Level 3 – Digging Itself Out of a Hole

Implications: For months, folks have been raining on Level 3 and Crowe about the condition of company and the lack of merger integration work that has gone on and the poor provisioning systems used by the company.  You can add me to that list of critics as well. However, I would not criticize Level for lowering its prices.

Analysis: Cogent Communications can blame Level 3 all it wants.  However, Level 3 did nothing wrong in lowering its prices.  Typically companies going through a restructuring are told to establish or re-establish a foothold in the marketplace by generating lots of sales as quickly as possible.

To generate sales this quickly, price reductions are necessary.  Level 3 has scale and needs to use it by reducing prices and reconnecting with customers.  I don’t think it is time yet to call in the coroner yet on this company.  Restructuring is a complicated task and is not for the feint of heart.  Investors need to examine Level 3’s action in total not as discrete activities.

As for Cogent’s complaints, well the wholesale network connectivity business is a low margin business that offers few opportunities for providers to offer product differentiation.  Cogent and Level 3 have been in business for quite some time and their networks are fairly mature.  However, Level 3 has a sizable network of networks that will take time to integrate.  The company went on a shopping spree for about 3 years and never spent any quality time pulling the pieces together.

Mergers and acquisitions just don’t happen.  Aside from the usual banking issues and associated transactions, a merger and acquisition requires integration work.  However, the integration work is usually what the bankers ignore.  Once the deal is closed the bankers walk away.  Next day the shareholders expect things to be running smoothly.

Give Level 3 until the end of 4Q2008 before you burn Level 3 in effigy.  Just be aware, companies like AT&T and Verizon are likely going to use Level 3’s services less and less.  The AT&T’s and Verizon’s of the world are going to use as much of their own networks as often as possible in order to control costs.

We are in a recession and Level 3 is doing all the right things to gain market foothold to ride out the storm.  Expect Level 3 to be even more aggressive.