Fitch Rates Level 3 Financing Secured Credit Facility 'BB+/RR1'; Outlook Remains Positive

CHICAGO--()--Fitch Ratings has assigned a 'BB+/RR1' rating to Level 3 Financing, Inc.'s proposed senior secured term loan (Tranche B 2022 Term Loan) under its existing senior secured credit facility. Level 3 Financing is a wholly owned subsidiary of Level 3 Communications, Inc. (LVLT). The Issuer Default Rating (IDR) for both LVLT and Level 3 Financing is 'B+' with a Positive Rating Outlook. LVLT had approximately $8.4 billion of consolidated debt outstanding on June 30, 2014.

Proceeds generated from the Tranche B 2022 are expected to be used to fund the cash utilized to fund, in part, the cash consideration of LVLT's previously announced acquisition of TW Telecom, Inc. (TWTC). The terms of the Tranche B 2022, including the security and guaranty structure are expected to be substantially similar to the existing Tranche B-III 2019 term loan and the Tranche B 2020 term loan.

Overall, LVLT expects to issue $3 billion of debt, including Level 3 Escrow II, Inc.'s $1 billion issuance of 5.375% senior notes due 2022, which will be used to pay the cash consideration of the TWTC acquisition and repay outstanding TWTC indebtedness. Pro forma for the TWTC acquisition, Fitch estimates LVLT will have approximately $11.5 billion of debt. The transaction is subject to shareholder approval (vote scheduled for Oct. 28, 2014) and customary regulatory approvals including the FCC and other U.S. and state regulatory agencies. The U.S. Department of Justice previously approved LVLT's pending acquisition of TWTC on Sept. 8, 2014. LVLT anticipates the transaction will close by year-end 2014.

KEY RATING DRIVERS

--The TW Telecom, Inc. (TWTC) acquisition 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 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 free cash flow (FCF; defined as cash flow from operations less capital expenditures and dividends). Fitch anticipates LVLT FCF generation during 2014 will range between 4% and 4.5% of consolidated revenues on a stand-alone basis, growing to nearly 10% 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.

LVLT leverage strengthened to 4.7x as of the LTM ended June 30, 2014, reflecting a decrease from 5.2x as of year-end 2013 and 5.4x as of the LTM ended June 30, 2013. Fitch expects LVLT leverage on a stand-alone basis will approach 4.5x by the end of 2014. Fitch continues to expect LVLT's credit profile will strengthen as the company benefits from anticipated EBITDA growth, FCF generation and cost synergies related to the TWTC acquisition. Consolidated leverage on a pro forma basis is 5.1x before consideration of any operating cost synergies and declines to 4.7x after factoring in $200 million of anticipated operating cost synergies.

The TWTC acquisition improves LVLT's ability to generate consistent levels of FCF. Fitch anticipates LVLT FCF generation during 2014 will range between 4% and 4.5% of consolidated revenues on a stand-alone basis before growing to nearly 10% by year-end 2016 on a pro forma basis. The company has generated approximately $147 million of FCF through the LTM ended June 30, 2014. Fitch believes the company's ability to grow high-margin core network services (CNS) revenues coupled with the strong operating leverage inherent in its operating profile position the company to generate consistent levels of FCF.

The TWTC acquisition 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 71%.

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 on Internet protocol.

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 June 30, 2014 totaled approximately $637 million, and expected FCF generation. LVLT does not maintain a revolver, which limits its financial flexibility in Fitch's opinion. LVLT has no 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 Lead to 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 service revenue growth and gross margin expansion.

What Could Lead to 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.

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=715139

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=891054

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Contacts

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

Contacts

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