CHICAGO--(BUSINESS WIRE)--Fitch Ratings expects to assign a 'B/RR5' issue rating to Level 3 Communications, Inc.'s (LVLT) proposed issuance of senior unsecured notes due 2022. The notes will rank pari passu with LVLT's existing senior unsecured indebtedness.
In addition Fitch has assigned a 'BB/RR2' issue rating to Level 3 Financing, Inc.'s (Level 3 Financing) 5.375% senior notes due 2022. Level 3 Financing is a wholly owned subsidiary of LVLT. The Issuer Default Rating (IDR) for both LVLT and Level 3 Financing is 'B+' with a Positive Rating Outlook. LVLT had approximately $9.4 billion of consolidated debt outstanding on Sept. 30, 2014.
Proceeds from the senior note offering are expected to be used to redeem the entire principal amount outstanding under LVLT's 11.75% senior notes due 2019. The notes had approximately $605.2 million of principal outstanding as of Sept. 30, 2014. Outside of the extension of the company's maturity profile and an expected reduction of interest expense related to this transaction, LVLT's credit profile has not substantially changed.
LVLT closed on its previously announced acquisition of TW Telecom, Inc. (TWTC) in a cash and stock transaction valued at approximately $5.7 billion on Oct. 31, 2014. As a result of the acquisition tw telecom, llc became a wholly owned subsidiary of LVLT. Level 3 Financing assumed the obligations under the 5.375% senior notes due 2022 that were originally issued by Level 3 Escrow II, Inc. on Aug. 12, 2014. Additionally both LVLT and Level 3 Communications, LLC have guaranteed the 5.375% senior notes on a senior unsecured basis. Pro forma for the TWTC acquisition including the redemption of approximately $1.8 billion of TWTC outstanding consolidated debt and the incurrence by Level 3 Financing of its $2 billion Tranche B 2022 Term, Fitch estimates LVLT has approximately $11.5 billion of debt outstanding as of Sept. 30, 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 4.5x as of the LTM ended Sept. 30, 2014 on a stand-alone basis (excluding the effect of acquisition financing) and 5.1x on an actual basis. 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 5.0x 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 $354 million of FCF through the LTM ended Sept. 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 Sept. 30, 2014 totaled approximately $729 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=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=925815
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