RealTime IT News

Trouble Ahead For Level 3

Level 3 has some tricky financial water to tread in the coming months, but a recent asset sell off and continued analyst confidence could be enough to stave off potential disaster.

Goldman, Sachs & Co. issued a warning Monday to its clientele that four of the carrier's top 10 customers are unlikely to keep up with contractual obligations as executives from those companies worry about their own financial troubles.

One of those companies that stand out is Enron , which analysts figure owes Level 3 around $7 million in the fourth quarter of 2001. Enron, a Texas-based energy company that recently filed for bankruptcy protection, got walloped in the press for it's shady accounting sleight-of-hand and Congress is mulling whether to bring executives in for hearings.

Another of its key customers is McLeodUSA, Inc. , once a rising star in the competitive local exchange carrier (CLEC) industry with more than 20 states in its coverage area and a massive fiber and wireless network buildup, is also in financial straits.

The "super-CLEC" (a moniker for a regional telephone company with national aspirations) recently threatened bankruptcy to bondholders clear its substantial debt.

On Dec. 7, McLeod was forced to sell its wholesales dial up access assets to Level 3 to help pay off its debts. The $55 million move was bad news for the independent phone company, a sign it is ramping back operations to its core analog telephone services; McLeod's fiber and wireless expansion are essentially dead in the water.

The acquisition is a mixed blessing for Level 3. While the wholesale business will bring in recurring revenues for the carrier, the company is now spreading its operations from just providing the fiber to providing services for the people who need Internet access -- markedly different operational mindsets are needed to make both successful.

Enron and McLeod only make up a portion of Level 3's business, but is part of a growing number of companies that are showing signs going away and leaving Level 3 to find their own financial solution.

Already, 40 percent of Level 3 revenues are tied into these failing companies, which include Enron, McLeod and SurfEU, a leading European Internet access unit. Last quarter, Level 3 was forced to write off $80 million in accounts receivable (almost one-quarter of its expected 2001 communications revenues), and analysts expect that loss to grow in the fourth quarter.

Goldman Sachs remains confident Level 3 can maintain its fourth quarter numbers, but is worried that continued write offs could hurt the company in 2002 despite a $650 million credit cushion and contracts with "blue chip" clients.

"The implication is that while we believe Level 3 has the cash to make it to break-even (for Q4 2001), the size of its funding cushion is highly dependent on the health of its customer base, creating yet more uncertainty and possibly negative news flow," its report to credits notes. "It will be a great challenge to grow its blue chip customer base faster than the rate of erosion of its 'troubled' customer base in a depressed demand environment."

Level 3 has taken steps to ensure its business remains viable into the New Year with deals that will reduce its worldwide clout in the short term but hopefully keep it afloat in the long run.

A Nov. 27 deal with ISP mega-giant AOL Time Warner ties the two companies closer, with added broadband pipe for AOL customers and leased collocation space in several cities throughout Europe for AOL's continued European expansion.

The carrier's decision to sell some of its assets to a rival means the end of Level 3's presence in the ever-growing Asian market but will shore up its bottom line for 2002. The short-term loss (a $500 million write off in the fourth quarter) will save the company $300 million in future funding requirements and the expenses needed to keep operations going in the Far East market.

Level 3 officials were unavailable for comment at press time.