01 Jul Level 3/tw telecom: Deal May Be a Response to Post-Merger Comcast/TWC’s Increased Business Focus

Excerpts from article published June 24, 2012.
Printed with permission from The Capitol Forum

Ostensibly, the Level 3 and tw telecom combination is complementary, combining tw telecom’s robust metro fiber footprint with Level 3’s long-haul, global capabilities. However, in recent years, Level 3 has made a stronger push into metro fiber enterprise and government markets, laying its own fiber at the metro level. DOJ and FCC review of the deal, then, will focus on the extent to which the two firms overlap in providing last mile, metro fiber services.

The combined Level 3/tw telecom would be a very significant nationwide provider of last-mile, metro fiber business services. Vertical Systems Group’s 2013 U.S. Carrier Ethernet LEADERBOARD identifies tw telecom as the third, and Level 3 as the ninth, largest US Ethernet services.

Rick Malone, Principal and co-founder of Vertical Systems Group, views the two firms’ footprints as “extremely complementary” in terms of their geographic reach. ”…the Level 3 metro footprint is robust in some states that tw telecom is not in. So for example, Pennsylvania is huge with Level 3. And tw telecom has very little infrastructure in Pennsylvania. So the synergy of the U.S. footprint is very impressive to me – by and large, it fits together like a puzzle piece. This is a deal that looks like they crafted it ten years ago when they laid out their networks.”

The deal could be a response to Comcast/TWC’s increasing move into business services. Comcast and TWC have traditionally focused their business services offerings on small and medium-sized businesses, smaller than tw telecom and Level 3’s target customers. As tw telecom explains in its 10-K, incumbent (AT&T/Verizon) and competitive (XO Communications, Cogent, Zayo) local exchange carriers are their primary competition, while “[c]able companies compete with us primarily for business customers that are generally smaller than our target market.”

That said, Comcast and TWC are increasingly targeting their business services to larger businesses and enterprises, and much of this growth has occurred recently. “What Comcast did in the past couple years in Ethernet has really been very impressive,” explains Mr. Malone. “Three years ago they didn’t have an Ethernet product, and everybody else was playing in the market for six, seven, eight years. Now they’re in the Leaderboard and moving up.”

And business customers have been the primary driver of revenue for Comcast and TWC in recent years—in 2013, TWC and Comcast’s business services divisions increased revenue year/year 22% and 26% respectively, while Comcast and TWC’s residential segments saw revenue increases of just 1% and 4% respectively.

Although Level 3 and tw telecom do not currently compete aggressively with cable, Level 3 CEO Jeff Storey appeared to raise that prospect on the companies’ post-deal conference call. “We know our primary competitors are very large companies, whether they’re incumbent telcos or cable companies,” he said. “We believe that this combination gives us the scale to effectively compete.” tw telecom CEO Larissa Herda echoed Storey, explaining “[s]cale matters…[i]t helps drive lower costs and our ability to compete with large and growing competitors.”

Mr. Malone likewise does not view Comcast/TWC merger as a near-term driver of the Level 3/tw telecom deal. “Structurally I just don’t think [cable companies] can compete for those customers in the immediate term—they’re not there yet. Now they are moving in that direction, and I’m sure that after this merger closes they’ll have some product announcements,” Malone explains. “If they had the same product sets as Level 3 and tw telecom, I’d think sure, they’d be major competitors because they have massive scale.” Malone describes Comcast and TWC’s recent roll-outs of significant fiber networks as “a big strategic weapon.