Crucial Test

Level 3's network, credibility on the line in wholesale strategy

The future of Level 3 communications is at stake this year, as its business vision — building a next-generation network to reap high wholesale revenue — undergoes trial by fire.

After spending more than $10 billion, the company is coming under increasing pressure to cut a large deal with at least one "anchor tenant" on its network, with mega-Bell Verizon Communications the most likely choice, observers say.

Jim Crowe, Level 3s CEO, has advised Wall Street that the company will more than double its revenue in 2001, to $2.5 billion, with gross margins of 50 percent, in spite of the gloom and doom surrounding telecom sector spending. If Level 3 fails, its credibility with investors is likely to be shot, the company demoralized and management victimized. In 2000, Level 3 reported revenue of $1.19 billion on a loss of $1.46 billion.

In an interview last week, Crowe was bullish on his companys prospects. "For three years we have been saying that we believed that we were going to see business much more horizontally focused. We didnt think it made a lot of sense for companies to be a lot of things for everybody," Crowe said. "We know that quite a number of the companies who have business services, residential services and wireless services are now thinking of outsourcing some part or all of their network, and thats just evidence that what we have been positioning for for three years is taking place."

The feeling around Level 3s Broomfield, Colo., headquarters is that this is the pivotal year for the company, as it delivers on its core beliefs: a business philosophy that high-margin wholesale sales are possible; faith in achieving competitive advantage through superior technology; and an ability to work with other carriers by convincing them that buying services on Level 3s network is cheaper than maintaining their own network.

"Understand this: This is a critical year for Level 3. This is the year when they really transition from being a construction company into being an operating company," said William Klein, a financial analyst at Wasserstein Perella Securities who has a buy rating on the stock.

Since Level 3 doesnt sell its services directly to businesses, its main focus this year is on signing up carriers as customers. The company promised investors that, with a combination of its provisioning tools and advances in fiber technology, it can earn an unheard-of 50 percent margin selling wholesale data, voice and colocation services.

Now that Level 3 believes it has the technology and network in place to be a networking equivalent of Intel, all it needs to do is to find a partner that would ensure bandwidth sales — its equivalent of Microsoft.

Observers following Level 3s progress believe that it is most likely to try find a premier partner, or an "anchor tenant," among cash-rich regional Bells. Analysts fingers point to Verizon.

"If they are talking to any Bells, it is not likely to be SBC [Communications], since they are using Williams [Communications], and not likely to be Qwest [Communications International]. BellSouth has a potential conflict because of their ownership of Qwest stock. Verizon is clearly the one with a question mark, because they need to get some sort of bandwidth relationship going and Level 3 would be perfect for them," said Vik Grover, a financial analyst at Kaufman Bros.

Crowe didnt deny that the regional Bell option was interesting. "I think there is a big opportunity for any company that wants to focus on their end-user customers — and the [Bells] are in this category — with an opportunity to improve their services and lower their costs by working with companies like Level 3," he said.

Asked about such a possibility, Verizon spokesman Mark Marchand said: "It is not our policy to comment on any deals before they are announced."