I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Level 3 Communications (Nasdaq: LVLT). Is this communications and data network operator the real thing? Let's get right to the numbers.

Foolish facts

Metric

Level 3 Communications

Motley Fool CAPS stars (out of 5) ***
Total ratings 1,805
Percent bulls 93.9%
Percent bears 6.1%
Bullish pitches 339 out of 363
Highest-rated peers Telkom SA, Shenandoah Telecommunications, NTELOS Holdings

Data current as of Oct. 13.

Fools are mixed when it comes to Level 3. You know who isn't confused? Value investors. Deep value specialists such as Mason Hawkins of Southeastern Asset Management love the Level 3 story. Southeastern owns roughly 30% of Level 3's outstanding shares, according to Capital IQ.

Other investors are buying. For example, board member Dr. Arun Netravali, a well-known engineer and managing partner of venture capital firm OmniCapital, bought 100,000 shares from CEO James Crowe in a private transaction arranged at $1.05 a share.

Why are they buying? My guess is the prospect of a Google buyout, transforming The Big G's fiber-to-the-home experiment into a full-blown project. At current prices, Google would have to offer at least $10 billion, or roughly three times revenue, to satisfy speculators.

The elements of growth

Metric

Past 12 Months

2009

2008

Normalized net income growth Not measurable Not measurable Not measurable
Revenue growth (9.5%) (12.5%) 0.7%
Gross margin 58.4% 58.4% 57.9%
Receivables growth (16.6%) (17.2%) (3.5%)
Shares outstanding 1,661.8 million 1,644.1 million 1,617.6 million

Source: Capital IQ, a division of Standard & Poor's.

Judging just by this table, Level 3 might not be worth that much. But in this case, looks might be deceiving. Let's review:

  • With revenue growth down and earnings nonexistent, there's little proof this business is a viable moneymaker over the very long term.
  • Having said that, Level 3 does have a history of producing free cash flow. More than $230 million worth, according to Capital IQ, which uses earnings before interest and taxes as a base, accounts for interest expense, adds back non-cash depreciation and amortization, and finally subtracts capital spending and changes in working capital.
  • I'm also slightly encouraged by the small gains in gross margin. Level 3 has to increase margins over time to boost profitability.

Competitor and peer checkup

Company

Normalized Net Income Growth (3 Years)

Akamai Technologies (Nasdaq: AKAM) 23.8%
AT&T (NYSE: T) 11.6%
Equinix (Nasdaq: EQIX) Not measurable
Global Crossing (Nasdaq: GLBC) Not measurable
Level 3 Communications Not measurable
Limelight Networks (Nasdaq: LLNW) Not measurable
Savvis (Nasdaq: SVVS) Not measurable

Source: Capital IQ. Data current as of Oct. 13.

This table tells me two things. First, it helps explain why Akamai commands a premium valuation. (Its profitability and growth set it apart.) Second, Level 3 isn't easily distinguishable from peers that don't share its advantages.

Grade: Unsustainable
Top of the list has to be Level 3's national network. It's too big and too important to be vaporized, and that has value. I like Level 3 as a long-term informed speculation based on the possibility of a premium buyout from today's levels. As such, I've rated the stock to outperform in my CAPS portfolio.

Now it's your turn to weigh in. Do you like Level 3 Communications at these levels? Let the debate begin in the comments box below. You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

For further Foolishness featuring Level 3 Communications:

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Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Akamai at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.