CenturyLink-Level 3: A $34B deal that creates a global fiber powerhouse, threatening AT&T, Verizon

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Sean Buckley, FierceTelecom

CenturyLink confirmed its $34 billion purchase of Level 3 Communications this morning, a move that will create arguably the third largest domestic enterprise service player and threaten AT&T and Verizon – two providers that have enjoyed their stance as dominant global enterprise service players for decades.

News of the acquisition comes after a report emerged on Thursday in a WSJ article that the service providers were in the final talks to merge.

By purchasing Level 3, CenturyLink will get access to global providers that have established relationships with multinational companies that have assets in multiple countries. The combination would also far surpass cable’s enterprise ambitions, which have only begun as of late following their initial small- to medium-sized business play.

Now that the deal has been confirmed, a number of questions linger.

CenturyLink will face a large integration project of not only the physical assets, but also people. At the end of the deal, the new company may have to conduct layoffs -- a complex proposition, since CenturyLink has a large unionized workforce.

Brian Washburn, service director of global Business Network and IT services for Current Analysis, told FierceTelecom that while issues could come up, they are not impossible to overcome.

“There may be concerns about the national fiber footprint (CTLK and LVLT -- with XO -- own two of the three major ULH DWDM capable national fiber footprints built in the 1990s,” Washburn said. “We might see some building address divestment, too. But I think these are both surmountable.”

Then, there’s also the question of wireless. Unlike AT&T and Verizon, which have large wireless operations that they bundle with their wireline Ethernet and optical services, neither Level 3 nor CenturyLink have any wireless capabilities.

For all of its potential challenges, CenturyLink’s acquisition will benefit it on three fronts: gaining a deeper set of greater set of fiber assets, offering more services, and advancing its competitive standing.

Deepening fiber, enterprise reach
A key value of the combined companies is the sizeable amount of fiber assets that both bring to the table. Each company has a large roster of long-haul, metro and last mile fiber facilities connected to buildings and major data centers.

CenturyLink, which has been expanding its fiber base to serve FTTH and FTTP services, currently operates 250,000 route miles of fiber in the United States and a 300,000 international transport network. At the local level CenturyLink currently has fiber to over 40,000 buildings. The network is also connected into nearly 300 data centers across 4 continents.

By extending FTTP to satellite offices of larger businesses and to smaller businesses located in multi-dwelling units (MDUs), the service provider can further the reach of its cloud-based and managed services lines.

Likewise, Level 3 also has a sizeable set of fiber assets. Level 3 has 64,000 route metro fiber miles and over 42,000 on-net buildings connected to its fiber network. It also has metro assets reaching more than 500 markets in more than 60 countries.

For CenturyLink, Deutsche Bank suggests that an acquisition of Level 3 could help the telco improve its scale in the enterprise market. Today, business services are 59 percent of the telco’s revenues, while 100 percent of Level 3’s revenues are business and wholesale with 70 percent focused on enterprise customers.

“We estimate total Commercial Telecom (SME/Enterprise) revenues in the US at ~$90bn annually, with CTL currently at ~12% share and LVLT at ~9% (T/VZ control the lion’s share of revenue, at 35%/20% of the market respectively),” Deutsche Bank said in a research report. “This would also help steer CTL further away from the Consumer market, where it is seeing significant share losses to Cable.”

Washburn agrees that the combination of fiber assets means that CenturyLink would be able to serve a broader set of customers in more locations, but the service provider lacks the wireless piece that AT&T and Verizon bring to the table.

“Plenty of attractive synergy in fiber and geographic reach, but CenturyLink remains without its own mobile wireless strategy,” Washburn said. “That's probably the single biggest critique, that more fiber scale doesn't fill the wireless services hole.”

Post seemed unfazed by the mobile piece, telling investors that it already resells wireless services profitably to its business and even residential customers.

“From our standpoint, the primary service we provide mobile backup to our fiber network in the SMB space,” Post said. “We think there will be opportunities to provide the advanced 5G services and we’re talking to them about further partnerships because we’ll have the primary access capability with our fiber and we’ll resell their wireless services.”

Post added that “we don’t see a need at this point to go out and buy a wireless carrier and we’re making money with the resale arrangements we have in place today.”

Competitive business shift
What’s interesting about mergers and acquisitions -- and the idea of a CenturyLink/Level 3 tie up is no different -- is how it impacts a service provider’s competitive standing, a phenomenon that’s been true for CenturyLink and Level 3, but from different perspectives.

Once nothing more than a sleepy POTS provider, CenturyLink has transformed itself into a larger domestic player, advancing itself as the third largest ILEC behind AT&T and Verizon, through acquisitions.

Following a series of acquisitions of other telephone line assets from the former GTE, the three most significant acquisitions came over the past five years: Embarq, Qwest and Savvis. The acquisitions of Qwest and Embarq gave CenturyLink deeper local and national fiber assets, while Savvis gave it a large set of data centers and cloud service capabilities. Now, CenturyLink is in the midst of selling its data center assets.

A similar situation has taken place at Level 3. After struggling to integrate multiple assets -- including WilTel Communications, Broadwing, Looking Glass Networks, Progress Telecom, and Telcove -- the transport provider broke out of its M&A hibernation by acquiring Global Crossing in 2011. Global Crossing gave Level 3 not only enhanced its domestic and global fiber reach, but it also gained further expertise in VPN services.

When Level 3 acquired tw telecom, the service provider immediately deepened its on-net building fiber and local access footprints. It also advanced its standing on Vertical Systems Group’s Leaderboard, surpassing Verizon as the second largest domestic Ethernet provider in terms of port share, trailing only AT&T. Level 3 has been able to maintain that lead over Verizon not only in the United States, but also in the international market.

By the same token, CenturyLink will now advance its own Ethernet provider standing when it completes the acquisition next year. Today, CenturyLink is ranked as the fifth largest Ethernet provider, according to Vertical Systems' most recent U.S. domestic Ethernet Leaderboard.

A similar trend took place in the international market. Level 3 also took over Verizon’s ranking as the fifth largest international global Ethernet provider, which VSG said is the result of Level 3’s aggressive build outs in EMEA and Latin America.

Other targets?

When the CenturyLink deal closes there’s going to be questions around whether CenturyLink will pursue additional deals to further expand its fiber network. Given the amount of integration work it must conduct following the acquisition, the telco is unlikely to pursue any in the near-term.

However, now that most of the larger fiber players have been snapped up, the one target that may remain in its sights is Zayo Group. While smaller than Level 3 and CenturyLink, Zayo has been continually expanding its domestic and international fiber footprint.

“In terms of implications for others, watch ZAYO. ZAYO has more top line growth and margins 15 percentage points above LVLT,” said Jennifer Fritzsche, Senior Analyst for Wells Fargo, in a research note. “If part of this is deal is due to the need for more fiber--there are few assets as deep as ZAYO.”

Besides Zayo, the other interesting scenario is the position this deal will put wireless operators like Sprint and T-Mobile in, as well as Comcast.

Washburn said that “this re-arranging of the board leaves Zayo, Sprint and T-Mobile in some interesting places and prospectively next might be a cable operator move.”

A prior report had suggested that Comcast may have an interest in Level 3, but some analysts said it is unlikely the MSO would conduct a competing bid for the company.     

“While we can see the long term value of an asset like Level 3 for Comcast, we believe the company may want to use its regulatory capital for transactions that are likely more important for its competitive positioning in the last mile,” said Cowen and Company said in a research note.

Since this deal has to clear multiple regulatory and state and local approvals, the actual impact of the deal won't be felt until 2017. However, it’s clear that the merger will create a new fiber-centric business force that will effectively challenge AT&T, Verizon and other global provider’s hold on the global business services market.--Sean