It's Level 3's turn to make a big acquisition. On Oct. 17, the company announced plans to buy telecom provider Broadwing for $1.4 billion. The deal gives Level 3 local telecom operations and technology for efficiently transporting data traffic around the Internet. It improves Level 3's balance sheet, although it also makes it a more expensive acquisition candidate.
Level 3 sells telecom services to a number of big Internet companies, including Yahoo, Microsoft, AOL, and YouTube. The telecom company also sold Google about $300 million worth of fiber-optic capacity about one year ago, says analyst Donna Jaegers of researcher Janco Partners. The Net companies use Level 3 telecom services to connect their servers to the telecom and cable companies that sell Internet access directly to consumers. Level 3 also provides services to corporations and telecom companies.
While an acquisition looks unlikely, at least in the near future, Google and Level 3 may forge closer commercial ties during the coming years. If anything, the Level 3–Broadwing deal may decrease the odds of a buyout by Google. The Level 3–Broadwing deal is complex and requires a lot of integration. Companies rarely do such deals if they believe they are going to be bought out.
Level 3 will reduce its debt level by acquiring Broadwing, a step that could make it more attractive to an acquirer. Its debt level will fall from 9.7 times earnings before interest, taxes, depreciation, and amortization (EBITDA) to about 7.7 times EBITDA. But that reduction still could be high enough to discourage a buyer.
Level 3 is expensive, with a market cap of $7 billion and $6.5 billion worth of debt. That means Level 3 would cost $13.5 billion, before an acquirer paid a premium. In all probability, Level 3 will remain independent for the present. The Broadwing deal, at least, makes that easier. In addition to improving the balance sheet, Level 3 is acquiring Broadwing's cash flow, which will be useful as the company's debt matures. It is due to pay off $140 million in 2008, $360 million in 2009, and the remainder of its debt between 2010 and 2013. The Broadwing deal will put more traffic from big corporate customers on the combined Level 3 network. That could improve operating profit margins from about 50% to the 60% to 65% range.