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A TechLine Primer
The tw telecom-Level 3 merger:
Love and marriage on the grid

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wo of Colorado’s largest tech companies — Level 3 and tw telecom — last week agreed to merge, creating one of the nation’s largest telecommunications enterprises. The deal calls for Level 3 to acquire tw telecom for about $5.7 billion in cash and stock. The combined company will have a value of $25 billion and encompass nearly 14,000 employees.

The marriage of the two telecom titans captured a lot of headlines, both locally and nationally. But what does it really mean to all the stakeholders — the employees, the investors, the management, the customers and the telecom industry as a whole?

While the dust will surely continue to settle in the weeks and months ahead, we’ve put together this FAQ to answer some of the more immediate questions and provide a primer on one of Colorado’s biggest enterprise weddings.

Who is Level 3?

Level 3, based in Broomfield, is one of the world’s largest providers of back-end Internet services. It operates and leases out fiber optic communications networks to telecom carriers for voice and data communication and connects more than 60 countries in North America, Latin America, Europe and a portion of the Asia/Pacific region.

The company is the second largest provider of fiber optic Internet access in the U.S. Its network is used by some of the nation’s biggest Internet enterprises, including Google and Netflix.

Level 3 began as a spinoff of Kiewit Corporation, a large construction company. Its name was changed to Level 3 in 1998, when the company went public. Since then, it has grown steadily through a series of acquisitions, including the purchase of network provider Global Crossing for $1.9 billion in 2011. The company is listed on the NASDAQ stock exchange with the symbol LVLT.

Despite spending more than $25 billion in the last 15 years to buy up competitors, Level 3 has posted annual losses every year since 1999. The losses have narrowed in recent years, however, and the company reported a profit of $112 million for the first three months of 2014. Level 3 reported total revenue of $6.313 billion for 2013, compared to $6.376 billion for 2012.

The company employs 10,200 people worldwide, including 2,700 in Colorado.

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Who is tw telecom?

tw telecom, headquartered in Lone Tree, is the third-largest business Ethernet provider in the U.S. It provides managed voice services, Internet and data network services, Internet access, and local and long distance voice services to corporate and government customers in 75 U.S. metropolitan markets throughout the country. It operates more than 30,000 miles of fiber-optic lines connecting to 20,255 buildings.

The company was created in 1993 as Time Warner Communications, a joint venture of U.S. West and Time Warner, Inc. In 1998, it was spun off as a separate entity called Time Warner Telecom and went public the following year. The company was renamed tw telecom in 2008. It is listed on the NASDAQ stock exchange with the symbol TWTC.

Last year, the company reported a profit of $36.5 million on $1.6 billion in revenue.

tw telecom employs nearly 3,400 people, including 1,300 in Colorado.

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Why are they merging?

Size matters in the telecommunications industry. The big players are getting bigger. Just this year, Comcast agreed to buy Time Warner Cable, AT&T is attempting to take over DirecTV, and Sprint and T-Mobile USA are talking about a merger. To compete effectively, companies like Level 3 and tw telecom need to scale up.

Level 3 CEO Jeff Storey

Level 3 CEO Jeff Storey

Level 3 and tw telecom compete with telecom giants like CenturyLink, AT&T and Verizon. With adversaries that size, you need all the friends you can round up in the schoolyard.

While both companies are major Internet network operators, analysts agree they incur minimal overlap of business objectives. The strengths of both enterprises are a natural fit.

Because tw telecom provides phone and data service primarily to business customers, Level 3 expects to gain a greater share of corporate and government customers. Buying tw telecom will give Level 3 direct access to large- and medium-sized businesses. It will also give Level 3 more network capacity in cities with the heaviest traffic and give it more control over pricing.

According to Level 3 CEO Jeff Storey, “We have less than 10 percent overlap with the tw telecom's nearly 21,000 buildings, giving us 35,000 unique locations globally."

In addition, direct access to a larger share of on-net buildings will allow the combined company to cut costs by reducing its reliance on third-party service providers.

In a conference call following the purchase announcement, Storey told analysts, "We know our primary competitors are very large companies, whether they're incumbent telcos or cable companies. We believe that this combination gives us the scale to effectively compete."

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What are the terms of the deal?

The total cost of the deal to Level 3 is about $7.3 billion, which includes the assumption of $1.6 billion in tw telecom debt. tw telecom stockholders will receive $10 in cash and seven-tenths of a share of Level 3 stock for each tw telecom share owned. That amounts to about $40.86 a share, 12 percent above tw telecom’s closing price on June 13.

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How much will the new company be worth?

According to the number-crunchers, the combined company will have a value of $25 billion. The combined company would have had $114 million in net income and $7.9 billion in revenue for the 12 months ended March 31, 2014. The new company will have about $11.5 billion in debt and $431 million in cash.

Future prospects, of course, are uncertain.

The companies are estimating the deal will create $240 million in annual savings, including $40 million from capital expenses. That will help.

But the merger notwithstanding, Level 3 and tw telecom together only hold about 6 percent of the fixed corporate communications market in the U.S., according to International Data Corp., an industry research firm. AT&T and Verizon together own nearly half. And despite previous acquisitions, Level 3 has not made an annual profit since 1998. Last year, the company reported a loss of $109 million on $6.3 billion in revenue.

On the other hand, tw telecom has nine straight years of revenue growth from one quarter to the next, and the company started an ambitious local network expansion in 28 U.S. cities late last year.

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Is the deal final?

No, not yet. The transaction is subject to approval by shareholders of both companies as well as the FCC and state regulators. Level 3’s largest shareholder — STT Crossing Ltd. — has already agreed to vote its 23 percent stake in favor of the deal. If all goes according to plan, the deal is expected to close by the end of the year.

However, tw telecom has been rumored to be up for sale for some time; another bidder could emerge. Fluctuations in the prices of both stocks last week led some analysts to predict that Level 3 might be forced to raise the purchase price offer. The current offer is a 12 percent premium over the June 13 closing stock price.

Complicating matters, The Denver Post reported last week that Levi & Korsinsky, a law firm that files suits on behalf of shareholders, is investigating tw telecom's board "for possible breaches of fiduciary duty and other violations" in connection with the merger. The lawyers are asking whether the board "adequately shopped" tw telecom and whether Level 3 is paying a fair price for the company.

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How will customers be affected?

Most industry analysts agree that the merger will benefit customers of both companies.

tw telecom CEO Larissa Herda

tw telecom CEO Larissa Herda

In an interview with website FierceTelecom, analyst Michael Sapien of the Ovum consulting firm, says "wholesale customers will see more fiber available in many local markets, especially on the West Coast, where Level 3 was weak.”

According to Sapien, "Enterprise customers, including government, will see more local market support and availability with the additional overlay of metro fiber networks each owned."

tw telecom CEO Larissa Herda agrees.

"A lot of the customers that we sell to have wanted us to do more, which is why we have been doing more and we have been stretching," she says. "We don't have a global network and we have a lot of customers who would love us to sell them a global network, so I think from our sales people perspective, they are in a great position."

Other potential benefits:

  • Level 3's global customers will benefit from tw telecom's deep metropolitan footprint and buildings connected to the network, enabling a higher quality and more reliable on-net experience for customers doing business in North America.
  • tw telecom's customers will benefit from Level 3's extensive local-to-global footprint, with owned network and data centers in more than 60 countries and significant global undersea networks.
  • Existing and prospective customers of both companies will benefit from the combined product portfolio.

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What will happen to the employees?

Level 3 employs 10,200 people worldwide, including 2,700 in Colorado. tw telecom employs 3,400, including 1,300 in Colorado.

Level 3 officials say tw telecom will continue business as usual for the near future, but consolidation of the two operations appears inevitable. tw telecom corporate headquarters are located on Meadows Drive in Lone Tree. Level 3 is just 37 miles up the road on Eldorado Boulevard in Broomfield.

In addition, Level 3 says it expects to save about $240 million a year through the merger. Part of those savings will likely come from job cuts in a labor pool that shares the same geographical space. Following Level 3's purchase of Global Crossing in 2011, the company eliminated more than 1,000 positions over a two-year period.

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What about the executives?

Not to worry. According to The Denver Post, tw telecom's top five executives could receive cash-and-stock payouts valued at more than $88 million when the merger closes.

Andy Vuong, The Post’s intrepid tech correspondent, reported that Larissa Herda, tw telecom’s CEO since 1998, is scheduled to receive nearly $42 million in cash, accelerated stock awards and other benefits, according to the change-of-control terms in her employment contract. Herda plans to step down after the deal closes.

Should they not join Level 3, Vuong reports, other tw telecom executives stand to gain as well. The Post estimates the payouts as follows:

  • John Blount, president and chief operating officer, $21.2 million.
  • Mark Peters, chief financial officer, $16.2 million.
  • Jill Stuart, chief accounting officer, $5.7 million.
  • Tina Davis, general counsel, $3.5 million.

The cash payouts for each of the four executives range from $889,000 to $2.7 million, according to the newspaper, and the executives will not get the cash if they join the new combined company.

The Post's estimates are based on the announced purchase price of $40.86 per share.

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Is the merger a good deal for stockholders?

According to Alex Dumortier at Motley Fool, the venerable investor advice website, the Level 3 acquisition of tw telecom has the potential to be a winning ticket.

“[Level 3 CEO Jeff] Storey is looking at the right metric and the right goals,” says Dumortier. “Management can do nothing more beneficial for shareholders than maximizing long-term growth in free cash flow per share — so he's already off to a good start.”

Reducing debt levels and increasing free cash flow, he says, are a formula for long-term success. To do that, Storey is estimating annualized cost savings of $240 million resulting from the combined company. Those savings, argues Dumortier, are worth three and a half times the $4.52 per-share premium that Level 3 is paying to buy tw telecom, which looks like a pretty good deal for shareholders.

In addition, he points out that following an acquisition, it is not uncommon for the acquirer's shares to fall if the market believes the target company's shareholders are getting the better of the deal. While Level 3's stock fell 4 percent after the announcement, he believes the drop was not significant.

“According to the deal terms, I have Level 3 shareholders coming out of this deal quite nicely,” he says. “This doesn't look like a failed connection.”

He also notes that Level 3 has been a popular pick among investors in the past. Its stock has almost doubled in the last 12 months.

Larissa Herda, chairman and CEO of tw telecom, also thinks the deal is a winner.

"The transaction provides our stockholders with meaningful immediate cash value for their investment in tw telecom,” she says, “while enabling them to participate in the substantial upside potential of the combined company."

tw telecom stockholders will own approximately 29 percent of the combined company's outstanding shares when the deal is completed.

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