A reader recently asked me to comment on a possible combination of CenturyLink (NYSE:CTL, news, filings) and Level 3 Communications (NYSE:LVLT, news, filings) after the two have finished their respective integrations. Various articles and research notes have alluded to the possibility of late, including this IBD piece. And of course I'm a sucker for the occasional M&A speculation, so here goes.
Both companies look far different today than they did a year ago. CenturyLink's purchases of Qwest and Savvis gave it much greater scale, an international focus, and a real presence in the cloud. Meanwhile, Level 3's purchase of Global Crossing has now put it in a position where its debt no longer looks as formidable alongside the business as a whole as it once did, lowering the barrier to an offer that had seemed insurmountable for so long. Hence, the possible merger of the two is a completely different question now than it was a year ago. So let's take a quick survey of things:
In support of the combination:
- Asset Fit — CenturyLink's main problem is the same one that Qwest faced earlier - the lack of metro depth, especially in the tier 1 markets outside their LEC footprint gives them a scarcity of off-ramps. Meanwhile Savvis had an international presence that, as nice as it was, didn't have fiber underlying it. Level 3's metro and international footprint would give CenturyLink some real infrastructure muscle to go with the international foothold they now have.
- Synergies — There can be no doubt that the potential synergies would be substantial. The savings on the combined longhaul networks alone would be a couple hundred million dollars, while Level 3's metro presence would help the former Qwest business's margins.
- A Cloud Boost — Savvis and Qwest gave CenturyLink a substantial colo footprint, but Level 3 has quite a lot of square feet as well and in a lot more places. Additionally, Level 3's multinational enterprise presence would be very complementary, giving CenturyLink more exposure to customers in this vertical and a more viable way to take on AT&T and Verizon with cloud-based services.
Hurdles it must clear:
- Intangibles and Multiples — Level 3 has gone through hell and back to get to the position it is in now. Both its management and its investors have something to prove here -- something they can't do by selling at multiples that don't give them credit for the unrealized potential they have been working for so long to bring out. To entice them over that hump will require a substantial premium well beyond the one their assets have always given them relative to other competitive operators. Putting it simply, Level 3 doesn't need to deal anymore whether it be buying or selling. CenturyLink paid up to bring home the Savvis deal, but would they do it again on a scale several times larger? I'm not so sure.
- Better targets — If CenturyLink is after those metro off-ramps, there are cheaper ways to get there. There are other collections of national assets out there that would give them what they need for a fraction of the overall price. tw telecom wouldn't be cheap, but their enterprise business is very finely tuned and always seemed to be a possible fit for the Qwest assets to me, with little baggage. XO would be a cheaper alternative that is likely to be available later this year, while AboveNet's tier-1 focus would be the most targeted purchase. Then there are regional possibilities too: Sidera or FiberLight would give them metro depth in the right places, for instance. Meanwhile, Level 3 has been hinting its inorganic interests are more of the international variety for now.
- Regulatory Scrutiny — The combination of Level 3 and CenturyLink would bring together such a large fraction of the most recent national (Level 3, Qwest) and partial national (Broadwing, WilTel) fiber/conduit builds of the bubble era that they would be sitting on the vast majority of raw theoretical intercity capacity in the ground. Level 3 already took some flak for its transit marketshare over the summer, but if you take out Qwest's remaining wholesale potential then some people are going to get quite nervous about the transport side of things.
- Culture — When it comes right down to it, both CenturyLink, Qwest, Embarq, and others purchased along the way are all ILECs, and the addition of the Savvis colo/cloud assets hasn't shifted that balance the way that the PAETEC/KDL/NuVox deals may be shifting Windstream. Level 3 and all those it has purchased have always been from the other side of the competitive tracks. You can make it work on a spreadsheet, but there are some major cultural pitfalls out there that don't show up on spreadsheets.
Final thoughts — I guess what I'm saying is that while one can definitely make the case for a CenturyLink purchase of Level 3 next winter, it isn't nearly as obvious a case as the CTL/Q or LVLT/GLBC deals were. The synergies and strategies are there, but the underlying driving forces aren't as compelling because both companies have other options and no particular urgency. It certainly could happen, but there are other combinations that seem just as likely to me, if not more so.
What do you think? Are these two destined to get hitched? Or are analysts barking up the wrong tree?