Long-rumored as an acquisition target of either Global Crossing or XO Communications, Broadwing today was acquired instead by Level 3 Communications, which will pay $1.393 billion in aggregate stock and cash. The acquisition is expected to help Level 3 grow its enterprise revenues and drive more traffic onto the metropolitan networks it has acquired.

“This is a good deal for Level 3 based on cost savings and synergies alone,” said Level 3 Chief Executive Officer James Crowe, in a morning teleconference. “There is real upside to the deal if we can further lower churn, increase revenue growth and improve margins, and we believe, based on history, that we have the ability to do that, although we have not counted that in the integration planning. Broadwing’s national marketing sales and capabilities to sell to enterprise customers is a valuable addition to Level 3’s business focus. We think we have the integration experience to insure the two companies will come together in a positive way. It is clear that this transaction is financially positive.”

"This is actually good for Global Crossing or XO because with fewer competitors, the fewer options there are for companies that want to bring in three or four companies for competitive bids," he said. "Now, there will only be a few nationwide backbone providers."

Under the terms of the agreement, Level 3 will pay $8.18 of cash plus 1.3411 shares of Level 3 common stock for each share of Broadwing common stock outstanding at closing. In total, Level 3 currently expects to pay approximately $744 million of cash and issue approximately 122 million shares. However, the $350 million in cash Broadwing had at the end of June lowers Level 3’s cash payment to $394 million. And its $150 million in excess cash above debt reduces the total purchase price to $1.243 billion, Level 3 said.

Level 3 has acquired both national fiber backbone companies (Wiltel) and regional service providers more focused on the enterprise (Progress Telecom, Telcove) and this purchase falls into both categories, said Level 3 President and Chief Operating Officer Kevin O’Hara. Level 3’s success in integrating Wiltel ahead of schedule and below projected cost gives the company confidence that it can manage the Broadwing integration quickly as well, he said.

Level 3 also believes it can improve gross margins on the Broadwing traffic, O’Hara said, in part by migrating Broadwing traffic onto Level 3’s metro network.

“We believe that over time the Broadwing customer base would migrate toward those Level 3 gross margins, which are 60% to 65% after integration of metro companies,” he said. “That is roughly double the Broadwing gross margins. This is a tremendous opportunity from an overall financial perspective.”

Level 3 expects Broadwing to have a positive impact on Operating Income Before Depreciation and Amortization (OIBDA) by 2008, said Sunit Patel, chief financial officer of Level 3.

Level 3 expects to spend between $110 million and $130 million over the next two years integrating the two companies, most of which will be spent next year.

After the two companies are integrated (a process Level 3 expects to be complete 18 months after the deal closes), Level 3 expects synergies to yield annual savings of $200 million, about 40% of which will come from eliminating redundancies in the network. In particular, the company expects to shed redundant network paths connecting the same cities. “We’d expect a good number of route miles would be eliminated,” O’Hara said.

Where redunancies in management exist, Crowe said the better person will continue with the combined company. But in terms of sales personnel, O’Hara said the company wasn’t overly concerned with geographic overlap between the two companies. “We like that kind of overlap,” O’Hara said. “We have room for as many good sales people as want to come to work.”

“Broadwing is expected to contribute positive Adjusted OIBDA in 2007, and even though we expect integration efforts to extend into 2008, we expect Broadwing will generate approximately $200 million to $250 million of Consolidated Adjusted OIBDA in 2008."

“Including the benefit of synergies and the cost of integration including capital expenditures, this transaction is free cash flow positive in 2008 and should contribute over $200 million of free cash flow in 2009,” he said. “Total integration costs are expected to be approximately $110 million to $130 million. We expect the transaction to further improve Level 3’s financial position and reduce leverage given its expected positive Adjusted OIBDA contribution and Broadwing’s approximately $150 million of net cash as of June 30, 2006.”

Broadwing also brings with it $180 million in convertible debt, about $20 million of which is related to leases. Level 3 is contemplating how to service that debt. “We don’t have any plans yet,” Patel said. “We certainly have all kinds of options.”

“We have pretty broad access to the capital markets, should we need to do so,” Crowe said. “Right now we feel pretty comfortable that we have the kind of liquidity we need.”

When asked if Level 3, which has made numerous acquisitions in recent years, would take a break from M&A following the Broadwing buy, Crowe said, “If you found some deal that was simply irresistible, by definition you’d have to at least look at it. But our appetite is pretty low, and the hurdle [for potential acquisition targets] is pretty high.”

Level 3 seems to have won a competitive bidding process for Broadwing, said Brian Washburn, analyst with Current Analysis. Crowe admitted as much on the teleconference announcing the sale, although he did not provide any further information. Washburn doesn't think this is bad news for the two companies rumored to be part of that bidding process, however.