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Carrier Services
Integration worries aside, Level 3 looks ahead
Concentrates on order provisioning and intelligent traffic management
by Doug Allen
Last week, James Crowe, president and CEO of national fiber provider Level 3, addressed financial reporters and attendees at the Goldman Sachs Communacopia XVII Conference in New York City, providing a State-of-the-Union overview of Level 3 and its overall position in the consolidating telecom market, as well as answering spirited, wide-ranging questions. Crowe struck a calm, thoughtful tone throughout, expressing neither panic about the tough fiscal times ahead for the carrier market, nor unqualified giddiness on Level 3’s recent sales performance, especially when it came to integrating recent acquisitions into the carrier’s business provisioning systems.
Here now are a few choice bits of Crowe-ian wisdom, slightly edited for the sake of clarity and brevity.
On Level 3’s wholesale and enterprise performance from the macro perspective: “We have not seen any slowdown broadly in wholesale demand. As of Q1 and Q2 market demand continues to exceed our ability to meet that demand. That being said, it’s time to be cautious. We’re paying particular attention to the financial vertical in our enterprise segment, and to usage — so far we haven’t seen any changes, but we want to be sure to keep an eye on those segments.”
On dealing with risk due to failing customer credit: “By my count, I think this is the fifth slowdown I’ve been involved in with since the breakup of the Bell System. Each one has it own characteristics. The last one, I don’t think it was a recession, but it sure felt like it in telecom and Internet services. The difference of course is that this is the financial services, the blood supply of the industry, and there’s a difference between a credit crunch and anything I’ve seen so far, so you want to be cautious in anything you say and do. Specifically, we haven’t seen an uptake in any bad debt, we haven’t seen any issues in our own case. Some of that has to do with when we went through the last very difficult slowdown, when the bubble popped, we built quite an extensive credit-checking mechanism throughout the company and that stood us in good stead. We don’t take bad credit…but so far, we’re seeing about the same thing as our larger competitors, Verizon and AT&T; they’re not seeing any direct impact, and neither are we.”
On the declining dollar: “We had 29 percent year over year growth in Europe, so a strengthening dollar is going to have some impact, a weakening dollar the same. But it is the fundamentals that are driving our European business, which is about 10 percent of our revenue, so any financial effects are not going to be material.”
On addressing operational issues that arose from Level 3’s integration efforts after acquiring six carriers over the last few years: “There were at least some silver linings to the operational challenges we caused ourselves last year. Last year, we signed orders in the first nine months of the year significantly above our ability to provision those orders. That caused problems that were well publicized…but as a result of that issue, we really have focused on two main issues. One, to get our operational abilities to where we could install at the levels that we had already shown we could sell. But we also said we wanted to hit sustainable free cash flow as soon as we possibly could, which we originally said would occur sometime by the end of 2008, but I’m happy to say we announced that goal at the end of the last quarter. So point one, we’re generating cash. Point two, we’ve got some $660 million on the balance sheet since last quarter, and that amount will grow. Point three, we’ve got no maturities of any sort until September 2009, when we have $360 million in maturities, and we have the cash to deal with that with our own liquidity, and that next maturity is in March 2010, about $500 million.”
“So the point of all that is we have time, we continue to look at the market and our own needs. Our bias is to act early and deal with the issues on maturities early, and to do in an equity-friendly way. What equity-friendly means, changes with the market. Today I’m not quite sure; as the cost of debt goes up you have to recalibrate…We’ve said our debt to EBITDA ratio goal is three to five times. That still makes sense for a business like ours.”
On lessons learned from its acquisition spree: “We acquired six companies, so last year we were selling, provisioning, billing and providing customer care over various parts of seven provisioning systems, now that was expected, and we should have done a better job of providing overlay software and tools to operate in that environment. When we ran into operational difficulties, we did a number of things. We added resources where we had bottlenecks, we improved the order entry system which was a source of some of the problems — orders were being entered that weren’t clean and clogged the system — and we built additional tools to shield our provisioning force from some of the complexities.”
That is largely done…but we would still consider ourselves constrained in our ability to meet overall market demand. At the same time we were dealing with existing provisional processes and systems, for almost three years we’ve been building a set of common integrated network processes, a common network inventory, what’s in our network, what’s being used for existing services, what’s available…We call that UNITY, and we have been moving to UNITY since about this time last year. We hope and expect that two-thirds of our network services’ new order volume will flow through UNITY by the end of the year, and that we will be effectively done by the end of the first quarter [next year] or early in the second quarter…We believe that set of processes, that common inventory system, is frankly better than anyone else’s in the industry and will be a real competitive weapon for us and improve the customer’s experience…with industry-leading service turn-up times.”
Speaking of integration problems, and which companies were the most problematic to integrate: “I’ll generalize… and say buying a long-haul company — a company that is largely in the business of connecting pops at a city edge over two different city edges and purchasing special access from a Level 3 or an ILEC, when we buy that company historically — Wilted and Genius are examples — we’ve had generally little problems. We moved the revenue over, we decommissioned the overlapping LH facilities, and there is a lot of apex savings. When we purchase companies that have local facilities, the strategic benefits are large and getting larger. We’ve been saying for two years expect price increases for local facilities. Consolidation means fewer and fewer choices, more and more pricing power… We now have more of our wholesale business running over those facilities (such as ICG, Progress Telecom, Looking Glass, a portion of Broad wing), the incremental demand is greater from our LH wholesale than local. Which simply says we’re getting a greater bang for our buck putting our own traffic over metro facilities. But they are also the most difficult to integrate. LH capacity you can allocate it automatically at cross connects. Local facilities you roll trucks, so there’s a lot of workflow, a lot of process. It’s an order of magnitude more difficult to manage and integrate than the LH business.”
On integration goals: “We’ll continue to reduce costs. We’re largely done with integrating physical network platforms… On the operating expense side, we’re dropping opex expense in absolute terms. For capex, we continue to see opportunities to take advantage of excess network capacity, and we saw some of that in the first half, but that will be somewhat at the margins.”
As for future direction, Crowe foresees another shakeout for telcos coming, and is already directing Level 3 to develop and deploy what he sees as the foundation for profitable services in the coming economy. “There’s going to be a shakeout, and it appears that intelligent traffic management will be the secret sauce. Software that does predictive management, geocoding, decides where to cache (video) there’s some intellectual property there. But today’s cutting edge intellectual property is tomorrow’s business as usual. As that happens, what’s going to be important is producing the next incremental level of bandwidth at the lowest incremental cost. That’s the key, and that takes national scope and scale, underlying facilities and technical innovation inside the network. And there’s going to be a very limited number of people who can do that.”
The other piece of the puzzle to complement improved order provisioning is bulking up the sales force. “We ended 2007 with about 390 quota bearing sales people [for the enterprise]. We have another 200 sales engineers who are quota-bearing who work with the salespeople. We’ve said we’re increasing the quota-bearing sale s force by 25 percent. We started that in Q1 as we began to feel better about our operational fixes. The new integrated systems will kick in the second half of the year… One mistake we don’t want to make is watching our expected provisioning intervals, and we target an interval of 45 days. That’s a competitive advantage in our industry. That grew to 70 days at one point. We’re back down to 45 days now. So we’re bringing the factory capacity up, at the same time we’re adding sales people. We want to end up at 490. We announced last quarter that we’re at about 460. It’s a process that will take the balance of the year to play out.”
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