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Level 3 Communications
LVLT's Revenue

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By valbull
October 29, 2001

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As a longtime investor and only occasional (on this board) poster, I would like to share some "concerns" about LVLT's future revenue. The 3rd qtr. call had great news about the gross margin and future cap ex linked to increased revenue. LVLT is preparing for a deep telecom recession and taking steps to survive. I feel better about their survival but as I analyze 3rd qtr revenues, I get more concerned about its future growth. Before the 3rd qtr, as I analyzed "data points" I was convinced that we would exceed cash revenue targets for the following reasons:

1. Calpoint was an unexpected dark fiber windfall. Some, including me, has speculated it could be as much as $100M. I was disappointed to find out it looks to be about $50M or less.

2. Many believed that LVLT would never use their cash for a buyback unless their were going to exceed revenue. It turns out that they are able to use cash for debt buyback because of massive cap ex reductions not a revenue increase.

3. Verizon is growing in the long distance and wireless markets and since they were one of LVLT's top 10 customers I thought Level 3 would benefit. I have this little "niggling". Why isn't Verizon a top 10 customer anymore?

4. There was lots of speculation that the events of 9/11 would increase the demand for bandwidth. Increases in video and tele conferencing were reported. The need for more backup and duplicate lines/colo was speculated. Less travel and more use of the internet was discussed. It appears that there was little impact on revenue growth from these issues and the decline in corporate demand was real.

5. The Williams CEO, in his conference call was insistent that there is no bandwidth glut, that bandwidth demand is growing at least 100% per year and new bandwidth eating applications are being developed. The Allegiance CEO also was very upbeat and provided data that showed that their demand had recovered after experiencing no sales for two weeks after 9/11. Again with LVLT planning for survival, it is hard to believe that bandwidth demand is growing 100% annually. I did not hear Crowe or others give indications that demand was recovering.

6. The speculation about Sprint becoming a large customer continues.

There were other data points. But when I analyze the 3rd qtr numbers, I reach the conclusion we would have missed cash revenue projections by $40M or so without Calpoint, This was not in LVLT's projections in July since they said the projections include no new dark fiber.

Now what about cash revenue going forward. I am being a little contrarian here because we longs always know the positive signs, like Govnet, which could surprise on the upside. What could surprise on the downside?

1. I heard O'Hara say in the conference call, that some of the previously classified good customers had fallen onto the credit watch list. Could churn be even greater than anticipated if the economy does not recover quickly?

2. Is there any problem with our Verizon relationship?

3. On Rukeyser's Wall Street Week, the global technology strategist for Merril Lynch stated that their survey of CIOs indicated that the technology recession will last well into the 2nd half of 2002. The CIOs reported that they don't see major technology spending increasing before that time.

4. If LVLT is going into their bunker to survive because the recession could be a deep one, shouldn't LVLT be concerned that two of our top 10 customers (XOXO & McCloud) are vulnerable to financial troubles? Grubman pointed this out in his report and I believe it is a valid issue.

5. What if many of LVLT's customers do as LVLT does and reduce spending to the bare minimum and go into a bunker to survive? What was the impact on Level 3 equipment providers revenue projections for 2002, when they heard Level 3's mandatory cap ex ($200M)? Could this happen to Level 3?

All of this has been rolling around in my head since the conference call. I thought I would share it and get others perspective on our future revenue vulnerability.

I would appreciate the perspective of others.

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