Level 3 Communications (NYSE:LVLT, news, filings) reports earnings on Wednesday morning, and therefore it is time for Ramblings' quarterly earnings primer. Level 3 spent 2010 recovering from a 2009 that saw churn eat away their revenue and set them back again from positive cash flow. Since the first quarter of 2010, the company has been growing core revenues steadily, albeit slowly. Their fortunes in 2010 depend on one thing: solid revenue growth. They know it, too - you can hear it in every investor presentation they give. And investors and analysts know it too. The debt mountain in front of them cannot be scaled any other way. With that in mind, here are my own detailed estimates of the numbers we might see on Wednesday:
|$ in millions||Q4/2009||
|- Large Enterprise & Federal||129||136||142||144||148|
|Core Network Services Revenue||706||694||699||707||720|
|- Wholesale Voice||162||165||163||161||161|
|- Asset Sale||7|
|Total Communications Revenue||906||900||892||895||905|
|- Communications Cost of Revenue||361||
|- Communications Cash SG&A||328||
|Communications Adjusted EBITDA||216||200||209||216||222|
|Free Cash Flow||97||(90)||(19)||(63)||25-5|
Q4 thoughts: Company guidance is for revenues and EBITDA to improve sequentially, and I see no reason to doubt that they will meet that limited goal. The question is by how much? While Q4 is traditionally a stronger quarter for them, I think it would be a mistake to expect too much too fast. From what I hear, no one segment is leading the charge at this point, although large enterprise and federal will probably tack on the fastest rate.
2011 and the path forward: The company keeps saying that it wants to first get back to the 8-10% growth in core network services in 2011. To put that in context, they would need to add $60-70M in quarterly revenues during the year, or $15-18M each quarter on average - a rate they have not managed in some time and probably won't in Q4 either. If they maintain that footing during the CC, it will definitely forecast a better year ahead. With Level 3's assets and the faster growth their peers have demonstrated, this is just a matter of execution, but then isn't it always?
8-10% growth is not a random goal: The path to sustainable free cash flow generation at LVLT runs directly through the $250M quarterly EBITDA barrier they bounced off of in 2007/2008. Once beyond that threshold, they reach a virtuous circle in which they have the cash flow to invest in faster growth and can then grow into their debt. Tacking on $60-70M in quarterly revenue at 65% incremental EBITDA margins gets them there, and 2-4% growth does not. That's really the bottom line and why their goal is what it is.
Capex: Higher capex levels need to continue. If you see them dropping back below $100M, that would improve FCF but would spell trouble nonetheless.
Free Cash Flow: It's probably safe to say that Q4 free cash flow will be positive on the back of working capital swings, and that Q1 free cash flow will be the opposite. That happens every year. Free cash flow guidance for the full year 2011 will be closely watched, but IMHO it won't be positive even with the revenue growth they will probably project given their capex spending plans. It'll be closer to breakeven though.
Conclusion: Is Level 3 ready to rumble at last? It's too early to say, but whatever qualitative guidance the company gives will be very cautious. The worst thing they could do now is to over-promise, as nobody would believe them anyway but would punish them for it later regardless. So we will see Q4 improvement, cautious optimism for 2011, and then we'll wait to see if their accelerator still works.
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