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Level 3 Communications
Jack Waters presentation

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By Dan110355
April 16, 2004

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I just finished listening to the recent presentation by Jack Waters:

It is clear from the presentation that Level 3 thinks its "singular opportunity" is voice. Waters even mentioned that it was the "one singular focus" for the company. This is premised on its softswitch technology. He pointed out that 45% of its total revenues right now are based on softswitch, most of which is the managed modem business. What is important for the future is that its VoIP offerings are built on this platform -- he claims the entire platform is capable of carrying voice.

Mr. Waters pointed out that broadband penetration has decoupled access from the end voice service. He said Level 3 could formerly only address $9 billion of the $245 billion voice market. With its current offerings, he claims it can now address about $71 billion of this market.

He still believes one of the "key differentiators" for the company is that it will not sell to the end consumer or enterprise. He pointed out that LVLT will never compete directly with Vonage, but its customers might.

Waters attempted to differentiate Level 3 from its competitors -- tried to describe the Level 3 "moat" as he sees it. He said the Level 3 trunks touch 93% of the United States. This allows the MSOs to connect to a national network. More importantly, Level 3 has 1.4 million local trunks that are scaled versus a legacy feature group 4 switching network that is not based on a local footprint, but long-distance (i.e.: WilTel & Global Crossing). Significantly, he pointed out that Level 3 has gone to the trouble of negotiating the interconnection agreements necessary to have a local footprint. He continually pointed out that Level 3 is built to a local footprint, not a long distance footprint.

In addition, Level 3 is a CLEC in all states except Iowa & Maine. So an MSO can again have a national footprint without making regulatory filing in every state. LVLT has also gone to the trouble of offering products that will give customers their traditional telephony services (directory assistance, 911, local #), plus the features one would expect from a data network.

Mr. Waters predicts that the voice industry will become even more disaggregated in the future. He pointed out that some services that have not even seen "pricing pressure" nevertheless cost 50% of what they were formerly priced at. He said that as "larger brands" (stating "IXCs and ISPs") entered the market, there will be more pricing pressure and more disruption.

What does this mean for Level 3? He said Level 3 has concentrated on providing the building blocks for the voice market. He claims they are gaining "early traction" in this business. Voice is now less than 3% of the company's total revenues. He said that if they execute, the market will be "huge." As far as this year, he thinks revenue contribution will be "meaningful toward the end of year." Who knows what this means? And will it be enough to offset losses from AOL?

One problem I see -- the pricing pressures might be even greater than they anticipate. In other words, the $245 billion market might shrink to 10% of that, or $24 billion. Assuming a 5% market share (as Lehman Bros. might predict), 5% of $24 billion is only $1.2 billion.

But then again, maybe it won't shrink by 90%.

Methinks VoIP may indeed be significant for LVLT.

Long live softswitching.

Long live managed modem. But when it dies, it looks like it will live on as VoIP.

Techies -- help me here. Is there a moat here? Is the MM/softswitching platform something that others cannot easily duplicate?

Dan


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