Earnings Preview: Looking for Growth at Level 3

October 22nd, 2012 by · 10 Comments

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:

Q4/11
Q1/12
Q2/12
Q3/12
(my guess)
Comments
 - 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
Transaction Costs 39 - -  -
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%
 
Capital Expenditures 148 138 180 192
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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10 Comments So Far


  • hondo209 says:

    hey rob, as i review your post from last february 24th, even a miss would be a win..http://www.telecomramblings.com/2012/02/for-level-3-even-a-miss-would-win/#more-15349….i noticed that almost all your revenue projections were a little high however it seems as if the adjusted ebitda number is doing better then what you projected..what can we take from this..synergies greater then expected? Also it seems like fcf is really lagging.

    • Re: revenue, my earlier guess in that older post didn’t anticipate the wholesale/other business would decline as quickly. The CNS revenues aren’t that far off after accounting for some currency effects. But as that was a ‘miss’ projection, clearly they need to do a bit better going forward!

      Re: synergies, Yes, it has gone better than expected so far, which has really saved them on EBITDA guidance (so far) since revenue growth has been a bit slow on the uptake. But to move beyond this, they need the incremental EBITDA from revenue growth to help move the needle.

      Re: FCF, it isn’t lagging, it’s just distributed differently. Q1+Q2 actual was -210 whereas that model had -212. In that hypothetical post the net cash interest I assumed was evenly distributed but in reality it has been weighted toward Q1 and Q3 and away from Q2 and Q4. Hence my expectation for a Q3 negative FCF number – though it could be offset by better working capital, we’ll see.

      Honestly, looking back I’m amazed at how closely that rather simple projection tracked in the first half. My ‘miss’ scenario was less about missing Q1/Q2 though, and more about growth in the second half failing to impress.

  • ABC says:

    Just play the woeful LVLT odds…expect paltry top line growth and the 1000th ‘kick the can down the road’ quarter in a row.

  • Bob says:

    Layoffs coming to help boost the bottom line!

    • One would have expected more layoff rumors to have come out of LVLT in the past year than we have actually seen, given the scale of the integration. They don’t report headcount numbers quarterly though, so it’s hard to tell how much of synergies came from that source via small ones and attrition as might have via the big one from the old days.

  • beetlejuice says:

    It’s worth pointing out that their version of “integration” amounts to having a press release saying they are now integrated. The “synergies” from that are likely to be about the same as those of the last 10 acquisitions, which is to say: they’re still internally operating a network stitched together no dfifferent than a bunch of carriers doing some peering and NNI’s with each other.

    That they “finished integrating” the last five like ICG or Broadwing or any of the others – LAUGH OUT LOUD hilarious!

  • beetlejuice says:

    Oh and here’s to waiting with baited breath for CarlK to set us all straight with his deep thoughts and clarity about wrong street and how Level 3 is the exception to it all….

  • Anonymous says:

    what would an LVLT earnings release without my cynicism.

    If memory serves, this is THE quarter LVLT is supposed to deliver their amazing future. Cost and sales synergies should be running full throttle at this point. So really no room for small miss for this quarter.

    I think the big story should be revenue although analyst community will get giddy (meaning overlook anemic top line growth) if EBITDA and CF impress.

    I’ll be curious to see what’s happening in LatAm. Macro conditions aren’t great there, but that’s not a reasonable excuse. If LVLT investors have to wait until the macro situation around the globe is “risk-off”, they should dump their shares now.

    The more times they reference macro-conditions in their earnings release and/or call, the larger the Q4 head winds are. If they attribute any Q3 shortfalls to macro-conditions, look out.

  • Bill says:

    Legere and crew need to come back to save this place.

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