Level 3 Communications Acquires TW Telecom For a Highly Coveted Asset

TW Telecom (NASDAQ: TWTC  ) shares soared 10% on Friday following news that Level 3 Communications (NYSE: LVLT  ) had intensified talks of an acquisition , and then on Monday a $7.3 billion offer was announced. This shows that Level 3 is prepared to be at the epicenter of an all-out broadband war that involves the likes of Google (NASDAQ: GOOG  ) (NASDAQ: GOOGL  ) and AT&T (NYSE: T  ) , but is this good for Level 3 investors?

Why acquire TW Telecom?
TW Telecom serves corporations as a national provider of managed network services. The $5 billion company has 12-month revenue of $1.60 billion and is expected to grow 7.4% and 8% over the next two years, respectively.

While profitable, the company's 12-month operating margin of 12.7% has been on the decline from 15.4% in 2012. The operating margin also declined to 11.3% in the company's first quarter, as increased competition and expenses weighed on its bottom line.

Nonetheless, TW Telecom has a single asset that likely attracted Level 3: fiber. It allows telecom equipment companies to offer fast mobile and Internet solutions. According to TW Telecom, it has a fiber network totaling 27,000 route miles with 21,000 miles in metropolitan areas. The company has 20,000 commercial buildings connected to its fiber network, leaving an enormous amount of potential for growth.

Source: TW Telecom

This is important to Level 3 because following its acquisition of Global Crossing a few years back, it is the worldwide leader in fiber, having 35,000 miles. Yet the key with TW Telecom is that all of its fiber is located in the U.S. with a high amount in large cities, while Level 3's network spans the globe.

Why is Fiber so important?
The state of mobile and Internet solutions is changing, with hardware becoming software and reliability and fast speeds becoming a necessity for large telecom companies.

This brings up Google and AT&T, both of whom are at the epicenter of a project that will boost Internet speeds to 1 gigabit per second, or Gbps, which is 100 times faster than the average broadband. AT&T's most advanced U-verse Gigapower has speeds of 300 megabits per second, but the company vows to boost those speeds to 1 Gbps.

AT&T recently announced 100 cities in 21 metropolitan areas as candidates to launch this new and improved service. The company is attempting to protect a U-verse segment of its business that is growing at 20%-plus annually and now accounts for 10% of total revenue. This upgrade is in response to Google's service, which has already launched in Austin, Provo, and Kansas City with speeds of 1 Gbps and will be entering 34 new cities in nine metropolitan areas.

Source: Google

The response of these services has been remarkable, and many believe that such rapid speeds will cannibalize existing and slower networks. The key ingredient to achieving these speeds is fiber, which includes the process of installing a fiber network or installing fiber onto existing telephone poles. Seeing as how metropolitan areas are first to be targeted, TW Telecom's network could become very useful, especially if other companies aside from Google and AT&T choose to build similar services.

For Google alone, the estimated cost of fiber is $20 to $28 billion over the next decade and $140 billion to offer nationwide service; AT&T will also spend billions. This means that whichever telecom equipment companies can offer the best services and most fiber stand to earn a lot of money from these build-outs. By acquiring TW Telecom, Level 3 won't own the entire fiber market, but its presence will be that much larger, especially in markets where AT&T, Google, and others are most likely to build first.

Foolish thoughts
A high-speed fiber network not only provides an enormous boost to Internet service, but also TV, DVR, and possibly phone in the near future. Therefore, Google could theoretically become the next massive telecom company, adding significant upside to its valuation, and AT&T would have a major edge over its peers as well.

Fiber is the centerpiece of a highly connected space worth billions to both the service provider and the equipment vendors. Therefore, Level 3's proposed acquisition of TW Telecom makes it best positioned to gain this business. Looking ahead, investors should like the combined outcome and the likelihood of long-term value being created as network build-outs intensify, and Level 3's newest asset becomes a necessity for service providers. 

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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