Will TW Telecom Acquisition Make Level 3 Communications a Top Enterprise Provider?

Enterprise may be the most important segment for Level 3 following its recent acquisition, but will it succeed in the space?

Jun 18, 2014 at 2:00PM


Source: Mashable

Level 3 Communications' (NYSE:LVLT) $5.6 billion acquisition of TW Telecom (NASDAQ:TWTC) has the obvious advantage of providing additional leverage in a fiber market that's expected to grow rapidly in the years ahead. But, for investors, the most important question is one that's been forgotten: Can the company steal enterprise market share from leaders like CenturyLink (NYSE:CTL) and become a solid long-term investment opportunity?

Another element to the story
In a previous article, Level 3's most obvious interest for acquiring TW Telecom was discussed, which was the ownership of a key asset prior to the build-out of new broadband services with speeds up to 100 times faster than the norm via the use of fiber. It was implied that TW Telecom makes Level 3 front-in-line to own the majority of this business as these networks are being built.

However, the battle for enterprise revenue is also a driving force behind the acquisition, an area that has been strong due to increased emphasis on customers and the importance of improved network speeds. Furthermore, consumers have a tendency to be fickle, but enterprise revenue tends to be long-lasting and evokes confidence from shareholders.

An overlooked fact
In Level 3's last quarter, nearly 60% of total revenue came from the enterprise segment of core network services, or fiber-related, which accounted for all of the company's growth at 11% year-over-year. Therefore, Level 3 basically gained a 100% enterprise business based on its guidance that 70% of its combined revenue, following the TW Telecom acquisition, would come from enterprise. This is a fact that has apparently been overlooked.

As a result, Level 3 is now on par with CenturyLink in the enterprise segment. Level 3's $962 million in enterprise revenue lagged CenturyLink's $1.56 billion that it created in the same segment during each company's last quarter.

Like Level 3 and TW Telecom, CenturyLink's growth has come from its enterprise business. In its last quarter, the company's total revenue of $4.54 billion represented near-flat performance versus the year prior, while its enterprise segment grew 4% in the same period. Thus, enterprise has been a blessing in the face of a struggling consumer business, much like Level 3.

Nonetheless, CenturyLink held an advantage over Level 3 due to a heavy supply of enterprise clients being located within metropolitan areas. CenturyLink owns 22,000 inter-city route miles of fiber, while Level 3's assets of 35,000 total miles are spread more diversely throughout the globe. While Level 3's inter-city miles lag CenturyLink's presence, the addition of TW Telecom's 21,000 inter-city miles now gives Level 3 the advantage in terms of delivery speeds.

What to expect?
With that said, the synergies gained in this acquisition not only creates a larger and faster network, but also the likelihood of Level 3 gaining market share, and the possibility of CenturyLink's enterprise growth slowing. Currently, Level 3 and TW Telecom are growing twice as fast as CenturyLink's enterprise business. However, the accelerated growth is likely only because CenturyLink's enterprise business is 50% larger than Level 3's business. Therefore, a smaller year-over-year growth rate should be expected.

Don't expect 20% annual organic growth in the enterprise segment following the Level 3 and TW Telecom merger. This isn't a space with overly aggressive growth figures. However, a 2%-3% increase in organic growth is very likely due to the network advantages created from this merger. While this may not sound impressive, it is enough to beat analyst expectations and allow for a more consistent long-term growth rate while fiber Internet build-outs provide a temporary spark.

Foolish thoughts
The bottom line is that this is a merger with various benefits, one that should strengthen Level 3's position, improve its products, and accelerate its growth in a key segment. The end result of these benefits could be an outperforming stock long-term, something all investors should welcome.

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