• David Klein

Should Level 3 Communications Investors Run For The Exits?


CenturyLink (CTL) struck a deal to acquire Level 3 Communications on Monday, 10/31/16. LVLT shareholders will receive $26.50/share and 1.4286 shares of CTL stock for each Level 3 share. Why would LVLT make this deal given the potential if they could achieve their revenue growth goals of 1.5 to 2% sequential growth. I think it's obvious (for me) they hit a wall and could not meet these goals going forward. Management must have concluded no to negative growth in 2016 and less than 1% sequential growth going forward, possibly much less. I can't know for sure but this forward view would justify the structure of this deal IMO.

LVLT, IIEX focus stock in July 2013, priced at $20.89 at the time had a good run but they had so much potential with just modest top line growth so on that note it's a major disappointment. So what now? Sell? Hold? The answer depends on what CTL is worth on a proforma basis and the potential for growth going forward.

Below are proforma results starting in 2013 starting with data from the income statement. TTM is through the second quarter.

Both companies are struggling to grow revenue organically and the combined entity will continue to struggle on the top line. Expect revenue to be flat especially since the integration is going to take most of management's attention. Accounting for synergies and the proforma historic EPS, growth should be positive. The NOL's are more important to free cash flow vs GAAP EPS. Actual EPS growth is about 5.8%. What about cash flow?

Free cash flow per share is about the same; 5.8%. The following is a range of fair values for CTL looking at the combined entity based on various growth rates, using a higher EPS and FCF starting point to account for synergies. Fair value is the minimum between the PE analysis or the average of DCF and Graham.

If they can maintain the EPS and FCF growth rates indicated by the proforma results a $25 target seems reasonable which would value LVLT at $62.21. The upper and lower limits yield a high of $65.35 and a low of $56.65 depending on how well you think management can execute the integration.

Should investors run for the exits? I'm not, I've sold a few January 52.5 puts to generate some additional income and if put the stock I expect a good return if my fair value calculations are in the ball park ... of course I could be wrong.

#CTL #LVLT

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