Fitch Upgrades Level 3 Communications' IDR to 'B+'; Outlook Revised to Stable

Mon Jun 2, 2014 11:47am EDT

(The following statement was released by the rating agency) CHICAGO, June 02 (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. (Level 3 Financing) to 'B+' from 'B'. In addition Fitch has upgraded specific issue ratings assigned to LVLT and Level 3 Financing as outlined at the end of this release. The Rating Outlook has been revised to Stable. Approximately $8.4 billion of LVLT's consolidated debt as of March 31, 2014 is affected by Fitch's actions. KEY RATING DRIVERS --LVLT is clearly operating within its 3x to 5x net leverage target. Fitch expects further strengthening of LVLT's credit metrics during the remainder of 2014 as the company benefits from anticipated EBITDA growth, free cash flow (FCF) generation and debt reduction. Fitch foresees LVLT leverage will approach 4.7x by the end of 2014 and under 4x by the end of next year. --The company is poised to generate sustainable levels of FCF (defined as cash flow from operations less capital expenditures and dividends). Fitch anticipates LVLT FCF generation during 2014 will approximate 4% of consolidated revenues, growing to 7.5% of revenues by year-end 2016. --LVLT's revenue mix transformation is proceeding. The company's operating strategies are aimed at shifting its revenue and customer focus to become a predominantly enterprise-focused entity. --The operating leverage inherent within LVLT's business model positions the company to expand both gross and EBITDA margins. The upgrade of LVLT's ratings is supported by the continued strengthening of the company's credit profile since the close of the Global Crossing Limited (GLBC) acquisition, positive operating momentum evidenced by expanding gross and EBITDA margins, and ongoing revenue growth within the company's Core Network Services (CNS) segment and its position to generate meaning FCF. Consolidated leverage as of the LTM period ended March 31, 2014 declined to 4.95x marking an improvement from 5.17x, 5.85x, and 8.1x as of years-ended 2013, 2012, and 2011, respectively. Fitch foresees LVLT leverage will further improve to 4.7x by the end of 2014 and to under 4x by year-end 2015. Fitch believes the company's ability to grow high-margin CNS revenues coupled with the strong operating leverage inherent in its operating profile positions the company to generate consistent levels of FCF. LVLT generated approximately $93 million of FCF during the LTM period ended March 31, 2014. In addition to LVLT's positive operating momentum driving EBITDA growth, additional factors such as interest expense savings derived from capital market activities completed during 2013 ($60 million of annual cash interest savings) and on-going operating cost optimization efforts (including 2013 head-count reductions) position the company to grow FCF during the ratings horizon. Fitch anticipates LVLT FCF generation during 2014 will approximate 4% of consolidated revenues growing to 7.5% of revenues by year-end 2016. Based largely on LVLT's strategy to invest in metropolitan facilities (which extend its on-network footprint and overall network depth) to carry more communications traffic on its network, the company derives strong operating leverage from its cost structure and network, enabling it to enhance margins. Additionally, the company's improving revenue mix can further strengthen its operating leverage and contribute to higher gross and EBITDA margins. LVLT's gross margin increased 170 basis points (bps) on a year-over-year basis during the first quarter of 2014. In addition, EBITDA margin increased 400bps, demonstrating the strong operating leverage inherent in LVLT's operating profile. LVLT's enterprise segment continues to drive overall revenue growth within CNS. LVLT's operating strategies are aimed at shifting its revenue and customer focus to become a predominantly enterprise-focused entity. The process started with the GLBC acquisition. LVLT's network capabilities, in particular its strong metropolitan network, along with a broad product and service portfolio emphasizing IP-based infrastructure and managed services, provide a solid base on which to grow its enterprise segment revenues. Fitch believes that revenue growth prospects within LVLT's CNS segment stand to benefit from the transition among enterprise customers from legacy time division multiplexing (TDM) communications infrastructure to Ethernet or IP VPN infrastructure based in internet protocol. Fitch anticipates that enterprise revenues will account for approximately 69% of CNS revenues by the end of 2015. Enterprise-segment revenues expanded by 10.4% on a year-over-year basis during the first quarter (11.2% on a constant currency basis). Importantly, revenue churn improved 10bps year-over-year during the first quarter to 1.5%. Overall, Fitch's ratings incorporate LVLT's 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. Fitch believes that LVLT's liquidity position is adequate given the rating, and that overall financial flexibility is enhanced with positive FCF generation. The company's liquidity position is primarily supported by cash carried on its balance sheet, which as of March 31, 2014 totaled approximately $607 million, and expected FCF generation. LVLT does not maintain a revolver, which limits its financial flexibility in Fitch's opinion. LVLT does not have any significant maturities scheduled during the remainder of 2014. LVLT's next scheduled maturity is not until 2015 when approximately $475 million of debt is scheduled to mature or convert into equity. RATING SENSITIVITIES What Could Trigger a Positive Rating Action: --Consolidated leverage maintained at 4x or lower; --Consistent generation of positive FCF, with FCF-to-adjusted debt of 5% or greater; --Positive operating momentum characterized by consistent core network services revenue growth and gross margin expansion. What Could Trigger a Negative Rating Action: --Weakening of LVLT's operating profile, as signaled by deteriorating margins and revenue erosion brought on by difficult economic conditions or competitive pressure; --Discretionary management decisions including but not limited to execution of merger and acquisition activity that increases leverage beyond 5.5x in the absence of a credible de-leveraging plan. Fitch upgrades the following with a Stable Outlook: LVLT: --IDR to 'B+' from 'B'; --Senior unsecured notes to 'B/RR5' from 'B-/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 'BB-/RR2'. Contact: Primary Analyst David Peterson Senior Director +1-312-368-3177 Fitch Ratings, 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 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (May 28, 2014). Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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