Judging by the past two days' rally in

Level 3

(LVLT)

, many investors like the company's acquisition of software reseller CorpSoft.

But not all, apparently. Some investors say the deal, which is notable primarily for keeping Level 3 in compliance with debt covenants, illustrates the perils of aligning managers' interests closely with shareholders'. While conventional wisdom says shareholding managers are a force for good, some observers say deals like Level 3's actually run counter to the long-term interest of the company -- and of the creditors who stand to own much of the company should it be forced to restructure its $5 billion debt, as many investors expect.

Sharpening the focus on Level 3 are the heavy shareholdings of CEO James Crowe, who by coincidence has also been a heavy seller of Level 3 stock in the past. Heavy selling by insiders, of course, has been closely scrutinized by scandalized investors ever since

Enron

rolled over. Level 3, whose shares are up 29% this week but down 85% from a year ago, hadn't returned a call seeking comment by Tuesday evening.

Blowing It?

At issue is whether debt-heavy Level 3 should join many of its peers and restructure its balance sheet now, while it still has the customers, talent and assets necessary to continue offering service. The alternative strategy for the cash-burning, loss-generating broadband provider is to essentially buy revenue until it can generate enough sales of its own to turn the corner. Few observers think Level 3 has much of a shot at turning that corner, though Legg Mason stock guru Bill Miller is

putting a big bet on the telco's chances.

"It's pretty clear now that every dollar

Crowe puts into the ground will get pennies on the dollar when these assets go back up for sale," says Paul O'Neil, an analyst with Canadian fund shop Knight Bain Seath & Holbrook, which doesn't own any Level 3 stock or bonds. "The creditors are watching him blow their money."

As an equity analyst, O'Neil rarely ventures onto the bondholders' side of the aisle. But he says he's fed up with stock-obsessed CEOs favoring shareholders at the expense of creditors.

"If he were acting in the best interest of all investors in the company, he'd say we need to restructure," says O'Neil. "But the more he's using the bondholders' money, the more he's favoring his own position."

Crowe has sold more than 4 million shares for about $70 million in the past two years, according to Yahoo! Finance and Baseline. He still holds about 6 million shares.

Round and Round

Call it the aftermath of a massive nationwide fiber-optic network construction project, but like rivals

Williams Communications

(WCG) - Get Report

and

Global Crossing

( GBLXQ), Level 3 is simply swimming in debt as it tries to patch together a business plan that has impressed few in the market.

The company has a $1.8 billion credit facility from a syndicate of bankers headed by J.P. Morgan Chase; $650 million of that loan is still available as long as the company reports $2.3 billion in sales this year. J.P. Morgan Chase declined to comment.

That's where CorpSoft comes in. Level 3 agreed to buy the obscure, closely held software reseller Monday for $89 million in cash and $50 million in assumed debt. CorpSoft had revenue of $1.1 billion last year, meaning that Level 3 paid roughly 8 cents for every dollar of CorpSoft revenue.

To O'Neil, the CorpSoft deal resembles nothing so much as a bond buyback Level 3 undertook last year. The company spent $721 million in the junk-bond market, retiring some $1.7 billion in outstanding debt. Some observers said that move was a foolhardy waste of cash, considering that the company remains addled with annual interest expense of $450 million. And creditors, it must be noted, hate to see borrowed cash used to pay off loans.

Corporate governance expert Ira Milstein, an attorney at Weil Gotshal & Manges in New York, says there's a point in a company's struggles when the interests should tip in favor of creditors over shareholders.

"If you are getting close to insolvency and you are aware that you may have some serious financial problems, you then have a duty that shifts from looking out for shareholders almost exclusively to looking out for your debt holders, at least at the same level or higher," says Milstein, who isn't counsel to Level 3 or any of its investors.

"Shareholders are going to get massively diluted as the company's stock goes to zero," says O'Neil. "We aren't debating this -- the question is how much bondholder wealth is he willing to destroy."