Question from Reader: 2/10/10
February 15, 2010
Dave: Do you think that LVLT (Level 3) will ever prosper due to the growth in the use of fiber. Will ownership of the “pipe” put them in a position to increase prices and gain leverage over customers? Your thoughts would be appreciated. Thanks. Richard
Dear Richard:
Thank you for reading and especially for asking a question.
Level(3) has an interesting history and you do have to give them credit. On the one hand, they are survivalists. On the other hand, for shareholders, it is an entirely different matter. In hindsight, Jim Crowe must have had a crystal ball when they started by loading up with tons of debt, enabling him to anticipate the 2001-2003 Internet meltdown, the ILEC dominance in the Federal Courts v. the Communications Act of 1996 (with whiny CLECs) and our latest banking crisis.
Level(3) is still with us but it is always given a hard time because of its debt. I would guess that if Jim Crowe decided upon the inception of Level 3 to incrementally obtain debt, the company would have gone bankrupt when banks pulled back on the sector in 2001-2003—much like the 1200+ bankruptcies back then. Call Crowe what you want—genius, psychic or mad man, but Level(3) is still in the game while 1200+ others are not.
I am having difficulty writing this response today because I have been laughing so hard that my ribs actually hurt over Google’s big FTTH announcement yesterday. Google is playing politics – calling it an experiment. I discount the announcement altogether and so will anyone who owns fiber optic infrastructure. I’ll elaborate more on this announcement in a future post. But my ribs do hurt so much from laughing that typing is almost painful.
I digress—back to Level(3). Level(3) met God a few years back—fortunately, they met in the marketplace and not prison (unlike many white collar Telecom convicts). Whenever I am asked about finding God, I reply, “I think God is in prison.” In my opinion, once a white collar crook finally has criminal charges filed against him and goes to the Big House, he finds God there. So follows my theory, just like regular criminals, it seems if you can’t find God and a moral compass on your own, you can always find God in prison as so many do. God is definitely in prison.
Pipes—a word that I both like and dislike. When Level(3) found God, they finally understood what I have known for years—all applications will originate and terminate in a metropolitan market with local access along with their associated revenues. Long haul pipes are in vast quantity with plenty of inventory buried in the ground. In all fairness, however, if you are going to build a long haul network, you don’t undergo the expense to put only one pipe in the ground. Many critics of Level(3) don’t understand this fundamental aspect of building any network, and when I hear the illogical point and criticism of installing multiple pipes, I discount the critics. If your favorite broker or analyst provides this logic, I suggest finding a new broker or following a different analyst.
All of the money is made in the local markets by origination and termination of services. With data IP and Ethernet dominating installations, there is an agnostic aspect of what applications run over the local pipes. In addition, customers can’t figure out why a 100 meg connection in a metro market may be priced 3-4x more than the same 100 meg between Washington, DC and Miami. It’s an apples and oranges type of answer. Metropolitan markets are 10x more expensive to build, operate and install than a long haul network. You actually require more fiber to be deployed in a metro setting in order to support stuffed, long haul dumb pipes from long haul networks dumping packets at a carrier hotel for metro distribution or third party interconnection facilities. Think about it—it makes perfect sense.
When Level(3) found God a few years ago, they went on a buying spree of metro assets because they realized they need a local and a deeper presence as opposed to just a co-lo interconnection point. So I characterize the last round of consolidation as a blessing because the larger CLECs such as Level(3), who are still puny compared to the ILECs, bought larger holders of metro assets and removed a lot of junk, bad investments, poorly run companies, and in some cases, inept CEOs.. I think they acquired eight companies and TW Telecom bought one after bottom-feeding for so long that it lost the first eight opportunities. Due to Level(3) and TW Telecom buying up some of the junk, my business (as well as others) improved immensely because the low price champions were removed from the game. Rational behavior relative to staying in business has prevailed in for the most part (although a few occasions you get a nutty CEO that thinks the low, low price/volume play will work).
The integration struggles have been well-documented and disclosed—and were not unexpected to me. The good news is Level(3) found God and is trying to find success by focusing its efforts in metropolitan networks. In fairness on their last call, TW Telecom spoke about the M&A deal they did with Xspedius Communications. Out of 18,000 customers they acquired, they have purposely churned out 14,000. A lesson for Level(3) and all carriers—it is about the quality and loyalty of customers as opposed to the top line growth. And yes, owning the local infrastructure is the key to margin growth. I’d rather grow margins and profitability than acquire marginal customers or unprofitable customers to please some analyst. Level(3) really needs to take this lesson to hear—it’s not about low price but about selling reliability and saying no to business that is not profitable. A stringent credit check is crucial to avoid churn. Finding and retaining salespeople that can say, “No” to bad deals and move on to better opportunities will also help Level(3).
Level(3) has its focus on the right target–metropolitan access—but the junk customers, systems and processes make it hard to clean up.
In my opinion, Level(3) needs to position itself better as a solutions company and not a network company. Customers buy solutions that are reliable! Selling them on the fact you own infrastructure is a confidence-builder but the true consideration is that you deliver on-time, on-budget, reliable service.
Regarding prices, Level(3) doesn’t need to increase them or decrease them—keep prices at the same level as the ILEC and just outperform them on quoting, on-time delivery, speed and reliability. That’s our focus and I’ll give you a few internal AFS data points to illustrate that this formula works:
• On-time delivery success rate to customers over 10 years of 98.5%
• On-budget success rate over 10 years to customers of 98%
• All-all optical customer service affecting failure rate less than 1% over 10 years
• Customers than have never experienced a service affecting outage in 10 years
• Margins continue to grow at double-digit rates annually for 10 years (quality top line by double digit growth annually excluding business we turn away for not meeting our disciplined financial hurdles)
• A churn of 0.7% per month.
How or why does this model work for us? It begins with hiring the right talent, having a culture of customer inclusion and focusing on constant improvement in all areas of the business with an emphasis on efficiency (without going overboard).
If Level(3) tries the same formula, given what they now have (and cleaned up to a certain extent) I think they will be on the road to riches. Simplicity, less layers of management, decision-making tools for those closest to the customer are required.
Did I answer your question? Oh, my painful ribs!!!!
Written by Dave Rusin - Telecom Executive
Posted by wbrache | Filed Under Dave's Corner, Telecommunications industry
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Mr. Rusin:
First of all, I have to agree with your take on Google’s announcement. I look forward to seeing how their grandiose plans work out in the end. I guess when you have LOTS of money and some very smart folks you feel you can re-invent any industry and how business is done.
Regarding your take on L3 and TW’s purchases over the years, I must say that having worked for TW’s first major acquisition (GST Telecom) for years prior to and at the time of merging, I think the $450M that they paid must rate up there with one of the best purchases ever in the industry. Talk about a company going from a completely regional play to national overnight with VERY little overlay of network assets! It’s evident that over the years their strategy of very specific acquisitions has done them very well financially.
L3, on the other hand, is truly amazing to me how they survive and prosper year over year. I wonder how many different ‘networks’ they actually have that are not integrated still today? I guess I wonder when is enough enough. Tough to have a core competency when you go in a million different directions.
Just my thoughts. Thank you for listening.