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CenturyLink Looks to Raise Its Game a Few Levels

By Jim Pearce on November 4, 2016

Earlier this week I sold Level 3 Communications (LVLT) out of the Personal Finance Growth Portfolio after CenturyLink (CTL) confirmed it has made an offer to buy Level 3.  After adjusting for the cash and stock pieces of the deal, the offer works out to about $66.50 per share, or nearly $20 above LVLT’s stock price just last week.

But, LVLT’s share price only jumped to $56 on the news, and has since drifted lower, which has some investors questioning if this deal will ever happen.

While merger activity is heating up, mergers are fickle things, and sometimes it’s best to take your profits on the announcement, and not wait for the deal to consummate.

The uncertainty surrounding this particular deal is regulators may reject it outright for competitive reasons, or they may impose such onerous conditions that the two companies will decide to call it off. And nobody knows how the next presidential administration will view mergers of this magnitude, which many view as being anti-competitive. Americans have had it with deals that benefit companies but hurt consumers.

And neither company is particularly strong to being with, with one analyst likening this deal to “two drunks trying to hold each other up.” True, both companies have been struggling to keep up with the likes of Verizon and AT&T, each of whom has recently completed a major acquisition of their own. Earlier this year Verizon bought most of Yahoo’s Internet assets, and just last month AT&T made a bid to buy Time Warner.

Playing With the Big Boys

However, unlike those deals, this transaction is not to expand the combined company’s product offerings by owning the content that can be accessed via the Internet access that they already provide. Instead, it is about expanding the size of their network so they can continue to compete against their much larger rivals. In that regard this deal makes sense, as the companies estimate by combining they can add as much as $975 million annually to their combined income statement.

In the current issue of Personal Finance I discuss this recent uptick in large-scale M&A activity as now being the quickest and safest way for giant corporations to continue to increase earnings in the midst of a slow growing economy. In this case the market has become saturated with access to broadband to the point that the companies providing it need to either create new products to sell over it (such as Verizon and AT&T are doing), or find a way to deliver it at a lower cost (which is what CenturyLink and Level 3 intend to accomplish with this merger).

Although the immediate impact of either of those strategies on the combined entities’ bottom lines may be similar, there is a significant long-term difference. While cost-cutting can improve earnings for a while, eventually a company has to find a way to increase revenues profitably to stay competitive.

Whatever cost savings CenturyLink is able to squeeze out of this deal will immediately begin to erode as the cost of delivering wireless access continues to decline over time.

In contrast, the additional revenue generated to Verizon and AT&T from their new content offerings could more than offset declining margins in their wireless businesses. In that regard, CenturyLink is taking the less risky route to near term profitability, since it already has a good idea of how much Internet access it can sell, and at what price. That being the case, the name of the game for CenturyLink, once this deal is consummated, is cashing in as quickly as possible, and then buying some form of content to sell over the combined network.

That means Century Link is about a year behind Verizon and AT&T, since its proposed acquisition of Level 3 is tentatively scheduled to close in the third quarter of next year. By then, Verizon and AT&T should have fully integrated their recent acquisitions, and have bought even more content-rich businesses.

That’s why some people think it is CenturyLink that will soon become the hunted instead of the hunter, being bought out by a huge content provider such as Netflix to compete with the expanded versions of Verizon and AT&T.

And that’s why I think regulators will let this deal go through without too much resistance. If they really wanted to limit consolidation then they never would have allowed AT&T to buy Time Warner in the first place. But they did so that Verizon would have an equal-sized competitor, and now they should let CenturyLink buy Level 3 for the same reason.

 

 

 

 


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