As Level 3 Communications (Nasdaq: LVLT) girded its loins for a second-quarter report this morning, market makers spent the day yesterday pushing the stock up to high heavens. Perhaps a Seeking Alpha story about how Level 3 seemed ripe for a short squeeze after a good report helped fuel the action; whatever the case, Level 3 closed 9% higher yesterday.
Now, the numbers are in, and they're not great: Sales shrank 3.6% year-over-year to $908 million, and net losses grew from $0.08 per share to $0.10 per share. Level 3 has given back all of yesterday's mighty gains. Such is life when you're dealing in penny stocks, albeit ones with a $1.8 billion market cap and $7.8 billion of enterprise value.
Investors in Sirius Satellite Radio (Nasdaq: SIRI) and Sealy (NYSE: ZZ) should know what I'm talking about: Like Level 3, these businesses carry both a crushing debt load and a distant promise of better times ahead on their minuscule share prices. All these stocks -- Level 3 included -- have sizable short positions over 5% of float in place. Betting on this kind of investment is risky whether you're going long or short. In the case of Level 3 and Sirius, there's expensive assets in place, whose build out has led to bankruptcy fears. In Sirius' case, the recent mission has been cutting costs; for Level 3, the trick is finding demand for higher-speed broadband adoption.
When it comes to Level 3, there's always the promise of lighting up massive amounts of dark fiber to profit handsomely if, and when, America needs a drastic increase in network capacity. It's a valid investment thesis, but one that takes a lot of patience. That opportunity has been lurking around for years, and while Cisco Systems (Nasdaq: CSCO) is getting rich on installing new networking equipment, Level 3 is thinking about removing about 25,000 of its 67,000 miles of active intercity fiber lines. In that respect, Level 3 reminds me of Maui Land & Pineapple, where day-to-day operations are basically a distraction from the company's true value, which is locked up in acres and acres of attractive real estate in Hawaii. Again, Maui Land sports an enterprise value four times the size of its market cap, thanks to huge amounts of debt.
But, I digress. I'm all for focusing on the profitable aspects of your operations, and Level 3 has made some good moves in recent years. The company is a credible alternative to Akamai Technologies (Nasdaq: AKAM) in content delivery services, for example. Doing that business the right way actually decreases the total load on network backbones even if end-user traffic increases; perhaps growing ambitions in content delivery is telling Level 3 to value its core network a little bit less these days?
Anyway, unless you bought shares yesterday, you haven't lost anything today. Level 3 is back where it was two days ago. Just tread carefully around these jumpy small caps -- even if they're sitting on massive capital assets.
