Fitch Rates Level 3 Financing's Senior Notes 'BB/RR2'; Outlook Remains Positive

CHICAGO--()--Fitch Ratings has assigned a 'BB/RR2' issue rating to Level 3 Financing, Inc.'s (Level 3 Financing) proposed issuance of senior unsecured notes due 2023 and 2025. 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 $11.3 billion of consolidated debt outstanding on Dec. 31, 2014.

Proceeds from the senior note offering along with cash on hand are expected to be used to redeem the entire principal amount outstanding under Level 3 Financing's 8.125% senior notes due 2019. The notes had approximately $1.2 billion of principal outstanding as of Dec. 31, 2014. The new notes will rank pari passu with Level 3 Financing's existing senior unsecured indebtedness. 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.

KEY RATING DRIVERS

--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 TW Telecom, Inc. (TWTC) acquisition reinforces Fitch's expectation for further strengthening of LVLT's credit profile.

--The 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.

--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 will grow 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.

Consolidated leverage, pro forma for the TWTC acquisition is 4.7x before consideration of any operating cost synergies and declines to 4.3x after factoring in $200 million of anticipated operating cost synergies. LVLT leverage increased to 6.0x on an actual basis as of Dec. 31, 2014 as a result of the effect of acquisition financing. 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.

The TWTC acquisition improves LVLT's ability to generate consistent levels of FCF. Fitch anticipates LVLT FCF generation will grow to nearly 10% by year-end 2016 on a pro forma basis. The company has generated approximately $251 million of FCF through the LTM ended Dec. 31, 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 71% of total CNS revenue from 68%. From a regional perspective North America CNS revenue would increase to 79% of total CNS revenue, up from approximately 73%.

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 Dec. 31, 2014 totaled approximately $517 million, and expected FCF generation. LVLT does not maintain a revolver, which limits its financial flexibility in Fitch's opinion. LVLT's maturity profile is manageable within the context of free cash flow generation expectations and access to capital markets. As expected, LVLT converted approximately $333 million outstanding principal remaining on its 7% convertible senior notes due 2015 into approximately 12 million shares of LVLT common stock. The company does not have material scheduled maturities during the remainder of 2015 and, the next scheduled maturity is not until 2018 when approximately $300 million of debt is scheduled to mature.

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=982923

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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:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

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:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com