Verizon's XO fiber deal may create opportunities for Level 3 and Zayo, says analyst

Verizon's (NYSE: VZ) newly announced $1.8 billion acquisition of XO Communication's fiber network may be taking out another fiber competitor, but since the telco still uses fiber from other suppliers like Level 3 Communications and Zayo Group there are plenty of opportunities for other players to compete for their business, a Wells Fargo analyst says.

By purchasing XO's fiber network assets, Verizon will gain a set of metro networks in 40 major U.S. markets with over 4,000 on-net buildings and 1.2 million fiber miles. The service provider's intercity network also spans 20,000 route miles connecting 85 cities.

However, XO's network size pales in comparison to Level 3 and Zayo, two providers that have increasingly enhanced their network through a mix of organic initiatives and various acquisitions that bolster their long-haul and metro fiber footprints.

Following its acquisition of Global Crossing in 2011, Level 3 made another bold move to acquire tw telecom, enhancing its long-haul and metro fiber capabilities.

Likewise, Zayo continues to expand its dark fiber networks via a host of targeted acquisitions and network builds, a number of which are driven by customer wins in the wireless backhaul arena for towers and small cells.

The company said during its fiscal second quarter 2016 earnings call that as of the end of December 2015 it had a total of 2,224 small cells on its network. Out of this mix, 596 were operational, while the remaining sites were under contract with major wireless operators. This is up from the 1,200 small cell sites it said it had in November 2015. Perhaps even more telling was that it revealed it would dedicate about $75 million in capital to build out 1,000 new small cell sites.

A key element in the mix will be dark fiber. Verizon has been a strong advocate of using dark fiber for small cell backhaul, a major pillar of the carrier's wireless densification effort.

While buying XO helps Verizon fill in some gaps, questions remain as to whether it will be enough to fill in the gaps it still has outside of its traditional wireline footprint?

Jennifer Fritzsche, managing director of the equity research group at Wells Fargo Securities / Wachovia Securities, said in a research note that even with buying XO, Verizon will still need to purchase metro fiber from other providers -- and Level 3 and Zayo are in a prime position to gain from that effort.  

Through a mix of targeted acquisitions like Latisys and its own buildout efforts that are often dictated by customer wins with large wireless operators, Zayo has invested over $355 million into its dark fiber network.

"VZ will still need metro fiber from both LVLT and ZAYO as it seeks to densify its wireless network with small cells and C-RAN (Centralized radio access network)," Fritzsche said. "XO's assets do not have nearly the depth or breadth of LVLT's or ZAYO's. XO's 33K route mile fiber footprint is still much smaller than LVLT's (207K route miles, including 64K metro miles) and ZAYO's (110K route miles). ZAYO has invested $355MM over the past year in expanding and densifying its dark fiber network and should still be in a strong position to capture future demand for high capacity, metro dark fiber."

One of the other interesting facts about XO's fiber network is that a large portion of it  -- over 16,000 km -- is supplied by Level 3 via a long-term indefeasible rights of use (IRU) lease, parts of which will expire in the next few years.

Given the density of Level 3's metro and long-haul fiber network facilities, Fritzsche said that Level 3 could be in a good position if Verizon decides to expand its fiber lease to accommodate more segments of its wireless and wireline network.

"After speaking to one of our expert fiber contacts, we believe XO's 33K route mile network is not sufficiently large to serve as a nationwide alternative for VZ, which may seek to convert its expiring IRU into a broader-reaching fiber lease to upgrade parts of its network. The network providers with the most expansive backbones -- LVLT in particular -- would be best positioned to capture this new business, in our view," Fritzche said.

Although Level 3 did not aggressively pursue the fiber-to-the-tower (FTTT) market like Zayo, it continues to see strong demand for dark fiber services, reporting in the fourth quarter of 2015 that transport and fiber revenue within its core network services unit was $590 million. Out of that mix, dark fiber made up 6 percent of its CNS revenue.

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