Fitch Affirms Level 3 Communications' IDR at 'B+' following TW Telecom Acquisition

CHICAGO--()--Fitch Ratings has affirmed the 'B+' Issuer Default Rating (IDR) assigned to Level 3 Communications, Inc. (LVLT) and its wholly owned subsidiary Level 3 Financing, Inc. (Level 3 Financing). In addition, Fitch has affirmed the specific issue ratings assigned to LVLT and Level 3 Financing as outlined at the end of this release. The Rating Outlook remains Stable. Approximately $8.4 billion of LVLT's consolidated debt as of March 31, 2014 is affected by Fitch's actions.

Fitch's action follows LVLT's announcement that it has agreed to acquire TW Telecom, Inc. (TWTC) in a cash and stock transaction valued at approximately $5.7 billion. LVLT generates approximately $7.9 billion of pro forma LTM revenue as of March 31, 2014 and approximately $2.2 billion of EBITDA before consideration of operating cost synergies. The transaction increases LVLT's scale and focus on high margin enterprise account revenues while increasing the company's overall competitive position and ability to capture incremental market share. The transaction is subject to customary regulatory approvals including the FCC and other U.S. and state regulatory agencies. LVLT anticipates the transaction will close by year-end 2014.

KEY RATING DRIVERS

--The acquisition is clearly in line with LVLT's strategy to shift its revenue and customer focus to become a predominantly enterprise-focused entity.

--LVLT remains committed to operate within its 3x to 5x net leverage target. The enhanced scale and ability to generate meaningful free cash flow (FCF) resulting from the transaction reinforces Fitch's expectation for further strengthening of LVLT's credit profile.

--The company is poised to generate sustainable levels of FCF (defined as cash flow from operations less capital expenditures and dividends). Fitch anticipates LVLT FCF generation during 2014 will approximate 4% of consolidated revenues, growing to 7.5% of revenues by year-end 2016 on a pro forma basis.

--The operating leverage inherent within LVLT's business model positions the company to expand both gross and EBITDA margins.

The transaction is in line with LVLT's strategy to shift its revenue and customer focus to become a predominately enterprise-focused entity. TWTC's strong metropolitan network supports LVLT's overall strategy. Pro forma for the transaction LVLT's revenue from enterprise customers increases to 70% of total CNS revenue from 66%. From a regional perspective North America CNS revenue would increase to 78% of total CNS revenue, up from approximately 72%.

LVLT's network capabilities, in particular its strong metropolitan network, along with a broad product and service portfolio emphasizing IP based infrastructure and managed services provide the company a solid base to grow its enterprise segment revenues. Fitch believes that revenue growth prospects within LVLT's CNS segment stand to benefit from the transition among enterprise customers from legacy time division multiplexing (TDM) communications infrastructure to Ethernet or IP VPN infrastructure based in internet protocol.

From a network standpoint the transaction combines a highly complementary footprint and will increase LVLT's scale of metro networks and broaden its overall product and service portfolio. The TWTC acquisition solidifies LVLT's metropolitan network position with the addition of 24,300 fiber route miles to LVLT's network. The transaction will create minimal network and customer overlap. LVLT indicates that there is less than a 10% overlap with TWTC's 21,000 on-net buildings providing LVLT with approximately 35,000 unique locations globally.

The investment in metropolitan facilities (which extend its on-network footprint and overall network depth) provides the company the foundation to derive strong operating leverage from its cost structure and network, enabling it to grow operating margins. Additionally, the company's improving revenue mix can further strengthen its operating leverage and contribute to higher gross and EBITDA margins.

Consolidated leverage on a pro forma basis is 5.1x before consideration of any operating cost synergies versus 4.95x as of the LTM period ended March 31, 2014. Pro forma leverage declines to 4.7x after factoring in $200 million of anticipated operating cost synergies. Fitch continues to expect LVLT's credit profile to strengthen as the company benefits from anticipated EBITDA growth, FCF generation and cost synergies related to the TWTC acquisition. Fitch foresees LVLT leverage will further improve to 4.7x by the end of 2014 and to under 4x by year-end 2015.

Based on the company's ability to realize cost synergies in past acquisitions, Fitch has a high degree of confidence the company will successfully realize the TWTC cost synergies. LVLT expects $200 million of annualized operating synergies and an additional $40 million of capital expenditure synergies. Similar to LVLT's Global Crossing acquisition, operating synergies will be realized as the company migrates traffic over to the LVLT network and utilize the combined network to reduce third-party access costs.

Network expense reductions represent approximately 55% of the anticipated operating cost synergies. The remaining 45% of operating cost synergies will be derived from a combination of head-count and no-head count expenses. Non-head count expense synergies will be driven by the elimination of duplicate corporate costs. LVLT expects to capture 70% of the run-rate operating cost synergies within 18 months of closing. The company anticipates it will spend $170 million in integration costs, of which 60% are operating expense related and 40% are capital expense related.

Fitch believes the company's ability to grow high-margin CNS revenues coupled with the strong operating leverage inherent in its operating profile positions the company to generate consistent levels of FCF. The TWTC acquisition improves LVLT's ability to generate consistent levels of FCF. Fitch anticipates LVLT FCF generation during 2014 will approximate 4% of consolidated revenues growing to 7.5% of revenues by year-end 2016.

Fitch believes that LVLT's liquidity position is adequate given the rating, and that overall financial flexibility is enhanced with positive FCF generation. The company's liquidity position is primarily supported by cash carried on its balance sheet, which as of March 31, 2014 totaled approximately $607 million, and expected FCF generation. LVLT does not maintain a revolver, which limits its financial flexibility in Fitch's opinion. LVLT does not have any significant maturities scheduled during the remainder of 2014. LVLT's next scheduled maturity is not until 2015 when approximately $475 million of debt is scheduled to mature or convert into equity.

RATING SENSITIVITIES

What Could Trigger a Positive Rating Action:

--Consolidated leverage maintained at 4x or lower;

--Consistent generation of positive FCF, with FCF-to-adjusted debt of 5% or greater;

--Positive operating momentum characterized by consistent core network services revenue growth and gross margin expansion.

What Could Trigger a Negative Rating Action:

--Weakening of LVLT's operating profile, as signaled by deteriorating margins and revenue erosion brought on by difficult economic conditions or competitive pressure;

--Discretionary management decisions including but not limited to execution of merger and acquisition activity that increases leverage beyond 5.5x in the absence of a credible de-leveraging plan.

Fitch affirmed the following ratings with a Stable Outlook:

LVLT

--IDR at 'B+';

--Senior unsecured notes at 'B/RR5'.

Level 3 Financing, Inc.

--IDR at 'B+';

--Senior secured term loan at 'BB+/RR1';

--Senior unsecured notes at 'BB/RR2'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835214

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Contacts

Fitch Ratings
Primary Analyst
David Peterson
Senior Director
+1-312-368-3177
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bill Densmore
Senior Director
+1-312-368-3125
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
David Peterson
Senior Director
+1-312-368-3177
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bill Densmore
Senior Director
+1-312-368-3125
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com