On the Level: Level 3 Is Fully Funded. Right

Sometimes you just have to smile.

Take, for instance, tonight's King of Comedy, Level 3 Communications(LVLT Quote - Cramer on LVLT - Stock Picks), perhaps the most aggressive of the big, money-losing telecommunications service providers floating on a sea of debt.

Last year, the company lost $1.5 billion after taxes. There are questions about its long-term financial health. And through it all, Level 3's management continues to reassure investors that the company is "fully funded" to get to break-even. Investors in this beaten-up stock naturally find such assurances soothing.

They shouldn't.

Late last month, Level 3 filed to sell $3 billion in new debt securities -- preferred and common stock to finance working capital and capital expenditures. Companies that are fully funded do not typically serve notice that they may need to borrow another $3 billion to pay bills and make the investments required to stay in business.

Level 3 matters to investors for a number of reasons. First, because it represents the entire New Era telco sector, which has seen more speculative money thrown at it than any other high-tech sector in the past five years. And that is saying something. If Level 3 runs into financial trouble, you can bet a lot of other telco services companies will, too. And second, if a slow-motion liquidity crisis hits the sector, it will not be good news for related industries such as telecom equipment, semiconductor manufacturers and contract manufacturers. As bad as the news has been for these industries already, if telecom continues to roll over, the news could get worse. (That's for all you folks looking for the bottom in tech.)

Level 3 is also worth paying attention to because there is a staggering amount of money at risk. Here are a few relevant numbers: The company's market capitalization is about $10 billion. It carries $7.3 billion in debt. It has about $4 billion in cash that it plans to spend real soon. By year-end, cumulative capital expenditures will reach $13 billion to $14 billion, which is a lot of money for a company that went public only in 1998. By 2010, cumulative cap ex is expected to top $40 billion. Global networks don't come cheap, you know.

You might reasonably ask, will Level 3 even get to 2003 -- let alone 2010? The answer may hinge on whether the company is as fully funded as it claims to be.

Last November, this column raised questions about Level 3's claims to be fully funded. Company management was not pleased.

Robin Miller, Level 3's vice president for investor relations, wrote in: "The fact is that Level 3 is one of the few emerging communications companies to be fully funded. Level 3 is fully funded through free cash flow break-even, at which point we are obviously self-funding."

Seeking Its Own Level -- Lower Level 3 is well off its highs

Source: BigCharts.com

Well, on Jan. 18 of this year, "fully funded" Level 3 filed its $3 billion shelf offering. The stock lost $1.70 a share that day to close at $45.30. Today, it closed at $26.56.

Today, we tried to reach Miller by phone to ask why a fully funded company like Level 3 would file a $3 billion shelf offering. She was unavailable, but Level 3's director of media relations, Paul Lonnegren, was. He said that the $3 billion filing "doesn't necessarily mean that the company has any intentions or plans to raise the money. ... It doesn't mean that we are going to go back to the market for more cash. ... We are confident we can get to cash-flow break-even without having to get more money from the market. We project cash flow break-even by 2004. ... We did not file to raise more money in case we are not fully funded. It was in case the markets bounce back positively enough to make the cost of money attractive. Of course, there are no signs of that happening."

No, there isn't any sign of the financial markets opening up for the likes of Level 3 anytime soon. There was a brief moment in January when the junk bond market eased a bit for high-risk borrowers. That was when Level 3 filed. But today, if Level 3 wanted to raise money in the debt market, it would have to pay north of 15% -- if it could get the money at all.

The idea that Level 3 can ease its debt payment problems by borrowing another $3 billion at 15% to 20% is laughable. Such new debt would be more expensive than existing debt. And according to the January registration statement, the company already had "deficiencies of earnings to fixed charges of $997 million for the nine months ended September 30, 2000." If Level 3 adds more debt, its debt-service costs simply go up that much more.

Lehman Brothers' convertible debt analyst Ravi Suria wrote in a report last year that "a company [is] fully-funded only if it has enough cash to last it to a point when it becomes capable of paying at least the ... fixed charges from internally generated operating cash flow or EBITDA." By this measure, Level 3 is not fully funded. If the company were, it would not have filed to borrow another $3 billion to fund operating expenses and the buildout of its network.

Level 3 management can say anything it wants about the company being fully funded. Investors should make up their own minds.