The biggest event on the slates of both CenturyLink (NYSE:CTL) and Level 3 (NYSE:LVLT) this year will be their blockbuster $34 billion merger, which was announced on Halloween 2016 and is slated to close in the third quarter of this year.
The telecom space is fierce and changing technologies, consolidation among participants, and tough bargaining between large entities are the norm. Scale is a huge advantage, capital costs can be quite high, and price wars are not uncommon.
No surprise then, that these two companies think they will be stronger as one, rather than fending for themselves. CNBC's David Faber said when CenturyLink's acquisition of Level 3 was announced that some were describing the marriage as an example of "two drunks holding each other up." Here are a few of the key things the companies should be able to do better together than they will apart, assuming there are not too many significant integration issues.
Increase cash flow per share
Merging companies always tout "synergies." In the case of CenturyLink and Level 3, there are certainly some costs that can be taken out once they combine. Beyond typical workforce efficiencies, CenturyLink can can immediately reduce peering fees -- the fees one network needs to pay to connect to another network -- by combining with Level 3. The deal will increase CenturyLink's "on-net" buildings by roughly 75%. "On-net" means the building connects to the company's network directly, without having to link to another company's network (which would require paying wholesale fees). The companies estimate total synergies at an annual run rate of $975 million.
Finally, Level 3 will add to CenturyLink's bottom line as CenturyLink expects the transaction to be "accretive to free cash flow in the first full year following the close of the transaction." This should help keep intact CenturyLink's dividend, which currently yields 8.8%.
Combine complementary networks and services
While Level 3 and CenturyLink do have some overlap, their networks are mainly complementary. CenturyLink, based in Louisiana, has its roots in the South and Midwest, and has also branched out to the western states with its acquisition of Qwest in 2011 With Level 3's 200,000 miles of network fiber, the company will have a Tier 1 network that covers virtually all of the major cities in the U.S. Level 3 also brings along an international business with connections to over 60 countries, and Level 3 has enterprise clients in both Latin America and EMEA.
Moreover, the two companies will be able to leverage their different products over the combined customer base. Between the two companies, there are network connections for enterprise and consumers, content delivery networks, cloud services, consulting services, and others. Combined, the companies can effectively be a "one-stop shop" and have the flexibility to provide the right products for its diverse customer base.
Another compelling data point is that both companies seem to have been falling behind the speed race. According to PC Magazine, in 2016, CenturyLink was not even in the top 10 fastest ISPs in the country, and only cracked the top 10 in a single region -- the Northwest -- where it placed fourth. Level 3 also had reason for concern. While it had been at the top of the speed rankings for business ISPs each of the last three years, and boosted its speeds again in 2016, it still wasn't enough. Five other ISPs leap-frogged the company in 2016! If a merger can help the combined entity spend more efficiently on beefing up speeds where it needs to, that is another plus.
Finally, the combined company will be the second-largest enterprise network provider in the country, behind only AT&T (NYSE:T) . Level 3 CEO Jeff Story said "scale matters," numerous times on the merger conference call, per a transcript on Seeking Alpha. This matters not only for the aforementioned reduced peering fees, but it also allows for an easier customer experience.
Story noted, for instance, that when a company wants its own virtual network to secure a remote computer or location, being a smaller provider means you often have to connect through another company's network. If one owned the entire network, however, the company could more seamlessly connect elements in the network and reduce wholesale fees at the same time.
CenturyLink and Level 3 should get several benefits from the deal, should they execute. And it looks like these benefits are sorely needed.