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Level 3 on the right track?


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http://finance.yahoo.com/news/Level-3-Announces-Redemption-bw-4131896284.html?x=0&.v=1

 

Nice to see this announcement this morning. In the past, Level 3 was only swapping near term dated debt with longer dated ones. Unless they issue something else in the near future, it could be a sign that free cash flow is now sufficient to fund these redemptions over time while keeping the cash pile stable.

 

Redeeming this convertible with cash now will reduce interest payments by $17 million a year or increase pre-tax earnings by the same amount and eliminate a very dilutive security which had the potential to add 48 million shares at a very low conversion price of $3.60.

 

With Qwest being acquired by CenturyTel, there are now very few options available to carriers to upgrade their national network unless they want to build from scratch and spend 10's of billions. Level 3 network is the most recent with completion in 2001, Qwest was in 1996 and Verizon (MCI), AT&T and Sprint were completed in the 80's. Some others were completed at the same time as Level 3, but they are not national. 

 

In the 80's! Just imagine how out dated that is and how much retrofits have been made to keep this running. There was no internet for everyone back then. It must be a mess, unreliable and must take very knowledgeable technicians and engineers just to understand and keep running. 

 

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With Qwest being acquired by CenturyTel, there are now very few options available to carriers to upgrade their national network unless they want to build from scratch and spend 10's of billions. Level 3 network is the most recent with completion in 2001, Qwest was in 1996 and Verizon (MCI), AT&T and Sprint were completed in the 80's. Some others were completed at the same time as Level 3, but they are not national.   

 

In the 80's! Just imagine how out dated that is and how much retrofits have been made to keep this running. There was no internet for everyone back then. It must be a mess, unreliable and must take very knowledgeable technicians and engineers just to understand and keep running. 

 

It's probably not really that bad.  The most important things in building these networks are having the physical places (rights-of-way) to actually put your cables.  Once you have those, rewiring specific sections isn't that bad.  In addition, most of the network upgrades since fiber was introduced (though there are different kinds of fiber) happen at the device level.  That is, you don't necessarily even need to replace your cables, but you can have an enormous increase in capacity by upgrading the electronics.

 

Change happens extremely rapidly at that level.  Level 3 would have had to make significant upgrades along the way to keep up with the other providers, even though their network was built comparatively recently.

 

The long term stable money is in leasing physical fiber to other companies, or just leasing particular rights-of-way themselves.  This would provide a reasonable return on capital without requiring huge and continuing capital expenses.  I say this without going into any company's particular business model.

 

Roman.

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On the 80's networks, you need relays every 40 km and need to switch back from light (optical) to electric signal. On Level 3's network, you stay with light all the way and relays are 100 km apart. Also, stations are 160 km apart on the 80's networks while 600 km apart on Level 3's network.

 

The 80's networks are also not fully optimized in terms of route: sometimes you use your competitor to transmit your signal, sometimes you travel more distance for nothing.

 

All together, the operating cost is about double. If they could have resolved these issues to drive their costs down they would have, but they can't.

 

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Was mono-mode (fastest type) fibers even deployed in the 80's?

 

BeerBaron

 

I can't answer this question definitively.  The standard for the first type of single-mode fiber (Nondispersion-Shifted Fiber (ITU-T G.652)) was released in 1984.  I don't want to stress the fiber part too strongly; the biggest and most difficult part to put together is the rights-of-way.

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On the 80's networks, you need relays every 40 km and need to switch back from light (optical) to electric signal. On Level 3's network, you stay with light all the way and relays are 100 km apart. Also, stations are 160 km apart on the 80's networks while 600 km apart on Level 3's network.

 

I can't disagree with your statement here, since I don't know what was deployed, but there's really no reason you can't upgrade the cables, or even splice older ones together.  There also exist optical-only switches and other mechanisms now.

 

The 80's networks are also not fully optimized in terms of route: sometimes you use your competitor to transmit your signal, sometimes you travel more distance for nothing.

 

All together, the operating cost is about double. If they could have resolved these issues to drive their costs down they would have, but they can't.

 

Not really sure on the cost issue.  Unless you're traveling over 1000 miles, the time delay in your route is pretty minimal, given that it's based on a factor very close to the speed of light.  This becomes significant over planetary distances, but it'd have to be a pretty bad route for most situations to matter.  If I did the math right, it would take about 5.3ms for light to go that 1000 miles.  Your times are swamped by the optical conversion and other hops.  Now, the one issue you bring up here which is critical is the idea that you use capacity from your competitor.  If this means you don't have any physical way to get from point A to point B, this is very significant indeed.

 

I need to reiterate that I don't really know what was done in terms of the technical deployment at the time, I'm thinking about what can be done given the resources available (plus cash).

 

If I was to speculate as to why certain changes aren't being made, it's probably that they aren't yet worth the capital investment.

 

Roman.

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Guest ValueCarl

Speaking of messes tied to cash flows, Global Crossing looks like a train wreck QoQ with and without currency devaluations caused by Venezuela. That can't be a good thing for such a capital intense business!

 

Cash and Liquidity

 

As of March 31, 2010, Global Crossing had $359 million of unrestricted cash, compared with $477 million at December 31, 2009 and $306 million at March 31, 2009. Including $14 million of restricted cash, Global Crossing had total cash of $373 million at March 31, 2010. The devaluation of the Venezuelan Bolivar in January had a $27 million unfavorable impact on our unrestricted cash balances as of March 31, 2010.

 

Cash used in operating activities for the first quarter was $31 million. Global Crossing received $23 million in proceeds from the sale of IRUs and prepaid services in the first quarter. Uses of cash for the quarter included $55 million for capital expenditures and principal payments on capital leases.

 

The company reported negative Free Cash Flow of $72 million in the quarter, compared with positive $72 million in the prior quarter and negative $32 million in the year-ago period. The sequential decrease was primarily driven by a use of cash for working capital, higher cash interest and lower sales of IRUs and prepaid services, as anticipated. Year over year, the variance was principally driven by an increase in cash interest expense and lower sales of IRUs and prepaid services. 

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Libor.plus1,

 

You are absolutely correct to be questioning this company. Here is what I think changed for Level 3 in the past 3 to 4 years:

 

1- More focus on delivering services directly to enterprises vs relying on carriers. Big new source of revenues and profits and only starting to gain traction.

2- Big players: U.S. government, Google, pushing carriers to do something to improve internet speed.

3- Significant consolidation in the industry and many players disappearing.

4- IPhone and IPad. Clearly demonstrating the need for faster, larger wireless networks. It is not just at the tower level, but between towers that the infrastructure is inadequate.

5- The economy is resuming its growth, which should lead directly to higher demand for bandwidth.

6- A share price that is now so low to reflect all possible bad news, without any reflection of any positive news.

 

I have kept an eye on this company for almost 10 years and decided only recently to enter since I think that the upside vs downside risk is now very promising. It reminds me a bit of big cell tower operators after the 2001 recession which were all considered caput under heavy debt loads. See how it changed with demand and profits.

 

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Guest ValueCarl

Cardboard, you might be overly optimistic as respects item #5, with the exception that, there might be an exception to internet use remaining or experiencing higher levels even if a "double dip" occurs because consumers will be using it as a more cost effective means of entertainment, and businesses will continue to look towards it for cost savings.

 

In the mean time, who they gonna call? It will be the "low cost provider" and not "GHOST BUSTERS!"  8)

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Guest longinvestor

In the mean time, who they gonna call? It will be the "low cost provider" and not "GHOST BUSTERS!"  8)

LVLT is in a low cost provider game. Unfortunately after the the illusion of turbo-growth & profits of the tech age went bust the reality is slowly sinking in that this is a cost game after all. Tech empowers cheaper(&better) means of existing services like communications and is not a way to "get price".  Besides, the ever shrinking disposable income in the western world plus the unwinding of a 100 year monopoly has assured that the low cost game being played will keep time in units of decades rather than quarters.

 

So anyone expecting fireworks this Q or next need to sober up or go elsewhere in search of fast returns. It aint just happening.

 

Folks who bought into the hype before the millenium are obviously bitter. While deep value folks (Prem et al) got in while blood was flowing on the streets. We just learned from Prem during the AGM that they have taken the impairment to the books and now have LVLT marked at 70 Cent cost basis (rather than $2) in their book. The story of LVLT bonds is a separate subject.

 

Most interestingly, I had a sidebar conversation with the folks at FFH during the AGM and the investment thesis of LVLT is "trust in management". Now, you go to any message board and long term LVLTers, it is all about the "lack of trust in management". Go figure. When it comes to LVLT, there are two mutually exclusive worlds indeed! Time is both a friend and an enemy depending on who you ask.

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In the mean time, who they gonna call? It will be the "low cost provider" and not "GHOST BUSTERS!"  8)

 

Most interestingly, I had a sidebar conversation with the folks at FFH during the AGM and the investment thesis of LVLT is "trust in management". Now, you go to any message board and long term LVLTers, it is all about the "lack of trust in management". Go figure. When it comes to LVLT, there are two mutually exclusive worlds indeed! Time is both a friend and an enemy depending on who you ask.

 

Longinvestor,

 

Thanks for the color from the AGM. You gotta like how accessible and friendly the Fairfax people are!

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It feels like LVLT

would benefit enormously from inflation. 

 

Do I understand it correctly that the maintenance costs are low, that replacement costs and barriers to entry are extremely high?  Further, long term demand is dependable and growing?

 

Isn't their asset a real one and aren't they levered a very high amount against that asset?

 

Would rising demand long term bring about pricing power to help them increase revenue at least in line with inflation?

 

Would a high interest/inflation environment make it tricky for competition to find the money to lay new fiber?

 

Or perhaps I'm ignoring a core reason why inflation would serve to hurt them instead?  Thoughts?

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Guest ValueCarl

Longinvestor, that is a most interesting fact that you have shared. Thank you as well.

 

I do have a question though.

 

Did they tell you if their asset impairment strategy(write down) was more of a "tax strategy" or factual belief system as to underlying "value"?

 

Are they exploiting the accounting loopholes prevalent in our financial universe like bankers who were blessed to hide toxic assets in basements rather than marking them to market, or is this their real belief in the value of that $25B cost network?

 

Maybe Valuecfa or someone else would be kind enough to weigh in on the mechanics of such a maneuver including future capital gains tied to "tax rates" in conjunction with write down today.       

 

You see, it's hard for me to believe people with $2 common stock cost basis' go about happily "trusting management teams" which they're writing down to SEVENTY CENTS!  :o

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It feels like LVLT

would benefit enormously from inflation.  

 

Do I understand it correctly that the maintenance costs are low, that replacement costs and barriers to entry are extremely high?  Further, long term demand is dependable and growing?

 

Isn't their asset a real one and aren't they levered a very high amount against that asset?

 

Would rising demand long term bring about pricing power to help them increase revenue at least in line with inflation?

 

Would a high interest/inflation environment make it tricky for competition to find the money to lay new fiber?

 

Or perhaps I'm ignoring a core reason why inflation would serve to hurt them instead?  Thoughts?

 

 

If they have pricing power then inflation may help them up until the point it is time for them to refinance their debt. Then inflation will kill them. Inflation of course is good for high debt companies (with appreciable assets) over the near term as their assets grow in value (while their liabilities in the form of debt stay fixed), yet it is terrible for high debt companies when it comes time to roll over that debt. I think many forget to factor in refinance rates in high inflationary environments.

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Guest ValueCarl

Valuecfa,

 

Have you ever looked at silicon economics being ingrained in bandwidth, a principle and thesis this network was founded upon? Then again, maybe "trusting the management team" with respect to this concept has been flawed on my part. Or, it has changed and somebody forgot to tell me including those fair and friendly acquisition folks at Fairfax.

 

Here's how it's supposed to work in a hypothetical environment where bit traffic is growing at 80 percent and prices to deliver services are plummeting 30 percent:

 

$1 +.80*.65=$1.17 or seventeen percent top line growth YoY. Without acquisitions, something that shouldn't be missed sooner rather than later, apply that to a $3B revenue base line (approx. core network revenues today). 

 

I've always stated that, unlike Nash's flawed thesis for COOPetition in the telecom space, one MOTHER TECHNOLOGY company in a  MONOPOLY position would serve all market participants, especially important END USERS very well compared to what has preceded it for more than one hundred years!   

 

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Valuecfa,

 

Have you ever looked at silicon economics being ingrained in bandwidth, a principle and thesis this network was founded upon? Then again, maybe "trusting the management team" with respect to this concept has been flawed on my part. Or, it has changed and somebody forgot to tell me including those fair and friendly acquisition folks at Fairfax.

 

 

 

ValueCarl, You are asking the wrong person about silicon economics. LVLT's economics is something that i don't understand well. Perhaps i will get around to reading the company's 10-k one day, but i have a feeling i still won't get it.

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It feels like LVLT

would benefit enormously from inflation.  

 

Do I understand it correctly that the maintenance costs are low, that replacement costs and barriers to entry are extremely high?  Further, long term demand is dependable and growing?

 

Isn't their asset a real one and aren't they levered a very high amount against that asset?

 

Would rising demand long term bring about pricing power to help them increase revenue at least in line with inflation?

 

Would a high interest/inflation environment make it tricky for competition to find the money to lay new fiber?

 

Or perhaps I'm ignoring a core reason why inflation would serve to hurt them instead?  Thoughts?

 

 

If they have pricing power then inflation may help them up until the point it is time for them to refinance their debt. Then inflation will kill them. Inflation of course is good for high debt companies (with appreciable assets) over the near term as their assets grow in value (while their liabilities in the form of debt stay fixed), yet it is terrible for high debt companies when it comes time to roll over that debt. I think many forget to factor in refinance rates in high inflationary environments.

 

One of the nuances I'm thinking of is that they already pay extremely high rates on their debt, much higher than average corporate debt costs -- my preliminary thinking is that this is partly based upon a thin margin between their total debt levels and what their assets would conservatively sell for at auction.  Inflation widens that gap between liquidation and total debt.  So if interest rates on corporate debt were to rise 700 bps, theirs might not rise as much.  Or maybe their debt would go up just as much -- perhaps what's recoverable at liquidation matters less to investors than I suspect.  Or maybe inflation would cause the opposite effect -- put such a squeeze on what corporations could afford to pay that instead of getting increasingly more money for sale of assets at auction, the bidders would simply be getting an increasingly terrific deal in real terms?

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Guest ValueCarl

I understand. There are people who claimed Crowe's commentaries to be SILLYECONOMICS instead.  ;D

 

OTOH, I can see how it could work out very favorably considering internet demand, and the untapped market share that they continue to be unable to tap. Seems like a great selling machine should be able to tap into a huge yet to be addressed communications market.

 

Because of your fine work on XoHO NOL subject matter previously, I would humbly ask you to offer your opinion on this FFH "write down" subject in my earlier inquiry. tia

 

 

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"Other than temporary impairments – At each reporting date, and more frequently when conditions warrant, management evaluates all available for sale securities with unrealized losses to determine whether those unrealized

losses are other than temporary and should be recognized in net earnings (loss) rather than accumulated other comprehensive income (loss). This determination is based on consideration of several factors including: (i) the length of time and extent to which the fair value has been less than its amortized cost; (ii) the severity of the impairment; (iii) the cause of the impairment and the financial condition and near-term prospects of the issuer; and (iv) the company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of fair value. If management’s assessment indicates that the impairment in value is other than temporary, or the company does not have the intent or ability to hold the security until its fair value recovers, the security is written down to its fair value at the balance sheet date, and a loss is recognized in net gains (losses) on investments in the consolidated statement of earnings. For debt instruments classified as available for sale, subsequent reversals of impairment losses are required when, in a subsequent reporting period, the fair value of the instrument increases and the increase can be objectively related to an event occurring after the loss was recognized."

 

I have not worked with auditors, but I guess that whenever they see a security that is 50% or more below cost and that has been for a certain period of time, that they will question management about it. They don't study the specific securities so to them, a double or triple does not exist. If something is materially below cost, then to them it is likely to end up being a realized loss at some point in the future.

 

So, management teams are forced to show this loss through the income statement which has the effect of reducing earnings. I guess it is a way to ensure that GAAP earnings are more reflective of what is truly going on. If not, earnings over time could be inflated since these losses are not realized and not flowing through the income statement. They would only appear within comprehensive income and book value. Somebody must have cheated in the past showing great profits and hiding unrealized losses, especially when securities were carried at cost on the balance sheet. So they came out with this accounting rule.

 

Cardboard 

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Guest ValueCarl

Thank you, Cardboard.

 

Once again, investors making buying, selling or passing decisions subject to any perceived Elephants in the room, most always, will subject themselves to "grave danger." Did you say "GRAVE DANGER"? Yes I did, because in this case, there is no other kind!

 

One example of a larger elephant stampeding in the room eight years ago while giving false signals tied to this security, was none other than, Walter Scott's close friend, Warren Buffett.  >:( 

 

He was a buyer during that period of common toilet paper, versus someone "writing down assets" like those friendly Fairfax people.     

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I understand. There are people who claimed Crowe's commentaries to be SILLYECONOMICS instead.  ;D

 

OTOH, I can see how it could work out very favorably considering internet demand, and the untapped market share that they continue to be unable to tap. Seems like a great selling machine should be able to tap into a huge yet to be addressed communications market.

 

Because of your fine work on XoHO NOL subject matter previously, I would humbly ask you to offer your opinion on this FFH "write down" subject in my earlier inquiry. tia

 

 

 

What Cardboard said.  :D

 

I haven't looked at the Q yet to know exactly what you are referring to, but seems you are saying they wrote down LVLT. This would be just an adjustment of carrying value to fair value. Given their ownership %, I believe LVLT was an equity method accounting item, and not available-for-sale. So this wouldn't be an adjustment from comprehensive income to net income. It was a write down of the carrying value listed on the balance sheet. As for the timing. I don't know. Perhaps the auditors tested it and upon a fall in share price decided impairment was necessary. Though i thought this would have been done at the end of the year. Perhaps the timing is for tax purposes. Can't tell ya for sure.

 

 

Edit: just checked FFH's ownership level of LVLT... Looks like it is an available for sale security (not equity method as i noted above), and this is just shifting from other comprehensive income to the income statement.

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  • 4 weeks later...
Guest longinvestor

Longinvestor, that is a most interesting fact that you have shared. Thank you as well.

 

You see, it's hard for me to believe people with $2 common stock cost basis' go about happily "trusting management teams" which they're writing down to SEVENTY CENTS!  :o

 

Here is an audio clip of Mason Hawkins/Stanley Cates commenting on their buying spree of LVLT. Talks about tax sheltering etc.

 

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Thanks for the clip Longinvestor.

 

FYI, Cisco just came out with their bandwitdh usage prediction up to 2014 this morning.

 

http://finance.yahoo.com/news/Annual-Cisco-Visual-iw-2003617535.html?x=0&.v=1

 

For the U.S., it should grow from 4.6 exabytes/month in 2009 to 17.1 exabytes/month in 2014. It is true that Cisco has a massive interest in the continued growth of IP, but I still think that this is data we can trust considering their size, reputation and previous forecasts accuracy.

 

IMO, Level 3 should get a piece of this action. If their revenues were to double over that period, which seems quite conservative based on the data above and the fact that pricing is stable, free cash flow and earnings will simply explode considering a net EBITDA-CAPEX margin of 50% on new revenues. I get an easy $7 share price target under this assumption.

 

Q1 was disappointing, however I still believe that we are very close to an inflection point on profitability or sometime in the next 12 months, so I agree with Southeastern on the 2010-2011 time frame.

 

Cardboard

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