Is Level 3 Communications Ready to Move to the Next Level?

After a terrific quarterly report, better times lie ahead for Level 3 Communications.

May 19, 2014 at 10:45AM

The threat of Apple and Netflix (NASDAQ:NFLX) moving to their own content delivery networks, or CDNs, has not dampened the performance of network services company Level 3 Communications (NYSE:LVLT). Level 3 shares are up 32% this year, driven by two terrific quarterly reports. Back in February, Level 3 posted an unexpected profit, and shares shot up. When the company reported its first-quarter results last month, investors found yet another reason to cheer.

Let's take a closer look at the company's recent results and see if it is still a buy after its strong performance in 2014.

A handsome performance
Level 3 reported total revenue of $1.6 billion, up 2% year over year, a shade ahead of the $1.59 billion consensus estimate. The company generated earnings per share of $0.47, way better than the $0.28 per share expected by analysts. Level 3 has focused on capturing more market share by helping enterprises optimize their cost structure. Also, the company is moving to newer, more scalable technologies that are more efficient and are helping it to lower costs. Moreover, the company raised its forecast for 2014's adjusted EBITDA growth and free cash flow

The company's results illustrate its execution and emphasis on profitable growth. Level 3 was able to offset the seasonal decline in its business due to continued growth from its enterprise customers, particularly in North America. 

Targeting more market share
Level 3 is looking to win over more enterprise customers from rivals. It is providing an easy migration path for enterprises to achieve the savings of technology transitions, such as cloud and voice over IP. In addition, Level 3 is enabling the businesses to improve their capabilities, reduce their costs, and migrate to more scalable technologies in a reliable, secure, and efficient way. Driven by such moves, Level 3 was able to capture market share last quarter in the enterprise channel.

Level 3 still has a lot of room to run. According to management, it only has a low-single-digit share of the addressable market for its products and services. Since businesses need to invest to move to more efficient technologies with greater capabilities and lower overall cost structures, Level 3 is seeing an opportunity to expand its business.

Key customers and solutions
Level 3 has entered into a strategic partnership with Microsoft to deliver private, direct connections to Microsoft Windows Azure. This partnership could be a key driver of Level 3's growth, as Microsoft Windows Azure is growing at a fast pace. In the recently reported third quarter, Microsoft's revenue from the Azure platform grew 150%. Looking ahead, Microsoft will be going all out to tap the cloud market; sales of Azure can be expected to improve. Accordingly, Level 3 could make the most of Microsoft's cloud focus with this partnership.

Level 3 will also be connecting Digital Realty Trust's customers in 14 major markets in the U.S. and Europe. Digital Realty, which is involved in data-center acquisition, ownership, development and operation, will leverage Level 3's virtual private network services and enable its customers to scale their bandwidth and only pay for what they consume.

During the quarter, Level 3 also announced the introduction of its Video Cloud offer. This targets content companies and broadcasters, combining its content delivery, video broadcasting, and cloud storage capabilities to create a more scalable, secure, and streamlined approach to global content distribution. 

Level 3 is also expanding its network footprint with the construction of a new subsea cable landing in Colombia to enhance capacity. Also, adding customers' locations directly to its network remains a key part of Level 3's strategy as directly connecting customers to the network allows it to deliver a better experience, drive profitability, and easily add new solutions to their existing services.

A minor concern
Netflix could spoil Level 3's party, at least to some extent. Its move to its own content delivery system could hurt Level 3. Netflix's Open Connect CDN has already started delivering content since last year.

Netflix was reported to deliver 5% of its content from its own CDN last year, and it has recently entered into a partnership with Comcast for paid peering. This would eliminate suppliers like Level 3 from the middle and might hurt revenue growth.

Bottom line
Overall, Level 3's diverse client base and rapid growth in enterprise should help it sustain its momentum going forward. The company's recent partnership with Microsoft and its focus on enhancing its offerings should help it report year-over-year revenue growth going forward. At just 23 times forward earnings, Level 3 could turn out to be a good investment, since it is rapidly growing its earnings.

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Mukesh Baghel has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of 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. The Motley Fool has a disclosure policy.

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