially, power to grow.  That is why we have been seeing Equinix, Dupont Fabros, Digital Realty, QTS, Telecity, and others raising and spending major dollars.  Level 3, however, must always manage its debt and cash flow very carefully in economic times such as these, and therefore is not likely to start spending piles of cash on colocation projects the way things are currently set up.  So to keep it growing they will need to build out more of their space, but the capex for that may not be there.  Selling the colocation business so that others can fund its expansion would perhaps solve many of their cash problems.  But I really don’t think such a sale is going to happen nevertheless.

Why?  For one thing, it would be very difficult to separate.  Level 3 uses much of these facilities for its own operations and would of course still need to do so.  They are deeply integrated with the rest of the company’s business, and there would be substantial integration expenses required (or is that disintegration expenses?) just to make it ready.  But more important is perhaps the fact that only a fraction of their footprint is really of the type that competes with Equinix in the main colo markets and most of that is largely full.  The rest is often in less active colocation markets or has space or power limitations that other providers solve by simply building giant new standalone facilities.  Despite how it might look on paper, separating this segment would be more costly and painful than one might think, would bring in less money than one might project, and would very much distract Level 3 from solving its real problem of finding a path to real growth in the world of bandwidth.

HOWEVER, that doesn’t mean that Level 3 can’t do anything here.  What I saw in Crowe’s comment was not a sale, but an indication of a possible organizational shift akin to its local markets initiative that decentralized power to metro fiber markets.  If they have sufficient reason, and the necessary cojones as well, they just might follow the lead of Zayo and find a way to horizontally disaggregate the colocation business.  They could functionally separate it, such that it really is carrier neutral and (hopefully) viewed as such by the rest of the industry.  Their carrier business would be the flagship customer of course, but it would have to negotiate for good rates just like anyone else, while other carriers willing to pay more could outbid them.  Thus the colocation business might find its way to the 20%+ growth rates its independent peers have found, while the bandwidth business might untether itself further from that footprint and thus find more opportunities outside it.

It not easy to do though, let alone to convince the marketplace of.  But it might let both the bandwidth and colocation segments of Level 3 focus better on their respective strengths, and therefore help them to turn their huge asset base into more value for investors.  Just a thought…

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10 Comments So Far

  • Notrom says:

    I see two possibilities that look interesting— 1] A sale leaseback— 2] An Ipo where lvlt keeps enough ownership to maintain control .

    Monetizing [lets say] 50% could allow them to pay down some debt & do some cash acquisitions in areas they see faster growth & better margins .


  • Anonymous says:

    how much of the LVLT debt could be ported over? I guess what we need to know is what ebitda those data centers are responsible for. Any guesses Rob?

  • m says:

    The big issue for Level 3 is that many of these “colo” facilities are small, telco-grade buildouts with DC power and limited AC power.

    In other words, they do not compete with an EQIX because someone needs to spend CapEx on UPS/PDU’s for an AC customer. L3 tends to want a customer to spend the CapEx and sometimes (begrudgingly) reduces the MRC to customer in return.

    The senior mgmt of L3 have never seen the value in its colo business and has let in languish for years without sufficient spending that was needed years ago. I was involved with it, so i am speaking first hand.

    Maybe now that L3 is picking up a lot of business from wireless carriers at their colos (and placing towers next door), they are starting to appreciate it a little more.

    But, if they had made investments in their colo business 3-5 years ago, they would be much bigger right now. A few years ago, they cut operations personnel to nothing, so they couldn’t support upgraded infrastructure anyway…that was a decision by senior mgmt, and was the wrong one (the proof is the growth of all the other colos in that time period – which L3 missed out on).

    Whether sold or not, the business needs a new direction and a substantial upgrade of equipment and personnel.

  • LVLT Deparatures says:

    Tench, Allen and CMO are all gone…Surprised you aren’t talking about this Rob!

  • carlk says:

    He did while seeming to imply that they “automated” themselves out of their own jobs.

    Don’t be surprised if Tench finds himself an open door at Zayo.

    Does anyone know how much co-lo (3) owns vs. leases?

    • Rob Powell says:

      carlk refers to an earlier response over on the investorvillage board. But they’d just have re-titled Tench if he were to stay. I wonder if he simply hasn’t headed for greener pastures now, it can’t have been fun at Level 3 lately. He’ll land on his feet, as will Choski. I do wonder where they will wind up…

  • carlk says:

    Yes, but I sort of misquoted you, my apologies for that. You seemed to say that he decentralized the group back into centralization. I’m sure “automation” played its role, however.

    Further consolidation is mandatary and a far cry from the “Titanic,” Robert.

    Mr. Market including some of his criminals with biased AKAM views and media influence, are attempting to ring their bell in order to “salivate” the traders onto a more “bullish case.”

    That’s never been the case for Jim Crowe’s “significantly under valued stock,” so maybe it is time to start playing the violins.

    On the other hand, Vanguard added in the Q, while still waiting to hear from SEAM and FFH.

  • AlB says:

    LVLT needs cash !!!
    have a spin-off and use an IPO to monitize the Data Centers which would allow LVLT to pay down its huge debt and become what their strength signifies and requires – a network company while the NEW Data Center company would have sufficient capital to expand as a start-up company.

  • dawg says:

    why not start with maximizing the existing space? 5kw product launch is a start but going to the boards and really turning up the power/sq ft would remove the need to expand the colo foot print. The capital cost of augmenting power is much less than entire brick and mortar costs. it is time to dump the telco/bell mindset. more power to the sq/ft means more draw on the network.

  • Al B says:

    These LVLT dta centers continue to have their same problem from initial design – lack of sufficient power –
    which just may be the problem why they remain unsold.

    everything has a sale price once the “lack of” has been “monitized” or is it “de-monitized” ??

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