Light Reading are claiming that Level (3) are in talks to buy either XO (AS2828) or AboveNet (AS6461) (or both!). I previously commented about various mergers going on in the industry affecting the Internet. The story here seems to all about metro fiber, as with the other recent Level (3) acquisitions.
When last we left this story, Level (3) was hungry and was on a shopping spree. The gobbled up Wiltel (AS7911) and have since managed to bring them under AS3356 (the main Level (3) Autonomous System number) as a customer. This happened while I was at RIPE meeting in Istanbul. (As an aside: I had never been to a RIPE meeting before. They are extremely high signal-to-noise ratio with the most respectful audience I've seen at a technical conference in recent years. The combination of tech with policy is a winning one and something we will have to strive for at the NANOG conferences when they are jointly held with ARIN in October.)
After Wiltel, Level (3) bought ICG, Telcove, and Looking Glass recently. And all of them were about metro fiber; access to customers. It makes sense.
The wholesale Internet transit game is brutally competitive. There are a medium-sized handful of carriers, all competing in the same "lit" buildings (where fiber is turned on and ready to offer service) for the same smallish customer base. So instead of $500 or $800 or more per Mb/s, the going price ranges from under $10 to around $35 for purchases of reasonable volumes of bandwidth. Cogent (AS174) is the low-price leader in this market and they have been responsible for driving down prices throughout the industry, with an especially pronounced impact on pricing in Europe.
In order to upset this dynamic, a company like Level (3) has determined (correctly, I think) that they must have direct access to more customers. Buying a bunch of metro fiber companies in the US is one way to do that, and not a bad long-term strategy. It gets them out of the perpetual price-war and into a longer-term, more-services relationship with a larger number of customers.
The only thing obviously missing from this strategy is Asia and Europe. Internet use is growing fast in both (although faster in Asia, since Europe has a big head start). In order to compete in the long run, Level (3) will have to acquire metro fiber assets in Europe and some kind of plausible carrier presence of any kind at all in Asia. I think those will be interesting stories as the year plays out.
Comments
Your comments regarding Level 3's buying spree seem strangely similiar to your previous post which predicted Global crossings as a potential target for Level 3...I think you are correct with your structural network implications for Level 3 and you are definately correct with assumption of the difference in market cap which is Level 3 $4 billion market cap and $6.5 billion in debt compared to Global crossings fully diluted is $1 billion market cap $500 million debt...
That is an amazing discrepency...so what is the better value? Obviously Level 3 is going after higher margin north american aggregation points as they call them where as Global is more geographical with less margin and more revenue...Do you think these valuations are correct? not number wise but the discrepency beween the two?
XO communications has a value similar to that of Global crossings yet it has very good metro exposure and a good list of business clients so how do they stack up against Level3 and Global crossings in your opinion other than the fact they are not have long haul network?
Posted by: Greg Clancy | June 22, 2006 09:03 PM
It's an interesting change in strategy for L3, if you ask me. Not that long ago, they were concentrating on high-volume and wholesale-type contracts only, cut their product portfolio (certainly in Europe, which is my area of knowledge, they removed all their "low speed" IP access products), and were trying to back away from large numbers of customers.
To some extent, they could be seen as one of the architects of the "bargain basement" pricing we see in on-net buildings.
Who knows, maybe this was their strategy all along? Force their competitors into "fire-sale" pricing in a small number of buildings thus limiting their customer base and their ability (i.e. cash resources) to expand, while L3 buy more infrastructure and are able to touch more customers in the long term.
Or is this just a simple strategy U-turn based on market forces?
Posted by: Mike Hughes | June 27, 2006 06:00 AM
I think you are correct in the strategy Level 3 took in terms of high volume wholesale. However, I believe they took this on as a survival tactic. Their revenues were very small not too long ago as the majority came from the resale of microsoft products or IT. This buying spree has been a remarkable turn in level 3's fortunes...Here is why. Level 3 had a huge short position in their common shares (short-speculators betting the stock would fall who borrow shares). When Level 3 bought Wiltel pricing began to stabalize and the shorts were caught in a short squeeze (they had to buy the shares back to cover their short positions and because of the large number of shorts they drove up the price of Level 3 shares). This was a large reason why they traded at such a premium to to the other networkers ( among other obvious reasons-margins etc). When you trade at a premium in the market anything you buy with decent margins will be accretive to earnings right away. (example-If one company trades for 20 times earnings and it buys a company who trades for ten times earnings they have more earnings power.(this disappears when they do not trade at a premuim so it may not be a long term thing). Moral of the story when you are Level 3 now and you are valued higher than your peers in the market you buy them while you can! As Level 3 is doing...My question is whether Level 3 deserves this premium in comparison to Global crossings and Xo communications for reasons other than I stated above? Obviosly Level 3 has a good network and strong management but is it that good in comparison to it's peers? Europe appears to be ahead of north america in terms of iptv and video phones etc how is the integration of these products going?
Posted by: Greg Clancy | June 28, 2006 03:48 AM