Level 3 Is Leveling Up, Slowly

Shares of Level 3 Communications (NYSE: LVLT  ) are up marginally today on an up day for the market, thanks to a good, but not great, fourth-quarter earnings report.

The company, which operates a massive national fiber-optic network and Web content-delivery service, reported an adjusted net loss of $1.02 per share, in line with Wall Street estimates. Revenue came in about $60 million light, however.

Investors are probably right to be cautious. Cash is flowing, but not as bountifully as I'd like:

Metric

Q4 2011

Q4 2010

YOY Growth

Revenue (mil.) $1,579 $904 74.7%
Free cash flow (mil.) $224 $181 23.8%
FCF as a % of revenue 14.2% 20.0% (5.8 points)
Cash / debt (mil.) $918 / $8,450 $616 / $6,448 29.1%

Source: Level 3 earnings press release.

None of these metrics inspires me. Quite the contrary -- I'd much rather see free cash flow (FCF) growing faster than revenue and accounting for a greater portion of sales. And while I can understand the use of leverage to acquire Global Crossing, it's somewhat troubling to see net debt rise 29% when Level 3 has spent years working off the leverage on its balance sheet.

Bulls will nevertheless point out that debt is the cost of scale, and acquiring Global Crossing gives the company salable fiber in 45 countries at a time when our collective appetite for fat data files -- (cough) video (cough) -- is rising. Level 3 is investing to meet demand.

The question is whether management's bets will yield a payoff above cost. It's been a struggle so far, but returns on capital and gross margin are rising, and that's despite peer Akamai Technologies (Nasdaq: AKAM  ) beating fourth-quarter profit forecasts by 12.5% as revenue improved 14%. The implication? Level 3's success or lack thereof doesn't necessarily have to come at the hands of rivals. More likely, this industry is like a pie big enough to feed all the industry's participants.

Do you agree? Disagree? Either way, it makes sense to study how the Internet has changed computing. The Motley Fool recently dug into this trend in a video research brief, "Two Words Bill Gates Doesn't Want You to Hear." The report is free, but only for a limited time, so click here to watch now.

Add Level 3 Communications to My Watchlist for up-to-the-minute Foolish coverage of the stock and your entire portfolio.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's web home, portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

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Read/Post Comments (7) | Recommend This Article (2)

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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 February 09, 2012, at 6:20 PM, lucasmonger wrote:

    I agree.... pie should keep growing. I've piled into AKAM, LLNW, LVLT, and CLWR for the same reasons as I believe all (or at least most) will prosper fulfilling the hungry data needs (partially thanks to Siri) of the consumers.

  • Report this Comment On February 09, 2012, at 8:48 PM, temp1028 wrote:

    Tim - you are joking right? Earnings came out yesterday morning at 9am EST. LVLT was up 9 percent on that report at yesterday's close. Your article doesn't mention the major move yesterday on that report but instead says that investors are cautious on the report. Your article states that today's move was the result of this quarter's earnings. Either you're trying to hide yesteray's move or you just aren't aware of it. Which is it? Either way, this article is a serious embarrassment for you.

  • Report this Comment On February 10, 2012, at 7:25 AM, TBGDISOK wrote:

    Its becoming clear that MF is short LVLT...Its interesting that the stock is heavily shorted, and was priced essentially to go out of business...And yet now we are talking about slow improvement, and the largest stockpile of valuable cable(35 Billion worth, at a 4 Billion valuation). As Synergies continue, LVLT Credit rating improves to allowing borrowing at reduced rates to replace high rates(lower interest costs), CDN and Revenue grow as suggested 20-25%......We are creating a perfect storm for a nice pop in LVLT. Buy recommendations are coming, and Video Demand on is SOARING.....One thing clear...LVLT is back on the tracks and going higher.

  • Report this Comment On February 10, 2012, at 9:22 AM, ddm08 wrote:

    "Its becoming clear that MF is short LVLT..." You are very close. Fool.com always write negative articles to bash LVLT and push shares down while Motley Fool Asset Management are too busy loading up shares at a discount.

    How the SEC doesn't go after this kind of conflict of interest is beyond me, EVEN if they have had disclosure? This is very self-serving and downright FRAUD!

  • Report this Comment On February 10, 2012, at 9:50 AM, TMFMileHigh wrote:

    @ temp1028,

    You're right; I missed the move. A big mistake on my part -- my apologies.

    As to whether there's a short conspiracy, I've been long LVLT in my CAPS portfolio since Oct. 2010. I still think it's a good business but I stand by everything I wrote about the numbers. Management has given itself essentially zero room for error.

    My apologies again and Foolish best,

    Tim

    --

    Tim Beyers

    TMFMileHigh, Motley Fool Rule Breakers Analyst

    Web: http://timbeyers.me

  • Report this Comment On February 10, 2012, at 10:29 AM, temp1028 wrote:

    Tim - Thanks for the acknowledgement. Good man

  • Report this Comment On February 10, 2012, at 4:06 PM, BlaineFred wrote:

    Critique of the Seeking Alpha Article by Rash Meneria

    There was a Feb 10, 2011 article by Rash Menaria published by Seeking Alpha titled "Vanguard Group's Top Sells: 3 Potential Short Candidates."

    The artilce is at: http://seekingalpha.com/article/357851-vanguard-group-s-top-...

    The article presents data indicated that the Vanguard Group HELD 85,446,292 shares on 9/30/2011 and 6,682,059 shares on Dec 31, 2011.

    While the tabulated data is correct, Menaria DID NOT CONSIDER A REVERSE 1-for-15 STOCK SPLIT that resulted in the much lower number of HELD shares.

    NO SHARES WERE SOLD,,,In fact, more shares where purchased following the split because 15x 6,682,059 shares equals 100,230,088.

    What an idiot!!! A corrected new edition should be published as soon as possible.

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