Wrong Move, Level 3!

"A pollen
fly makes

so much
of sounding

like a
bee because

he has
no sting."

-- "Hype," by A.R. Ammons

The $1.9 billion takeover bid that Level 3 Communications (Nasdaq: LVLT  ) just placed for rival Global Crossing (Nasdaq: GLBC  ) is the closest thing available to a simple plug-in, add-on, accretive deal. That's not necessarily a good thing, though.

The two pure-play network systems are the largest of their kind. If you want to go any bigger in this space, you'll run into telecom services without fail. Verizon's (NYSE: VZ  ) UUNet and the global data networks of AT&T (NYSE: T  ) might be even more logical partners for an Internet backbone of Level 3's size, but they come attached to wired and wireless telecom services that Level 3 wouldn't be interested in. A deal like that would go the other way, with the phone people looking for expanded data capacity in a Level 3 buyout.

So what, exactly, is Level 3 getting for its $1.9 billion in freshly minted shares and $1.1 billion of assumed debt? For one, the merger joins Level 3's focus on metropolitan networks with Global Crossing's large array of transcontinental and undersea cables, creating a whole new set of end-to-end services on a global stage. That makes plenty of sense. Global Crossing brings $2.7 billion of gross networking equipment into the fold (or $1.2 billion of net physical assets), which is a respectable addition to Level 3's $12.5 billion of gross property or $5.3 billion, net.

Level 3 shareholders love this deal, pushing the share price up by 17% as of Monday's closing bell. That might be an overreaction, though.

You see, adding Global Crossing and its enormous network capacity does very little to heal what ails Level 3: profitability, or lack thereof. Despite a rash of high-profile customers that includes digital video wrangler Netflix, Level 3 remains a cash-burning operation. The company rarely reports positive earnings, and whatever operating cash that is generated gets eaten by high capital expenses.

There will be some synergistic cost savings, of course, but Level 3 would have been better off with a vertical move. For a similar sum, Level 3 could have bought SAVVIS (Nasdaq: SVVS  ) to bolster its cloud-computing services, or Limelight Networks (Nasdaq: LLNW  ) to expand its content delivery operations. These are value-added services that might entice customers to sign up for fatter data traffic pipes and pad Level 3's bottom line.

Instead of a growth-promoting move like that, Level 3 gets an impressive asset base with shrinking revenue and even less impressive cash flow trends. Looking back at this purchase five years from now, I'm betting it'll be through bloodshot eyes and not rose-tinted lenses.

Make sure that you don't miss a beat as this saga develops -- add Level 3 and Global Crossing to your Foolish watchlist right now.

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies discussed here. Yea verily, National Poetry Month is upon us. Netflix is a Motley Fool Stock Advisor pick. Motley Fool Alpha LLC has bought puts on Netflix. 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. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (3) | Recommend This Article (3)

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 5:46 PM, bottomfisherman wrote:

    You kidding me? Did you just read about this deal and form an opinion without doing any research other then just scratch the surface? Do you know the meaning of the word POTENTIAL. What I read would suggest otherwise. This deal now makes LVL3 one of the largest communications companies in the world. Five years from now when I still own this stock and it has skyrocketed I will be laughing at you more then I am laughing at this pathetic attempt of yours to analize this merger.

  • Report this Comment On April 12, 2011, at 7:57 PM, dogofthefuture wrote:

    How much would it cost to build that network today? How long would it take (multi-permits, multi-license, multi digging up major metro streets) in a world no longer excited by the future but dreding it? Fat T Fat VZ? Forget the blips, think deep value.

    Disclosure: I am long the future

    dotf

  • Report this Comment On April 12, 2011, at 9:54 PM, dogofthefuture wrote:

    ISorry tag police. Just sayin'

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