Text-Fitch raises Level 3 Communications IDR to B

Tue Oct 4, 2011 12:25pm EDT

(The following statement was released by the rating agency.) CHICAGO, October 04 (Fitch) Fitch Ratings has upgraded the Issuer Default Rating (IDR) assigned to Level 3 Communications, Inc. (LVLT) and its wholly owned subsidiary Level 3 Financing, Inc. to 'B' from 'B-'. In addition, Fitch has upgraded the ratings assigned to the various debt securities issued by LVLT and Level 3 Financing by one notch as summarized at the end of this release. Fitch has assigned a 'BB-/RR2' rating to the 8.125% senior unsecured notes due 2019 assumed by Level 3 Financing. Fitch has removed LVLT's ratings from Rating Watch Positive and has assigned a Positive Rating Outlook for all of LVLT's ratings. Approximately $7.2 billion of debt as of June 30, 2011 is affected by Fitch's action. The rating actions follow LVLT's announcement that the company closed on its previously announced agreement to acquire Global Crossing Limited (GLBC) in a tax free, stock for stock transaction. The upgrade of LVLT's ratings recognizes, in part, the de-leveraging of the company's balance sheet resulting from its acquisition of GLBC. Pro forma for the acquisition, LVLT's leverage declines to 6.5 times (x) for the latest 12 month (LTM) period ended June 30, 2011 compared with the company's actual leverage of 8.1x as of June 30, 2011 and 7.5x as of Dec. 31, 2010. Moreover, based on the company's ability to realize anticipated operating cost synergies, the GLBC acquisition positions LVLT to further improve its credit profile and generate consistent levels of free cash flow. The transaction accelerates LVLT's progress in achieving its target leverage ratio of 3.0x to 5.0x. The Positive Rating Outlook reflects Fitch's belief that LVLT's credit profile will strengthen as the company achieves the cost synergies associated with the GLBC acquisition. Fitch anticipates that LVLT's credit protection metrics during 2012 will remain relatively consistent with year end 2011 metrics as integration costs will largely offset positive operating momentum. Fitch expects LVLT's leverage as of year end 2011 (on a pro forma basis) will approximate 6.2x and dip below 6.2x as of year end 2012. Fitch expects to observe the strengthening of LVLT's credit metrics during 2013 as cost synergies begin to take effect. From Fitch's perspective the GLBC acquisition strengthens LVLT's competitive position. In addition to increasing LVLT's scale, the acquisition enhances the breadth and depth of LVLT's service offering and permits the company to expand into new markets. Importantly, the acquisition broadens the spectrum of customers LVLT serves including large multi-national enterprise customers. GLBC's network complements LVLT's existing network and the combined network positions LVLT as a global network operator enabling the company to expand existing customer relationships and capture new customer opportunities. Achievement of expected cost synergies is reasonable from Fitch's viewpoint. LVLT anticipates the transaction will yield annualized cost synergies of approximately $340 million including annualized capital expenditure reduction of $40 million. Over 50% of the expected cost synergies are coming from network expense and capital expense savings. Fitch anticipates that network cost synergies will be realized as GLBC network traffic is migrated to LVLT's network and the company leverages the collective 'on-net' footprint to reduce third-party network access costs. Additional cost synergies will be realized as LVLT rationalizes its combined network and eliminates duplicate circuits. LVLT expects to achieve two-thirds of the run rate cost synergies within 18 months of the closing of the transaction. The cost of synergies is expected to range between $200 million and $225 million, and half of the costs will be spent during the first year following the close of the transaction. Fitch believes LVLT's ability to manage the integration process and limit the disruption to the company's overall operations is key to the success of the transaction. The integration of the networks is primarily focused on long haul assets. LVLT has a successful history of integrating long haul assets with the company's acquisition of Genuity, WilTel and the long haul portion of the Broadwing acquisition. LVLT's liquidity position is adequate given the rating and is primarily supported by cash carried on its balance sheet, which as of June 30, 2011 totaled approximately $584 million. The company does not maintain a revolver and relies on capital market access to replenish cash reserves, which when combined with the lack of positive free cash flow generation limits the company's financial flexibility in Fitch's opinion. However, after considering the effects of the GLBC acquisition, LVLT's cash balance should increase to over $1.1 billion (calculation includes LVLT and GLBC cash as of June 30 as well as net cash generated from financing activities related to the close of the GLBC acquisition) as of June 30, 2011 on a pro forma basis. Fitch believes LVLT's cash position is sufficient to address scheduled maturities during 2012 and 2013 (totaling $566 million) while funding anticipated free cash flow deficits. LVLT's next significant maturity tower is in 2014 when approximately $2.5 billion ($3.2 billion pro forma for the transaction) of debt is scheduled to mature. Positive rating actions will likely occur as the company demonstrates that it is successfully integrating GLBC without material disruption to its operations. Equal consideration will be given to the company's ability to attain cost synergies while maintaining positive operational momentum. Evidence of positive operating momentum includes stable to expanding gross margins and revenue growth within the company Core Network Services segment. Fitch would expect LVLT to be generating consistent positive free cash flow and reduce leverage to 5.5x before taking a positive rating action. A stabilization of the Rating Outlook at the current rating level would coincide with LVLT experiencing difficulty or delay in fully integrating GLBC and achieving anticipated cost synergies. A weakening of LVLT's operating profile, as signaled by deteriorating margins and revenue erosion brought on by difficult economic conditions or competitive pressure will likely lead to negative rating action. Overall, Fitch's ratings incorporate LVLT's highly levered balance sheet, its weaker competitive position and lack of scale relative to larger and better capitalized market participants. The ratings for LVLT reflect the company's strong metropolitan network facilities position relative to alternative carriers, as well as the diversity of its customer base and service offering, and a relatively stable pricing environment for a significant portion of LVLT's service portfolio. Based largely on LVLT's strategy to invest in metropolitan facilities and carry more communications traffic on its network, the company derives strong operating leverage from its cost structure and network, enabling it to enhance margins and rapidly increase cash flows once revenue growth returns. Additionally, Fitch expects that the company can further strengthen its operating leverage as it continues to migrate its revenue mix to more margin rich data services and away from lower margin voice services. Fitch has upgraded the following ratings with a Positive Outlook: LVLT: --IDR to 'B' from 'B-'; --Senior unsecured notes to 'B-/RR5 from 'CCC/RR5'. Level 3 Financing, Inc.: --IDR to 'B' from 'B-'; --Senior secured term loan to 'BB/RR1' from 'BB-/RR1'; --Senior unsecured notes to 'BB-/RR2' from 'B+/RR2'. Fitch has assigned the following ratings with a Positive Outlook: Level 3 Financing, Inc.: --Senior unsecured notes due 2019 'BB-/RR2'. Contact: Primary Analyst David Peterson Senior Director +1-312-368-3177 Fitch, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Bill Densmore Senior Director +1-312-368-3125 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 (New York Ratings team) (email: Harold.Barnett@thomsonreuters.com; Reuters messaging: harold.barnett.thomsonreuters.net; Tel: +1-646-223-4186))

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