Level 3's Slip Points to the Turmoil in Telecom
Scott Moritz
09/23/03 - 07:08 AM EDT
The bug that laid low
Level 3 (LVLT Quote) on Monday is about to take a bite out of the rest of the telecom industry.
After a brief period of stability, wholesale phone capacity prices once again appear to be in free fall. Here's why: A stampede into what was one of telecom's few remaining high-margin businesses has reignited a damaging price war.
It wasn't supposed to be like this. After a three-year plunge in business communications spending resulted in a raft of bankruptcy filings, the industry was finally beginning to breathe easier, its bloodiest battles behind it.
But Level 3's
warning on Monday indicates that the plunge continues -- an observation that has some investors worrying again about the creaky foundations beneath the telecom business. On Monday, Level 3 slipped 2 cents, to $4.76.
Disaster Calls
Blaming a weak industry, the Broomfield, Colo., telco
cut third-quarter sales projections by 5% Monday while slashing its network spending budget by 14% to $60 million. Level 3 executives didn't need to wait eight more days to confirm what some observers say has been a disastrous quarter in the wholesale phone market.
With its adaptive business plan (most of its revenue now comes from software sales), its seemingly inexhaustible sources of financing, and its vast and technologically advanced network, Level 3 should have risen victoriously from the phone market plunge.
But Level 3's big problem is coming on two fronts: Wholesale rivals are back from the brink, and so-called service integrators have entered its turf. It seems some failed foes have returned with a vengeance: Restructured outfits such as
WilTel (WTEL Quote) and
ICG have emerged from bankruptcy, wielding a sharp knife on capacity prices. Not to be outdone,
AT&T (T Quote),
Qwest (Q Quote) and
Sprint (FON Quote) have been willing to take lower terms to keep customers.
A big contribution to the new wholesale price war, say analysts, is the influx of integrators such as
IBM (IBM Quote),
EDS (EDS Quote) and
Accenture (ACN Quote). These outsourcing firms bargain for the cheapest available wholesale phone rates as they cobble together complete communications plans for their business clients.
The encroachment of service integrators not only adds fuel to the price wars, it threatens to take the prized business network management duties from the big players like AT&T and
MCI. As more communications services go the way of low-priced commodities, one of the remaining areas of big profits is helping companies manage their communications needs. It's no longer an exclusive club, and some investors expect the managed-services contracts to follow phone and data services down the price slope.
Down Days for Dial-Up
Level 3's problems don't end there. Most of the company's telecom revenue comes from so-called managed modem or dial-up services for big customers such as
AOL(AOL Quote). Ironically, however, broadband services such as cable modems and digital subscriber lines have spelled the end of narrowband.
Even Level 3's software business, the thin-profit cash cow that helped the company stay in good graces with its bankers' revenue covenants, has been in decline. It didn't help that
Microsoft (MSFT Quote) changed some of its licensing arrangements. The software giant now bills and collects some of its software payments through licensing programs and Level 3 is given a fee. Previously, Level 3 could book the entire sale as revenue.
Level 3 said Monday that software sales would come in about 7% below previous third-quarter guidance.
And though the company burned through $227 million of its cash supply last quarter, it still has about $915 million on hand. Level 3 says it plans to raise $500 million through sale of a senior note.
Earlier this year, to raise cash, the company sold its Orange County, Calif., toll road business for $46 million, and it recently sold the former Genuity headquarters for $20 million. Last year, Level 3 sold 90% of its stake in Commonwealth Telephone for $325 million.
With rivals slashing prices and Level 3 running out of assets to sell, the financing question will loom ever larger in coming months.
