| Level 3 Floating On a Sea Of Debt
Level 3 Money Loss Expands
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Level 3 Communications (LVLT:Nasdaq - news), 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."
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.
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