This Deal May Be Doomed From the Start

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I'm not sure who put a quarter in the stock market over the weekend, but yesterday was truly a merger Monday. We saw deals literally emerging from the woodwork. Endo Pharmaceuticals agreed to buy American Medical Systems; Fiat announced its intentions to up its stake in Chrysler; Flowers Foods announced the purchase of Tasty Baking; and Valeant Pharmaceuticals hinted it'd be willing to up its hostile takeover bid for Cephalon.

This snapshot represents just half of the deals that were agreed upon this weekend. But one deal stood out and made me shake my head. Whereas every move mentioned above incorporates at least one dominant sector player, the $1.9 billion deal between Level 3 Communications (Nasdaq: LVLT  ) and Global Crossing (Nasdaq: GLBC  ) has that deer-in-the-headlights feel to it.

Level 3 is a telecommunications company that derives its revenue from transmitting data across its fiber optic networks in the U.S. and Europe. The company has never posted a quarterly profit! That's 44 losses in the past 44 quarters. Combine that with the company's negative book value and more than $6.5 billion in debt and you can clearly see why this is the ... purchasing company???

It's not surprising that Level 3 is choosing to finance this deal through an all-stock offering -- 16 shares of Level 3 for each Global Crossing share -- because it's unlikely it could get the financing to support the buyout since it burned through $97 million in free cash flow in the trailing 12 months. Now let's take a look at what Level 3 is purchasing.

Global Crossing, which possesses a fiber optic network spanning across the lucrative Latin American market, emerged in 2005 from a $30 billion bankruptcy only to pick up right where it left off. Like its new parent, Global Crossing hasn't produced a single quarter of profitability. The company, which boasts $1.1 billion in net debt, managed just $82 million in free cash flow over the trailing 12 months.

Even with synergy costs of what analysts estimate could be up to $340 million, I'm not so sure that the combined entity would be profitable even then! The net debt of the combined company will exceed $7 billion, which is downright scary. It's true that AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) are even more leveraged to their debt than the Level 3-Global Crossing combination will be, but it's also a fact that AT&T and Verizon have consistently generated a profit on the $9.5 billion and $15.2 billion in free cash flow the two have generated respectively in the trailing 12 months.

So far, I haven't even mentioned what a hypercompetitive space data transmission can be. The combination should help eliminate some costs, but it doesn't speed up growth for a sector still struggling with a rebounding economy. With a sea of choices in data transmission, it's going to be difficult for this new company to establish itself as the premier choice, especially given the inconsistent track records of Level 3 and Global Crossing.

If you ask me, this combination has all the markings of a merger of the weakest links in the telecommunications sector and may be reason enough to avoid both companies until they net shareholders a profitable quarter.

Does this deal have a chance to succeed? Sound off in the comments section below with your thoughts and consider tracking these stocks as well as your own personalized portfolio of companies with My Watchlist.

Fool contributor Sean Williamshas no material interest in any companies mentioned in this article. He would like to remind you not to forget about our friends in Japan who could still use a helping hand. You can follow him on CAPS under the screen name TMFUltraLong. Flowers Foods is a Motley Fool Income Investor selection. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's free of mergers and acquisitions.

Read/Post Comments (5) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 12, 2011, at 9:24 PM, bottomfisherman wrote:

    Anders naysayed this with his superficial analysis I assume you two share notes from reading his and your pathetic attempt to post an objective analysis on this merger and its POTENTIAL benefits of these two companies becoming one "new' company that will now be one of the biggest communcation companies in the world.

  • Report this Comment On April 12, 2011, at 9:36 PM, ronbeasley wrote:

    Level 3's two biggest investors are Prem Watsa (Faifax Financial) and Mason Hawkins (Longleaf Partners Funds). Between them they own nearly 50% of Level 3. Both are superb longtime value investors.So take your choice - pay attention to highly successful experienced investors, or to superficial comments from some Motley Fool blogger.

    This deal is what both companies needed.

  • Report this Comment On April 13, 2011, at 1:04 AM, nelsonbostrom wrote:

    typical terrible motley fool content. why does this even show up in yahoo finance?

  • Report this Comment On April 13, 2011, at 1:05 AM, nelsonbostrom wrote:

    if you want to read articles that have more than zero thought, unlike this article, see fierce finance, networking world, telecom ramblings, etc.

  • Report this Comment On April 14, 2011, at 11:54 AM, mdtopper wrote:

    facts are facts. the two are each losers. why would the combo be any better? especially without any real pricing power. (synergy shouldnt even be in the finance dictionary - it never ends up being a real contributor to merged company's values)

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