Internet and telecommunications company Level 3 Communications (LVLT) has been on a roll since it posted an unexpected profit on Feb. 5. The stock has risen more than 27% after Level 3 turned in a profitable fourth quarter after 19 successive quarterly losses.
Level 3 provides content delivery services for Apple (AAPL 0.52%) and Netflix (NFLX 1.74%), among others. The company is seeing positive results because of an increase in revenue from service-based products, reduced churn rates, and strong demand from its broadcast and content customers.
At first sight, it seems that Level 3 enjoys some good underlying growth drivers. But is this the case? Let's check.
Solid numbers
Over the years, Level 3's management has built a strong foundation for growth in revenue, operating profit, and free cash flow. The company's core networking services business has put together an impressive streak of results, growing for eight consecutive quarters. The improvement in the company's business was there for all to see when it reported earnings of $14 million -- $0.06 per share -- for the fourth quarter, as compared to a loss of $56 million, or $0.26 per share in the year-ago quarter.
In addition, Level 3 became free-cash-flow positive in 2013, posting a figure of $29 million for the full year as compared to a negative $165 million in 2012. This year, Level 3 also expects to generate free cash flow in the range of $225 million-$275 million, as its business continues to improve.
Factors driving growth
The growing demand for bandwidth, an increasingly complex mobile and cloud operating environment, the rising need of connectivity, and the increasing threat of security lapses are growth drivers for Level 3. The company has positioned itself to address such needs. Level 3 provides flexible, reliable, secure, and cost-effective solutions to its customers, so it doesn't come as a major surprise that its business is now turning around.
The enterprise business is one of the key growth engines for Level 3. Enterprise is driving demand for Level 3's core network services and leading to robust demand in North America and Latin America. Level 3's core networking services business posted revenue growth of 11% in the fourth quarter, and the company is going to build upon this performance in the future.
The growth in data usage, improvements in churn, and a strong order log should help Level 3 post even better performances in the future. The company sees Latin America as a strong growth area. It expects healthy sales from this region due to demand for Internet protocol and virtual private network services, high-capacity transport connectivity, data-center services, and Ethernet services for both enterprise and wholesale customers.
Level 3's IP and data-center business was up 5.2% in 2013, and the company expects this segment's growth to touch double digits this year. Level 3's high-speed IP, VPN, co-location and data services have gained good momentum in recent times due to strong adoption rates at customers.
For example, Level 3 is upgrading the network capability of one of the world's largest insurance providers, Trustmark Insurance. Trustmark provides health insurance, life insurance, voluntary benefits, and benefits management. It covers more than 2 million people across the globe. With contract wins such as these, Level 3 looks to be in a good position to deliver long-term growth. But there are some concerns that investors should keep in their minds.
Apple and Netflix: Potential concerns
Level 3 provides content delivery services to both Netflix and Apple. The problem here is that both companies are probably moving to their own content delivery networks. While Netflix has already started delivering content from its Open Connect content delivery network, rumors are flying that Apple is also going to build one of its own.
Netflix's Open Connect went into operation last year, and the streaming giant was reportedly delivering 5% of its content on its own. The gradual shift of Netflix to its own content delivery platform is a threat for Level 3. In addition, Netflix recently inked a deal with Comcast regarding paid peering, eliminating a supplier such as Level 3 from the middle.
Apple, on the other hand, has also been reported to build its own content delivery network. According to Dan Rayburn of Frost & Sullivan, Apple can use its own infrastructure to distribute content from iTunes, the App Store, and iCloud. Apple is already building data centers, so a content delivery platform is not a far-fetched idea. Apple currently uses Akamai and Level 3 for its content delivery needs.
Bottom line
Level 3 is on the comeback trail and it is expecting solid growth in the enterprise segment. Analysts also remain highly positive about its growth and project that earnings will grow at a rate of 81% a year for the next five years, well above the industry's average of 16.85%. But investors shouldn't ignore the potential threats, and they should invest in the company depending on their own risk tolerance.
