For Level 3, this quarter's numbers to be released on Wednesday morning will mark the fourth quarterly report to include the Global Crossing business, and the good news is that the questions around Level 3's future are about its enterprise growth, and not about its integration progress. The integration has been going as steadily as anyone could realistically have hoped for. But the company's second quarter numbers still didn't yet show as much of the growth potential that investors really want to see developing, and so now everyone will be looking even closer at Q3 to discern that elusive second half ramp. Here's a quick table of my guesses and some further thoughts:
|- North America – Wholesale||388||381||382||384||Enterprise growth picking up.|
|- North America - Enterprise||588||610||621||635|
|- EMEA – Wholesale||94||92||91||92||UK government declines stilloffsetting other growth.|
|- EMEA – Enterprise||80||79||81||83|
|- EMEA – UK Government||50||48||42||38|
|- Latin America – Wholesale||35||34||33||34||Restored growth trend,no currency headwinds this time|
|- Latin America – Enterprise||133||138||136||139|
|Total Core Network Services||1,368||1,382||1,386||1,404|
|- Wholesale Voice & Other||211||204||200||196||Steady decline, but unpredictable.|
|Total Comm. Services||1,579||1,586||1,586||1,600|
|Comm. COGS||660||657||648||643||Synergies offsetting costs fromhigher revenue and seasonality.|
|Comm. Cash SG&A||587||587||568||566|
|Integration Costs||23||15||17||17||$40-45M synergies realized again|
|Comm. Adjusted EBITDA||270||327||353||375||On track for the lower bar of guidance|
|Adjusted earnings per share||(0.62)
||(0.37)||(0.29)||(0.30)-(0.20)||Still a lot of noise here.|
|Adj. Gross margin %||58.2%||58.6%||59.1%||59.8%|
|Adj. EBITDA margin %||17.1%||20.6%||22.3%||23.3%|
|Free Cash Flow||103||(213)||3||(50)-0||Higher net cash interest|
Revenue Growth: No getting around it this time, the second half is here and the market wants to see an improving organic growth trend. It does not appear there are big currency headwinds this time either. Sales in the first half were reported to be higher, and it's time to see those start to hit the top line. That being said, it would be silly to expect more than a gradual improvement given the moribund macroeconomic situation, especially in Europe. Plus, UK government revenues are sure to take another hit, although hopefully not as big as last quarter. Analysts seem to be forecasting $1.60B give or take, and that's where my model points to as well. Obviously the wholesale voice business could swing that number, but the CNS revenue growth must be there to make the markets happy.
EBITDA & Guidance: Full year EBITDA guidance of 20-25% above the $1.216B pro forma number from the prior year continues to be optimistic as a range, with the lower rung being the number to beat. That's 1.459B and it includes integration expenses, and the way you get there is with EBITDA of $375M+ this quarter and $400M+ next quarter. Both remain possible according to my models given continued integration progress and some of the promised growth. I continue to simply look for that, while keeping a closer eye on the revenue growth ramp - assuming there is one to look at of course.
Cash Flow: There was a fair amount of refinancing activity during the quarter, as the company took advantage of a window in the credit markets. At the end of July they raised $300M , then in early August they refinanced $1.415B of their senior secured term loans, and raised $775M of 7% senior notes due 2020 to repay $700M of 8.75% bonds due 2017. After the quarter's end, they then refinanced the other $1.2B of their senior secured term loans. All this will continue to cut their interest expenses going forward, but it makes figuring out their cash interest expenses this quarter a bit harder. But as far as I can tell, it should be a higher seasonal number due to the timing of payments, and hence free cash flow seems likely to shift negative again before moving back the other way for the usual big Q4. Capex should hopefully stay high like last quarter as they spend to fulfill the higher sales levels they've been talking about.
Conclusions: Perceptions of Level 3 remain balanced on a knife edge. If they continue to attain synergies and raise EBITDA toward what looks like a run-rate of $1.7B+ in 2013, then to stay in the usual EV/EBITDA multiple range as other fiber operators the stock price must go up. But the market remains skeptical (and impatient) when it comes to the company's growth prospects beyond the integration, and thus Level 3 really does have something to prove before they earn that respect.
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