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Why Does CenturyLink Want to Acquire Level 3 Communications?

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Nov. 22 2016, Updated 2:04 p.m. ET

Deal rationale

CenturyLink (CTL) expects to acquire Level 3 Communications (LVLT) in a cash and stock deal valued at $34.0 billion, including the assumption of Level 3’s debt. The deal is expected to close by the end of 3Q17 and is subject to shareholder votes and regulatory approvals. After the deal closes, CenturyLink shareholders will own 51.0% of the combined company.

The deal will create the second-largest domestic communications provider serving global enterprise customers. It will also put together highly complementary businesses and expand the combined companies’ fiber presence.

CenturyLink expects to achieve synergies of $975.0 million within three years of the closing of the merger. These synergies consist of $850.0 million in operating expenditure and $125.0 million in capital expenditure–related synergies.

Level 3 has ~$10.0 billion in net operating losses. The acquisition is expected to lower CenturyLink’s tax burden. The deal is expected to be accretive to FCF (free cash flow) in the first full year after the deal closes and significantly accretive on an annual run-rate basis after that.

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CenturyLink’s revenue over the past few quarters

In the above graph, you can see CenturyLink’s revenue over the past five quarters. A look at its 3Q16 performance shows that CenturyLink failed to impress in the quarter. Its revenues of $4.4 billion fell nearly 4.0% year-over-year, barely meeting the consensus estimate. CenturyLink posted EPS (earnings per share) of $0.56 in 3Q16, a fall from $0.70 a year earlier.

The combined company is likely to be more resilient to competition. While Level 3 boasts one of the world’s largest Internet backbones, CenturyLink has been upgrading its network infrastructure to compete with AT&T (T) and Verizon (VZ). In efforts to bolster its infrastructure, CenturyLink acquired landline assets from Sprint (S) for $6.0 billion.

This deal could be positive for CenturyLink since it will meaningfully improve its competitive position, growth profile, cost structure, and FCF per share.

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