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Wrong Move, Level 3!

By Anders Bylund - Updated Apr 6, 2017 at 10:27PM

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Don't believe the hype.

"A pollen
fly makes

so much
of sounding

like a
bee because

he has
no sting."

-- "Hype," by A.R. Ammons

The $1.9 billion takeover bid that Level 3 Communications (Nasdaq: LVLT) just placed for rival Global Crossing (Nasdaq: GLBC) is the closest thing available to a simple plug-in, add-on, accretive deal. That's not necessarily a good thing, though.

The two pure-play network systems are the largest of their kind. If you want to go any bigger in this space, you'll run into telecom services without fail. Verizon's (NYSE: VZ) UUNet and the global data networks of AT&T (NYSE: T) might be even more logical partners for an Internet backbone of Level 3's size, but they come attached to wired and wireless telecom services that Level 3 wouldn't be interested in. A deal like that would go the other way, with the phone people looking for expanded data capacity in a Level 3 buyout.

So what, exactly, is Level 3 getting for its $1.9 billion in freshly minted shares and $1.1 billion of assumed debt? For one, the merger joins Level 3's focus on metropolitan networks with Global Crossing's large array of transcontinental and undersea cables, creating a whole new set of end-to-end services on a global stage. That makes plenty of sense. Global Crossing brings $2.7 billion of gross networking equipment into the fold (or $1.2 billion of net physical assets), which is a respectable addition to Level 3's $12.5 billion of gross property or $5.3 billion, net.

Level 3 shareholders love this deal, pushing the share price up by 17% as of Monday's closing bell. That might be an overreaction, though.

You see, adding Global Crossing and its enormous network capacity does very little to heal what ails Level 3: profitability, or lack thereof. Despite a rash of high-profile customers that includes digital video wrangler Netflix, Level 3 remains a cash-burning operation. The company rarely reports positive earnings, and whatever operating cash that is generated gets eaten by high capital expenses.

There will be some synergistic cost savings, of course, but Level 3 would have been better off with a vertical move. For a similar sum, Level 3 could have bought SAVVIS (Nasdaq: SVVS) to bolster its cloud-computing services, or Limelight Networks (Nasdaq: LLNW) to expand its content delivery operations. These are value-added services that might entice customers to sign up for fatter data traffic pipes and pad Level 3's bottom line.

Instead of a growth-promoting move like that, Level 3 gets an impressive asset base with shrinking revenue and even less impressive cash flow trends. Looking back at this purchase five years from now, I'm betting it'll be through bloodshot eyes and not rose-tinted lenses.

Make sure that you don't miss a beat as this saga develops -- add Level 3 and Global Crossing to your Foolish watchlist right now.

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Stocks Mentioned

Level 3 Communications, Inc. Stock Quote
Level 3 Communications, Inc.
LVLT
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
VZ
$50.52 (-0.87%) $0.45
AT&T Inc. Stock Quote
AT&T Inc.
T
$20.61 (-0.79%) $0.17
Limelight Networks, Inc. Stock Quote
Limelight Networks, Inc.
LLNW
$2.29 (-0.22%) $0.01

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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