Level 3 Goes Out on a Limb With $3B Global Crossing Deal

Level 3 has announced plans to buy Global Crossing for US$3 billion in a stock-for-stock transaction. Level 3 will also assume Global Crossing’s $1.1 billion debt. This transaction creates a company with pro forma combined 2010 revenues of $6.26 billion, the companies said in a joint announcement. Global Crossing shareholders will receive 16 shares of Level 3 common stock for each share of Global Crossing common stock.

Level 3 expects the transaction to create substantial annualized adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) synergies of about $300 million and an annualized capital expenditure reduction of about $40 million. The merging of the two companies will give Level 3 a more extensive global service portfolio of transport, IP and data solutions, content delivery, data center, colocation and voice services. Level 3 did not respond to the E-Commerce Times’ request for comments by press time.

Good Times for Telco Acquisitions

The current network market favors growth by acquisition, which has prompted a trend in mergers.

“In general, this is a positive time for Internet infrastructure acquisitions and deal valuations,” Jim Davis, senior analyst of networks and media at Tier 1 Research, told the E-Commerce Times. “We’ve held the position that consolidation among telcos would continue this year, with a focus on companies seeking new growth services and properties outside their core business.”

The trend kicked off in earnest with Verizon’s acquisition of Terremark, Davis noted. The Level 3 deal differs from Verizon’s acquisition because of its focus on IP. Even so, expect the joined company to look to expand its reach.

“While the logic of the Verison deal revolved around cloud computing services and data center services, the Level 3/Global Crossing deal is certainly more focused on IP services like IP transit and VoIP, which have been under constant price pressure,”said Davis, “but both companies have also been looking to expand their offerings in other areas such as data center services, broadcast video transport, collaboration/conferencing and CDN.”

The value of this deal depends on how well Level 3 manage the transition, especially given Level 3’s track record.

“Level 3 has a mixed record when it comes to post-merger integration,” noted Davis. “The company says that some of those problems were the result of the acquisition of metro assets from CLECs and the integration of billing systems and processes. Even if this deal is simpler on a technical level because it revolves mainly around long haul assets, a lot of investors are going to be very skeptical of Level 3’s ability to manage this process and generate the promised synergies.”

Focusing on cost savings as justification for the deal is wise, suggested Davis.

“Level 3 gains both in terms of reduced capex and reduced operational costs on the network side,” he said. “Low expectations will make it easier for the combined entity to potentially surpass goals for synergies at the revenue level.”

The acquisition is bound to shake up the market. Look for changes in the content delivery network and video transport markets, suggested Davis.

“The combined companies will have greater reach and lower costs in a smaller market,” he added. “In terms of data services, Level 3 puts itself in a position to better compete for business against the likes of AT&T and BT at the global level — if the integration goes as planned.”

Feeding Frenzy Ahead

While the merger may look good on paper, a long period of regulatory scrutiny could weaken the deal.

“This is an impressive acquisition which gives Level 3 a powerful market position,” Rob Enderle, principal analyst at the Enderle Group, told the E-Commerce Times.

“Yet large mergers tend to be relatively difficult to pull off, and the acquired company tends to have difficultly retaining employees and customers during what appears to be a protracted approval process for this deal,” he said. “At the end of the period, Level 3 could end up with a shell.”

Predatory competitors may pick at Global Crossing’s assets before the deal is finalized. Even so, the end result may be a winner.

“Near term, it should spark a bit of a feeding frenzy on Global Crossing’s high-value employees and customers,” predicted Enderle, “but long term, it should result in a much more powerful competitor in a dramatically smaller market.”