Fitch Ratings has affirmed the 'B+' Issuer Default Rating (IDR) assigned
to Level 3 Communications, Inc. (LVLT) and its wholly owned subsidiary
Level 3 Financing, Inc. (Level 3 Financing). In addition Fitch has
affirmed the specific issue ratings assigned to LVLT and Level 3
Financing as outlined at the end of this release. The Rating Outlook has
been revised to Positive from Stable. Approximately $8.4 billion of
LVLT's consolidated debt as of June 30, 2014 is affected by Fitch's
Fitch Ratings expects to assign a rating to Level 3 Escrow II, Inc.'s
(Level 3 Escrow) proposed $1 billion issuance of senior unsecured notes
due 2022 once the conditions to release funds from escrow are satisfied
and Level 3 Financing has assumed all obligations of Level 3 Escrow. Key
conditions include, among others that the closing of the TW Telecom,
Inc. is completed. Once released from escrow, proceeds from the issuance
will be utilized to fund, in part, the cash consideration of LVLT's
previously announced acquisition of TW Telecom, Inc. (TWTC). Overall
LVLT expects to issue $3 billion of new debt which will be utilized to
pay the cash consideration of the TWTC acquisition and repay outstanding
TWTC indebtedness. Pro forma for the TWTC acquisition, Fitch estimates
LVLT will have approximately $11.5 billion of debt. The transaction is
subject to customary regulatory approvals including the FCC and other
U.S. and state regulatory agencies. LVLT anticipates the transaction
will close by year-end 2014.
KEY RATING DRIVERS
--The TW Telecom, Inc. (TWTC) acquisition increases LVLT's scale and
focus on high margin enterprise account revenues while increasing the
company's overall competitive position and ability to capture
incremental market share;
--The acquisition is clearly in line with LVLT's strategy to shift its
revenue and customer focus to become a predominantly enterprise-focused
--LVLT remains committed to operate within its 3x to 5x net leverage
target. The enhanced scale and ability to generate meaningful free cash
flow (FCF) resulting from the transaction reinforces Fitch's expectation
for further strengthening of LVLT's credit profile.
--The company is poised to generate sustainable levels of FCF (defined
as cash flow from operations less capital expenditures and dividends).
Fitch anticipates LVLT FCF generation during 2014 will range between 4%
and 4.5% of consolidated revenues on a stand-alone basis, growing to
nearly 10% of revenues by year-end 2016 on a pro forma basis.
--The operating leverage inherent within LVLT's business model positions
the company to expand both gross and EBITDA margins.
The TWTC acquisition is in line with LVLT's strategy to shift its
revenue and customer focus to become a predominately enterprise-focused
entity. TWTC's strong metropolitan network supports LVLT's overall
strategy. Pro forma for the transaction LVLT's revenue from enterprise
customers increases to 70% of total CNS revenue from 66%. From a
regional perspective North America CNS revenue would increase to 78% of
total CNS revenue, up from approximately 71%.
LVLT's network capabilities, in particular its strong metropolitan
network, along with a broad product and service portfolio emphasizing
IP-based infrastructure and managed services provide the company a solid
base to grow its enterprise segment revenues. Fitch believes that
revenue growth prospects within LVLT's CNS segment stand to benefit from
the transition among enterprise customers from legacy time division
multiplexing (TDM) communications infrastructure to Ethernet or IP VPN
infrastructure based in internet protocol.
From a network standpoint the transaction combines a highly
complementary footprint and will increase LVLT's scale of metro networks
and broaden its overall product and service portfolio. The TWTC
acquisition solidifies LVLT's metropolitan network position with the
addition of 24,300 fiber route miles to LVT's network. The transaction
will create minimal network and customer overlap. LVLT indicates that
there is less than a 10% overlap with TWTC's 21,000 on-net buildings
providing LVLT with approximately 35,000 unique locations globally.
The investment in metropolitan facilities (which extend its on-network
footprint and overall network depth) provides the company the foundation
to derive strong operating leverage from its cost structure and network,
enabling it to grow operating margins. Additionally, the company's
improving revenue mix can further strengthen its operating leverage and
contribute to higher gross and EBITDA margins.
LVLT leverage strengthened to 4.7x as of the LTM period ended June 30,
2014 reflecting a decrease from 5.2x as of year-end 2013 and 5.4x as of
the LTM period ended June 30, 2014. Fitch foresees LVLT leverage on a
stand-along basis will approach 4.5x by the end of 2014. Fitch continues
to expect LVLT's credit profile will strengthen as the company benefits
from anticipated EBITDA growth, FCF generation and cost synergies
related to the TWTC acquisition. Consolidated leverage on a pro forma
basis is 5.1x before consideration of any operating cost synergies and
declines to 4.7x after factoring in $200 million of anticipated
operating cost synergies.
Based on the company's ability to realize cost synergies in past
acquisitions, Fitch has a high degree of confidence the company will
successfully realize the TWTC cost synergies. LVLT expects $200 million
of annualized operating synergies and an additional $40 million of
capital expenditure synergies. Similar to LVLT's Global Crossing
acquisition, operating synergies will be realized as the company
migrates traffic over to the LVLT network and utilize the combined
network to reduce third-party access costs.
Network expense reductions represent approximately 55% of the
anticipated operating cost synergies. The remaining 45% of operating
cost synergies will be derived from a combination of head-count and
non-head count expenses. Non-head count expense synergies will be driven
by the elimination of duplicate corporate costs. LVLT expects to capture
70% of the run-rate operating cost synergies within 18 months of
closing. The company anticipates it will spend $170 million in
integration costs, of which 60% are operating expense related and 40%
are capital expense related.
The TWTC acquisition improves LVLT's ability to generate consistent
levels of FCF. Fitch anticipates LVLT FCF generation during 2014 will
range between 4% and 4.5% of consolidated revenues on a stand-alone
basis before growing to nearly 10% of revenues by year-end 2016 on a pro
forma basis. The company has generated approximately $147 million of FCF
through the LTM period ended June 30, 2014. Fitch believes the company's
ability to grow high-margin CNS revenues coupled with the strong
operating leverage inherent in its operating profile positions the
company to generate consistent levels of FCF.
Fitch believes that LVLT's liquidity position is adequate given the
rating, and that overall financial flexibility is enhanced with positive
FCF generation. The company's liquidity position is primarily supported
by cash carried on its balance sheet, which as of June 30, 2014 totaled
approximately $637 million, and expected FCF generation. LVLT does not
maintain a revolver, which limits its financial flexibility in Fitch's
opinion. LVLT does not have any significant maturities scheduled during
the remainder of 2014. LVLT's next scheduled maturity is not until 2015
when approximately $475 million of debt is scheduled to mature or
convert into equity.
What Could Trigger a Positive Rating Action:
--Consolidated leverage maintained at 4x or lower;
--Consistent generation of positive FCF, with FCF-to-adjusted debt of 5%
--Positive operating momentum characterized by consistent core network
services revenue growth and gross margin expansion.
What Could Trigger a Negative Rating Action:
--Weakening of LVLT's operating profile, as signaled by deteriorating
margins and revenue erosion brought on by difficult economic conditions
or competitive pressure;
--Discretionary management decisions including but not limited to
execution of merger and acquisition activity that increases leverage
beyond 5.5x in the absence of a credible de-leveraging plan.
Fitch affirmed the following ratings with a Positive Outlook:
--IDR at 'B+';
--Senior unsecured notes at 'B/RR5'.
Level 3 Financing, Inc.:
--Senior secured term loan at 'BB+/RR1';
--Senior unsecured notes at 'BB/RR2'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage
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